Kim Mobley and Claire Turcotte
Healthcare financial executives need to understand valuation methodology to ensure legal and regulatory compliance.
At a Glance
When developing and reviewing their physician compensation programs, healthcare organizations should:
- Understand the market data
- Test outcomes of incentive plans for fair market value
- Check total compensation for fair market value and reasonableness
Structuring competitive physician compensation arrangements can be a challenge for healthcare organizations trying to balance complex regulatory requirements against strategic business decisions, physician satisfaction concerns, and a highly competitive physician labor market. Many healthcare organizations are employing greater numbers of physicians to achieve physician alignment and vertical integration. These organizations are increasingly faced with developing novel and more sophisticated physician compensation programs that will attract and retain physicians, often including productivity-based incentive compensation or rewards for high-quality outcomes. As healthcare organizations develop and review their physician compensation programs, they should keep in mind the legal and regulatory framework that governs hospital payments to physicians as well as valuation concerns.
The federal Stark law, antikickback law, and for federal tax-exempt organizations, IRS requirements should be understood and followed to ensure that compensation models are legal to avoid compliance problems down the road. These laws generally require healthcare organizations to pay physicians an amount that is fair market value (FMV) and reasonable for their services. One way to make sure that your organization is compliant from a regulatory perspective is to understand market benchmark data and the valuation methodologies commonly used to calculate FMV for physician services.
Understand the Market Data
Organizations need to make sure they thoroughly analyze the market data they are using as a benchmark to establish their physician compensation levels. Although this analysis may sound simple, organizations need to understand what the benchmark data reflect.
A number of high-quality, commercially available, and proprietary physician compensation surveys conducted by independent organizations contain the information needed to benchmark physician compensation. Some surveys, such as the Medical Group Management Association's Physician Compensation and Production Survey, are largely based on private medical groups, and the cash compensation levels reported include base salaries, incentive compensation, on-call pay, compensation for ancillary services, compensation for midlevel provider work effort, and shareholder profits. Other surveys reflect compensation data for not-for-profit medical groups and hospital-employed physicians; these surveys focus on compensation for personally provided services only and exclude compensation for ancillary services and shareholder profits. Additionally, there are varying physician roles such as teaching, research, and administrative services that reflect a different segment of the physician labor market.
The key issue is to identify the organization's target labor markets, usually including the markets from which physicians are recruited to the organization and those to which the organization loses physicians. Today, the labor market for clinical physicians typically includes a range of labor markets that reflect private practices, medical group employees, and hospital-employed physicians.
Historically, physicians in private practice earned more than the total cash compensation levels paid to hospital-employed physicians, but that gap is closing. In addition, the productivity levels of private practice physicians are higher. One mistake hospitals often make is to benchmark their physician compensation levels to the private practice market only, which includes compensation elements that cannot be directly paid to physicians in the not-for-profit setting.
Many organizations today have adopted a strategy of using multiple survey sources so compensation is benchmarked against a broader physician labor market and not tied to just one aspect of the market. Use of multiple survey sources helps to balance unusual swings that may occur within a survey from year to year. This strategy is also helpful when reviewing physician compensation levels for reasonableness and FMV, which is discussed below.
The Stark law (42 USC 1395nn; 42 CFR 411.351) requires a hospital or other entity billing Medicare for certain services (called "designated health services") to pay its employed physicians total compensation that is FMV for the physicians' services. The Stark law defines fair market value as the general market value, or "the compensation that would be included in a service agreement as the result of bona fide bargaining between well-informed parties to the agreement … based on bona fide comparable service agreements, where the compensation has not taken into account the volume or value of anticipated or actual referrals." Organizations compensating physicians for services also need to be aware that the Stark law is a zero tolerance law, meaning that the government views even seemingly minor deviation from Stark requirements as violations. Violations can result in severe penalties, including repaying of the organization's Medicare reimbursement for services referred by the physician.
Federally tax-exempt organizations also need to keep in mind that IRS rules prohibit using charitable assets to benefit private persons, such as physicians. These rules require tax-exempt entities to pay FMV compensation to employed physicians. Generally, IRS standards require the total physician compensation package for actual physician services rendered to be reasonable for the geographic market and physician specialty. By "total compensation," the IRS means base salary, bonus, fringe benefits, deferred compensation, and any other form of compensation. The IRS standard also suggests that employers benchmark physician compensation appropriately using comparable information reflecting the specific services the physician will perform, the comparable elements of compensation, and the geographic market.
Another federal fraud and abuse law, the federal antikickback law-42 USC 1320a-7b(b)-also applies to a hospital or other organization's compensation of physicians if the physician is providing services billed to government payers, such as Medicare, Medicaid, or Tri-Care. In the context of bona fide employment of physicians, the antikickback law is more flexible than the Stark law and permits payment of any amount to the physician for services without limiting the amount to FMV. However, other physician payment arrangements, such as payments to independent contractors, requires payment
To meet the Stark definition of FMV means identifying the appropriate comparable data that reflect the nature of services for which the organization is compensating an employed physician. As indicated above, the compensation in the private practice market typically includes additional payments for a physician's professional services, such as compensation derived from the practice's ancillary services, shareholder profits, midlevel provider services, and other sources. Typically, hospitals and other organizations employing physicians do not compensate physicians for these elements.
For example, shareholder profits simply do not exist when a hospital or affiliated entity employs physicians because the physicians are not owners entitled to profit distributions. Similarly, if midlevel providers are involved with the practice of employed physicians, they are generally also hospital employees and any collections for their services would accrue to the hospital and not to the employed physicians. Likewise, most hospitals employing physicians do not include ancillary services, such as laboratory and diagnostic services, as part of the employed physician practice operations, opting instead to have these services performed and billed to third-party payers as hospital outpatient services. For that reason, the employed physician practice operations have no revenue stream from ancillary services referred by employed physicians that can be paid to employed physicians.a
Although none of the statutes state what is FMV, the Centers for Medicare & Medicaid Services states that "reference to multiple, objective, independently published salary surveys remains a prudent practice for evaluating fair market value."
Test Outcomes of Incentive Plans for FMV
An organization's physician incentive compensation approach should be carefully designed and tested to make sure it produces the intended results. Today most organizations use some form of productivity-based incentive compensation for their physicians. There is no single productivity incentive compensation approach. Instead, incentive plans and the methodology used to compensate physicians range from having all of the physician's compensation "at risk"-which means the physician receives no guaranteed base salary and is paid on a pure productivity model-to an approach that provides a salary with no incentive compensation at all. Most organizations fall somewhere in the middle of this spectrum.
The productivity incentives used today are typically based on work relative value units (wRVUs) or collections for personally provided services. Organizations should consider several key issues when developing a productivity-based incentive compensation approach. First, productivity incentives should be based on productivity benchmarks for the physician specialty. Second, the market position of the base salary should be relatively consistent with the incentive threshold. The incentive rate paid should also be appropriate and balanced properly with the base salary and the incentive threshold.
Two key productivity metrics need to be considered when developing an incentive compensation approach: the productivity threshold and the ratio of total cash compensation to productivity. The threshold is the point at which the physician starts to receive the incentive. For example, the physician might be paid $40 per wRVU for all wRVUs over 4,000. For a physician on a pure productivity model, there is no threshold. The productivity threshold and the rate paid per wRVU should also be based on the physician's specialty area.
In designing the physician compensation plan, organizations often overlook the importance of establishing the appropriate productivity incentive threshold. The threshold should be consistent with the market position of the base salary. The top exhibit is an example of a threshold that is set too low. The bottom exhibit shows what happens when the incentive threshold is set too high.
In the top exhibit, the wRVU threshold is set at the 30th percentile of the market, while the base salary and the rate paid per wRVU are set at the market median (50th percentile). Even though the rate paid per wRVU is reasonable (50th percentile), the incentive payments will be paid for productivity levels that are lower than the base salary. As a result, total cash compensation is at the 81st market percentile, while productivity is at the 73rd percentile. Thus, the productivity is not aligned with the total cash compensation in this instance. Furthermore, the rate paid per wRVU is at the 69th percentile of the market, which arguably falls outside the bounds of FMV.
In the bottom exhibit, the wRVU threshold is set at the 59th percentile of the market, while the base salary is at the 50th percentile. Therefore, the resulting total cash compensation (TCC) will be low relative to productivity. In this instance, the productivity is at the 73rd percentile and the TCC is at the 63rd percentile. In this instance, the TCC is lower than productivity and may result in recruitment and retention issues.
Another key issue is to properly balance the rate paid per wRVU so that it is not too high or too low. Physicians often make the case that if their productivity is at the 75th percentile of the market, their rate per wRVU should also be set at the 75th percentile. However, rates per wRVU that are set at the 75th percentile of the market will produce TCC levels that are too high relative to the physician's productivity level. This may sound counter-intuitive, but it occurs because the rate paid per wRVU for high-producing and highly paid physicians tends to go down as their pay goes up.
The exhibit illustrates how the rate paid per wRVU for the higher-paid physicians is lower than for the lower-paid physicians. Lower-paid physicians tend to be newer physicians and/or physicians with lower levels of productivity; however, there is typically a minimum amount of compensation that a physician will accept, and this amount varies by specialty. Therefore, the rates per unit of productivity paid to lower-producing physicians tend to be higher than the similar rates paid to their high-producing counterparts.
From a compliance perspective, it is critical that physicians with upper-end compensation-typically the 75th percentile or higher-have compensation levels that are supported by their productivity levels. The exhibit at left illustrates the effect of paying rates per wRVU, or a ratio of TCC to collections, that are too high.
If the physician had wRVUs at the 75th percentile (11,556) and was paid at a rate per wRVU of $66.72 (a 75th percentile rate), the total cash compensation would approximate the 89th percentile. Therefore, the TCC paid would not be supported by the physician's productivity (89th percentile TCC for 75th percentile productivity). However, paying a rate per wRVU that approximates the 50th percentile of the market would result in TCC that approximates the 76th percentile of the market for 75th percentile productivity. In this instance, the TCC is supported by the wRVU productivity (76th percentile TCC for 75th percentile productivity) and as a result falls within the range of FMV.
Check Total Compensation for FMV and Reasonableness
Physicians are often paid for services beyond their clinical work effort, such as medical director or other administrative work, call coverage, and the like. They may also receive additional compensation such as a quality bonus, sign-on bonus, and/or retention bonus, all of which need to be factored into FMV. The total value of all of these compensation elements can have a significant impact on the reasonableness of the overall compensation arrangement, even if each element on its own appears to be reasonable and within FMV. The exhibit illustrates a compensation arrangement that has several compensation elements.
The following key issues are important to address in reviewing this arrangement.
Does the clinical productivity support the clinical cash compensation? In this instance, the answer is yes, because the wRVU productivity is at the 66th percentile, while clinical cash compensation is at the 62nd percentile, and the ratio of clinical cash compensation to productivity (i.e., the rate paid per wRVU) is at the 46th percentile. Overall, the clinical cash compensation percentile is slightly less than the wRVU productivity percentile. The percentile paid per wRVU also falls below a market median, all suggesting that clinical total cash compensation is not excessive.
Is compensation for medical director duties reasonable based on the physician's specialty and work effort? The answer is yes because the medical director duties require a 0.2 FTE. In terms of reasonableness relative to the specialist's area, the compensation falls below the 60th percentile of the market. In many organizations, compensation below the 75th percentile of the market is considered reasonable; however, some organizations require additional documentation for compensation paid to medical directors that exceeds the 50th percentile of market benchmark norms.
Are the benefit costs reasonable for the physician's specialty and role? In this instance, the costs are at the upper end of the market (72nd percentile). The market benchmarks for benefit costs typically include health and welfare insurance, life and disability insurance, organizational payroll taxes, retirement plan contributions, and in some instances, continuing medical education expenses. They do not include the value of paid time off or malpractice insurance.
Is the on-call pay approximating the 73rd percentile of the market considered within the bounds of FMV? The answer would depend on whether the physician is receiving wRVUs toward the incentive plan when called in to provide services. If so, that could result in "double payment" for services, and the total amount paid for call coverage could result in this arrangement falling outside the bounds of FMV. Therefore, the on-call pay for this arrangement should be reviewed.
Another consideration is that the total compensation paid for the services outlined in exhibit above approximates the 77th percentile of the market, even though the key elements of the arrangement all fall below the 75th percentile. This is because the sign-on bonus must also be included in the calculation of the total compensation.
In addition to reflecting FMV, the compensation arrangement should be commercially reasonable. This is particularly important for physicians providing administrative services. One key factor to consider when compensating physicians for administrative services is whether the position serves a legitimate business purpose. The time spent on administrative duties cannot overlap with other work, such as clinical work or call coverage. Time records need to be kept for administrative duties, and work product and results achieved should be documented.
Physician compensation arrangements are unlike other types of compensation arrangements. Not only do they need to meet the tests of complex laws and regulations, but also the types of payments can include such variables as base salary, productivity incentives, quality bonuses, administrative pay, on-call pay, and pay for services when called in, all of which should be carefully evaluated from both a legal and a valuation perspective. When developing a physician compensation plan, organizations should involve those who understand physician compensation benchmarking methodologies, compensation plan design strategies, the financial impact of the plans, and the compliance and regulatory challenges.
As part of compliance, organizations should also develop governance policies and procedures to ensure that the physician compensation plan and the compensation levels paid comply with regulatory standards. For example, organizations should develop a policy and process for review of physician compensation that is consistently applied to all new physician compensation arrangements. This may include developing model contracts, with pre-approved salary ranges, productivity thresholds, and incentives. Arrangements falling outside these pre-approved parameters would require special review and approval, such as by the organization's board of directors or a compensation committee established by the board. Many organizations now also require that FMV opinions be obtained for any physician compensation arrangement that deviates from pre-approved norms (e.g., employment where TCC for clinical services exceeds the 75th percentile of the market).
Finally, it is increasingly important to demonstrate to government authorities that organizations are tracking and monitoring physician contracts after they are signed going forward throughout the term to ensure that physicians are actually performing the services reflected in the contract and that contracts and compensation are modified if the nature or amount of services, or the FMV of services, changes over time. Meeting all of these compliance standards will become even more complex as the market for physician pay evolves to reflect more emphasis on meeting quality initiatives and other new approaches to physician compensation.
Kim Mobley is a principal, Sullivan, Cotter and Associates, Inc., Detroit (email@example.com).
Claire Turcotte, Esq., is a partner, Bricker & Eckler LLP, West Chester, Ohio, and a member of HFMA's Southwestern Ohio Chapter (firstname.lastname@example.org).
a. Some hospitals or organizations may in fact choose to employ physicians through a separate legal entity and to qualify that entity as a "group practice" meeting Stark law requirements, and to provide ancillary services ordered by employed physicians through that entity using the Stark law "in-office ancillary services" exception (42 CFR 411.355). In that case, if all Stark law requirements are met, it is permissible for the physician entity to pay its physicians a share of ancillary services collections, and overall profits, subject to certain limitations on compensating physicians for their ancillary service referrals. A complete discussion of these detailed Stark law requirements is beyond the scope of this article, but should be reviewed carefully by any organization considering this option.
Publication Date: Wednesday, December 01, 2010