Arthrocare Division Feeling Insurers' Heat

The company's DiscoCare unit is drawing increasing scrutiny in connection with a popular back operation.
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OKLAHOMA CITY -- In 2006, government billing records show, Palm Beach Lakes Surgery Center performed hundreds of spine surgeries that are normally suitable for just a small fraction of the population.

Thanks in part to

Arthrocare

(ARTC)

, which supplied the disposable SpineWands used in those surgeries, the surgery center made millions. It caught the attention of insurance companies as well.

Palm Beach Lakes Surgery Center uses Arthrocare SpineWands to perform plasma disc decompression (PDD), a minimally invasive surgery designed to relieve the pain caused by herniated discs. Arthrocare promotes PDD as one of the cheapest and most effective treatments in the spine arena. Although SpineWands lack routine health insurance coverage -- a factor that weighed on their performance for years -- they currently rank as the biggest source of revenue in Arthrocare's booming spine division.

Yet even Arthrocare readily admits that PDD isn't for everyone. Indeed, the company estimates that just 10% to 15% of patients who seek treatment for back pain actually need the operation. It touts a special "treatment algorithm," formulated by its new DiscoCare subsidiary, as an effective safeguard designed to weed out poor surgery candidates and ensure proper patient selection.

Even so, some major car insurance companies suspect that PDD surgeries are being grossly overused. They have grown especially suspicious of cases involving patients referred to surgeons by personal injury attorneys. DiscoCare often supplies the $7,500 SpineWands used for those operations.

Dan Martinez, a law partner at St. Petersburg, Fla.-based Callahan Martinez, says he is contesting "close to 20" PDD cases on behalf of

AllState

(ALL) - Get Report

alone. Martinez expressed grave concerns about those cases involving DiscoCare in particular.

Since DiscoCare first surfaced two years ago, car insurers have fielded skyrocketing claims for PDD surgeries performed on accident victims covered by pending legal settlements. Many times, insurers are being asked to pay doctors tens of thousands of dollars -- more than the listed price for brain surgery -- for a half-hour operation that traditional health insurers regularly refuse to cover at all.

"The last couple of years, car insurance companies have been inundated with big claims," confirmed Richard Adams, a law partner at Miami-based Adams, Adams & Baca. "The real change has been the addition of this new treatment -- which requires a significant amount of billing.

"But the number of people who say they got better? That hasn't changed," Adams says.

Arthrocare's stock has been suffering lately, too. The shares fetched $65 before rumors began surfacing about DiscoCare late last year. The stock, which fell below $35 this spring, now trades in the mid-$40s.

Split Decision

Adams began contesting PDD cases even before DiscoCare emerged as a possible driver of the surgeries. So far, he has represented three different car insurers -- AllState,

AIG

(AIG) - Get Report

and

Progressive

(PGR) - Get Report

-- fighting PDD claims.

In one case, Adams says, a patient who underwent both PDD and fusion surgery sought damages totaling $1.4 million. However, he says, the jury delivered an award for just $10,890 instead. In the other two cases, he adds, the jury awarded no payments at all.

Since then, another insurer has gone on to prevail in a PDD case that clearly involved DiscoCare. Meanwhile, a lawyer for yet another big insurer has revealed plans to challenge every DiscoCare case that comes his way.

Arthrocare could suffer if this pattern continues. Through DiscoCare, a two-year-old billing firm the company purchased in December, Arthrocare essentially supplies surgeons with free SpineWands and then seeks reimbursement for the devices after the operations. Based on comments made by management, about half of all U.S. surgeons who use Arthrocare's SpineWands opt for DiscoCare's services.

In the past, Arthrocare has repeatedly stressed that it relies on DiscoCare for just a small portion of its revenue overall. Going forward, however, Arthrocare has laid out clear plans to use DiscoCare far more -- spreading its reach to other product lines -- now that it actually owns the company.

From the start, Arthrocare has stood firmly behind DiscoCare and scoffed at any notion that the company might be engaged in wrongdoing.

"In our acquisition due diligence (on DiscoCare), we found no evidence that PDD is being used overly aggressively or inappropriately by any of our customers who follow the DiscoCare treatment algorithm," Arthrocare CEO Michael Baker assured back in January. "The only magic in this equation is that the algorithm ensures that only patients that actually need and can benefit from the procedure get treated."

Close to Home

Chances are, however, that Arthrocare would have noticed Palm Beach Lakes Surgery Center -- a key target of PDD-related lawsuits -- during its review, critics say.

Jonathan Cutler, a podiatrist at the surgery center, actually founded DiscoCare. Meanwhile, Jeffrey Kugler -- a busy spine surgeon there -- lent a big hand to Arthrocare itself.

"I wrote their

Arthrocare's protocol, or I revised most of their protocol," Kugler explained in a September 2006 deposition for AllState. "Anyone who wants to do this procedure in the country needs to basically come here and make sure they are doing it appropriately ... We have written the training documentation."

Kugler relies on another of his partners, pain management specialist Jane Bistline, for help. Kugler performs the actual PDD surgeries, with Bistline handling the diagnostic "discograms" that immediately precede the operations.

The two doctors charge plenty for their time. They have yet to receive payment for some of their high-priced surgeries, however, including a PDD operation performed on Mohammed Islam following a routine traffic accident.

With insurance investigators pressing hard for details about DiscoCare, Islam's lawyers recently dropped his case after waiting almost two years for a big settlement.

Apparently, Kugler's office tried to charge more than $1,000 a minute for that surgery. Kugler billed $34,800 for Islam's operation, legal filings show, while Bistline charged another $12,155 for his discogram. The entire procedure took less than half an hour.

Based on a formal 2007 pricing guide, an obstetrician would have to treat a pregnant woman throughout her entire pregnancy -- and then deliver her baby by Caesarean section -- to charge about one-third of the amount that Bistline billed for her discogram alone.

But Islam, a medical doctor who is familiar with discograms, doesn't believe he ever received a discogram at all. In a partial deposition supplied in legal filings, Islam insisted that he would have known whether he had undergone the invasive diagnostic test. Islam denied receiving an incision during the actual surgery as well.

"Contrary to plaintiff's testimony," court papers state, "Dr. Kugler's operative report states that 'a skin incision was made with an 11-blade scalpel.'"

Palm Beach Lakes Surgery Center refused to be interviewed for this story.

Secret Code

In its 2005 reference guide on PDD, Arthrocare specifically identifies 62287 as the proper code for the minimally invasive surgery. It also pegs Medicare reimbursement to physicians performing the operation at less than $600.

However, in 2006 -- the very year that DiscoCare burst onto the scene -- Kugler started using a new code for the surgery. For many cases, state records show, Kugler submitted bills under the 63056 code normally reserved for open back surgeries instead.

Open surgeries, requiring actual incisions, carry much higher reimbursement rates. Kugler's own fees, already considered steep, sometimes doubled -- or even tripled - as a result.

Today, Arthrocare discusses PDD coding in more flexible terms. Baker says that physicians can choose from "half a dozen" different codes when billing for the procedure. Still, he portrays that decision as the physician's alone.

"We don't code for surgeons," Baker declared a January conference call. "And we don't tell them how to code."

Yet sales material obtained by

TheStreet.com

clearly suggests otherwise. Nikki Bryant, a national sales trainer for Arthrocare, specifically highlighted coding in her "key talking points" on PDD surgery.

"I skim over 62287," Bryant's paper states, "and focus on 63056."

Another marketing tool, supplied for Arthrocare's 2007 sales meeting, describes the DiscoCare model -- when applied to personal injury cases -- as a "life-changing win for practices that 'get it.'"

Courtroom Drama

But sometimes those bustling practices face backlash in court.

Early last year, for example, Kugler found himself struggling to justify a PDD surgery he had performed on a 14-year-old girl. In that case, Kugler's own notes proved damaging.

Notably, the court testimony shows, Kugler recorded an absence of symptoms that normally accompany back pain. He also acknowledged that a radiologist found the patient's MRI results "fairly normal." Moreover, despite an algorithm that calls first for conservative care, he admitted that he gave the patient just one epidural shot -- despite the relief that it provided -- before moving forward with surgery.

Ultimately, the testimony indicated, Kugler relied on information supplied in an office "template" that automatically includes the symptoms necessary for surgery instead.

While insurers regularly settled cases involving Kugler in the past, they are paying much closer attention to PDD claims generated by his office these days. Going forward, they feel increasingly confident that they can challenge -- and win -- those cases in court.

More than a year later, car insurance companies continue to seek answers from Kugler and his staff. Last month, for Islam's case, one of them scrambled to subpoena Mark Izydore -- a convicted felon suspected of orchestrating the DiscoCare scheme -- at Kugler's office.

But a formal process server, aided by a private investigator, failed to catch the elusive Izydore in the end. With help from Kugler's staff, court documents claim, Izydore managed to escape the subpoena and flee the scene.

Going forward, insurers hope to question Arthrocare itself. At least one of them has set out to subpoena Arthrocare's CEO and its spine chief already. It is seeking massive information about the DiscoCare model.

Despite that mounting pressure, which some view as the key reason why lawyers dropped Islam's case, Arthrocare's Baker insists that his company has nothing to hide. Still, he stopped short of promising to discuss matters under oath.

"The practical reality is that, when we're not party to a case (and named directly in a lawsuit), we don't have to," Baker explained. "What on earth would we have to say that would be relevant?

"With us," he declared, "what you see is what you get."