Financial Sustainability

Hospitals enjoy greater flexibility in compensating physicians for value-based care

February 19, 2021 12:06 am

New regulations effective January 19, 2021, afford hospitals, providers of certain ancillary services and accountable care organizations (ACOs) they own significantly greater flexibility to compensate physicians for collaboration on value-based care initiatives.

In recent years, the government has acknowledged that restrictions on physician compensation in the federal physician self-referral law (commonly referred to as the Stark Law) have impeded migration to value-based care. (For a discussion of the existing barriers to physician value-based compensation and what constitutes DHS, see the sidebar “Stark Law: barriers to physician value-based compensation,” below.)

The new regulations afford greater flexibility for value-based compensation arrangements, a significant development that has received comparatively little attention given ongoing efforts to combat the COVID-19 pandemic. Affected providers should use this new flexibility in responding to payer demands to better manage utilization and the total cost of care.

New exceptions for value-based physician compensation

In the recent Stark regulations, CMS grants hospitals, physician groups furnishing ancillary services, and other providers of designated healthcare services (DHS) increased flexibility to compensate physicians for their efforts to enhance quality and efficiency.  The arrangements, however, must be structured in accordance with very specific requirements summarized below.

1. The purpose of the service. The compensation paid to the physician, whether cash or in-kind items or services, must be paid for (or result from) a specific action or inaction that is “reasonably designed” to meet a “value-based purpose” recognized by CMS. CMS recognizes the following value-based purposes:

  • Coordinating and managing care
  • Improving the quality of care
  • Reducing the cost (or growth in cost) of care without reducing quality
  • Transitioning from volume-based to value-based delivery and payment mechanisms

2. The patient population. The specified action or inaction must be followed for an identified “target patient population,” which could include patients who:

  • Reside in a specified area
  • Are enrolled in a particular health plan
  • Have a specified clinical condition

3. The entity that pays for the service. The compensation must be provided by a value-based enterprise (VBE) in which the physician participates or by a fellow participant in the VBE.   A VBE is any collaboration of two or more providers who agree to collaborate to fulfill one or more of the value-based purposes recognized by CMS and who participate in at least one of the value-based care activities facilitated by the VBE. The collaborators must:

  • Designate the specific value-based purposes that their VBE will pursue
  • Designate a person or body responsible for financial and operational oversight of the collaboration
  • Maintain written criteria for selecting the target patient population for whom they will collaborate

The VBE can be structured as a distinct legal entity or as merely a contractual arrangement between participants.

4. Compensation structure. The parties must structure the compensation so it neither creates an incentive for physicians to reduce or limit medically necessary items or services for any patient nor is conditioned on the physician referring patients outside the target population or generating other business for the hospital or DHS provider. If the remuneration is conditioned on the physician referring patients within the target population to a particular provider, then the requirement must be memorialized in a writing signed by the parties, and it must specify that the referral mandate will not apply if the patient asks for – or insurer dictates – a different provider or the physician determines an alternative is in the patient’s best interest.   

5. Documentation requirements. The parties must adhere to a set of specified documentation requirements. For starters, they must retain their records addressing payment methodology amount for at least six years and make the documentation available to the government upon request. 

The extent of supplemental documentation requirements depends on the specifics of the underlying arrangement.

In most cases:

  • The arrangement must be memorialized by the parties in a signed writing executed in advance of the compensated activity.
  • The writing must specify the compensated activities, their relation to one or more of the VBE’s value-based purposes, the target patient population, the type of remuneration provided to the physician and the methodology for calculating the remuneration to be provided. 
  • If outcome measures are used to determine compensation, they must be documented in advance of performance, and be objective, measurable, and based on credible medical evidence. 
  • The arrangement must be documented to be commercially reasonable.

The parties are exempt from meeting the foregoing supplemental documentation requirements (but not the record retention requirements) if they instead can document that:

  • The compensation methodology was established in advance of the physician’s compensated activity.
  • The compensated physician is at risk of having to forgo or repay at least 10% of the value of the remuneration under the agreement if the physician fails to achieve objectives related to the value-based purpose of the arrangement.

Theoretically, the parties also will be exempt from meeting the documentation requirement if they can demonstrate that the VBE itself bears full risk for the cost of all patient care items or services covered by the applicable payer for the target population. As a practical matter, however, that is extremely unlikely because CMS interprets the requirement to mean that the VBE must literally bear risk for the entire scope of care covered by the payer (e.g., primary care, acute care, post-acute care, outpatient prescription drugs, behavioral health) and can include no carve outs (e.g., transplant or other high-cost services). 

6. Monitoring. The parties must monitor the activities on which compensation is based not only to ensure they are being performed, but also to revalidate that they are still reasonably expected to further the VBE’s value-based purpose. If monitoring indicates otherwise, the arrangement must be modified or terminated.

The bottom line

The increased flexibility hospitals and other DHS providers have gained for compensating physicians for collaboration in reducing the total cost of care and enhancing quality should serve to accelerate adoption of value-based compensation arrangements between providers. The Stark Law changes will become increasingly important as government payers, commercial payers and employers continue pressing hospitals and other DHS providers to assume greater responsibility for the utilization risk and unit cost of the services they furnish. 

Recognition that unprofitable does not mean noncompliant

The new regulations also offer flexibility on aspects of physician compensation extending well beyond value-based care. For example, CMS explicitly acknowledges that the mere fact a compensation arrangement or other transaction between a health system and a physician is not profitable does not mean it violates the Stark Law.

This is important reassurance. The Stark Law has long mandated that employment, lease and other arrangements between health systems and physicians be commercially reasonable. In the absence of definition for the term, enforcement officials and whistleblowers have contended (with some success) that a compensation arrangement between a health system and physician in which the system loses money cannot be deemed commercially reasonable. 

In the new regulations, CMS explicitly rejects that position, recognizing that — even in the absence of profitability — an arrangement may well be commercially reasonable if it fulfills the health system’s goals related to patient access, caring for the underserved, network adequacy for health plan contracting, regulatory requirements or other factors. This recognition is important given that the lack of commercial reasonableness can, in certain contexts, give rise to significant overpayment and False Claims Act liability by a health system. 

Flexibility regarding use of salary surveys

On a related note, CMS also acknowledges that there are circumstances when a health system might deviate from compensation ranges identified in third-party physician salary surveys yet still be able to demonstrate that the resulting compensation is FMV. 

CMS presents several hypothetical scenarios:

  • A scenario involving the recruitment of a nationally renowned orthopedic surgeon, where CMS acknowledged that it might be appropriate to compensate the physician above locally adjusted compensation benchmarks. 
  • A scenario in which a hospital has two interventional cardiologists but has been unable to recruit a cardiothoracic surgeon who could perform surgery in the event of an emergency in the catheterization lab.
  • A scenario involving recruitment of a family physician to an attractive locale with a low cost of living, where CMS suggests that the fair market value compensation may be well below national compensation benchmarks. 

In short, CMS provides helpful acknowledgement that cost of living, candidate experience, historical recruitment challenges are relevant considerations that might yield FMV compensation at a level deviating from standard benchmark data.

Next steps

As the exigencies of COVID-19 recede and hospitals return to the enduring clinical and financial challenges facing them prior to the pandemic, they cannot afford to overlook the opportunity the new self-referral regulations provide to better align incentives with independent physicians to eliminate unnecessary expense while enhancing quality for key patient populations.

To avail themselves of this opportunity, hospitals should take five steps:

  1. Assess which patient populations cause the greatest outlay in unnecessary medical expenses
  2. Identify the drivers for those expenses
  3. Determine which providers are best positioned to reduce that expense without reducing quality of care
  4. Collaborate with the providers to determine the appropriate interventions
  5. Use the new flexibility to provide targeted compensation for the identified interventions

CMS also has provided hospitals with greater clarity about when it might be permissible to provide compensation at the higher end of compensation benchmarks and what to do if they discover a preexisting financial arrangement for which appropriate documentation is lacking. (See the sidebar, “Options for responding when the parties failed to execute a signed contract,” below.)

Hospitals have good reason to welcome all these developments.

Stark Law: Barriers to physician value-based compensation

The Stark Law precludes a physician from referring Medicare fee-for-service patients to a provider with whom the physician has a financial relationship if the referral is for furnishing any of the following services, called designated healthcare services (DHS): 

  • Hospital inpatient and outpatient services
  • Diagnostic imaging
  • Laboratory services
  • Radiation therapy
  • Home health services
  • Outpatient prescription drugs
  • Durable medical equipment
  • Physical and occupational therapy
  • Speech language pathology

Moreover, a provider that furnishes services pursuant to an impermissible referral is prohibited from billing for the services (even if they are medically necessary). The referral and billing prohibitions do not apply, however, if the financial relationship between the compensated physician and the hospital or other DHS Provider is structured to satisfy one or more of the Law’s exceptions. 

The first generation of value-based care arrangements typically involved payments from health plans or independent practice associations (IPAs) to physicians or physician practices for achievement of quality or shared savings goals. The Stark Law was irrelevant to these arrangements because physicians do not refer Medicare fee-for-service patients (or any other patients) to health plans or IPAs for hospital care or other DHS. Rather, they refer patients to other healthcare providers, who then furnish and bill for the care.  

However, the Stark Law has impeded implementation of the second generation of value-based care arrangements. These newer arrangements stem from efforts of many health plans and IPAs to minimize expense by moving beyond their historical practice of paying providers limited, discrete financial incentives related to quality and efficiency. In many markets, they are demanding that hospitals and other DHS providers assume significant financial risk of both utilization and unit cost inflation for the services.

These DHS providers, however, have a limited ability to unilaterally combat unnecessary utilization and enhance quality. They realize that they must collaborate with physicians who treat their patient base if they are to achieve meaningful efficiency and quality gains, and they must compensate those physicians accordingly for helping in this effort. Yet any such compensation will implicate the Stark Law and, therefore, must be structured in accordance with one of the Law’s permissible compensation exceptions to avoid triggering the Law’s referral and billing prohibition.

Unfortunately, the traditional Stark exceptions include common requirements that make them inapplicable to beneficial value-based compensation arrangements. These requirements include mandates that the compensation:

  • Be for clearly specified services
  • Be at fair market value (FMV) for such services
  • Not be calculated in a manner that takes into account referrals or other business the physician generates for the hospital or other DHS provider

The table below offers examples of impediments to constructive value-based compensation arrangements.

Historical impediments to constructive value-based physician compensation imposed by Stark Law

 Proposed Arrangement

Historical Stark Law Barrier

An orthopedic group offering diagnostic imaging and physical therapy services wants to compensate a local primary care practice if it follows a protocol to wait one week after recommending certain stretches for patients with non-traumatic lower back pain before requesting an orthopedic consult.

  • Is the primary care group performing a “service” by merely delaying a consult request?
  • If so, how does one calculate the fair market (FMV) value for such a “service”?

A hospital wants to compensate a local cardiology group if it meets timeliness standards for post-discharge follow-up with its patients who are experiencing heart failure.

  • How does one calculate the FMV  for such a “service”?

A hospital wants to compensate a local surgical group if a lower-cost, clinically equivalent physician preference item is used in more than x% of relevant surgical procedures.

  • Is the surgical group performing a “service” by using a different item?
  • If so, how does one calculate the FMV for such a “service”?
  • Depending on how it is structured, the payment might take into account the volume or value of referrals or other business generated by the surgical group for the hospital.



Options for responding when the parties failed to execute a signed contract

CMS also clarifies the options available to a health system or other provider of designated healthcare services (DHS) that discovers it has failed to draft or execute a written contract for which the physician has already furnished services or received compensation. Failure to memorialize many types of agreements (e.g., medical directorships, call coverage arrangements, administrative or consulting services, leases) in an appropriate signed writing has long constituted a Stark Law violation, thereby precluding the hospital or other DHS provider from accepting Medicare fee-for-service referrals from the compensated physician (or billing for any such services if furnished pursuant to an impermissible referral). 

In the new Stark regulations, CMS makes clear that if the parties have failed to draft or execute a written agreement, they have several possible potential avenues to remedy the situation and prevent application of the Stark Law referral and billing prohibition. Although it would be imprudent to intentionally rely on any of these options on a prospective basis, they provide a safety valve if the parties discover retrospectively that an arrangement has “slipped through the cracks.” 

First, if the parties can identify written correspondence or course-of-dealings documentation that collectively provides a clear, consistent description of the services required and compensation terms, they might be able to rely on it to satisfy the writing requirement. To do so, however, they need to have a tenable claim under state law that the written or e-mail communication reflects the relevant party’s “signature” to be bound by the described terms. The parties also should collect and summarize the pertinent documentation for ease of review and audit should the government subsequently review the transaction. 

Second, if the parties catch the error within the first 90 days of the arrangement (i.e., within 90 days of the earlier of either the first episode of service or first payment to the physician), they can memorialize and sign the agreement within the 90-day window, and the late writing will be deemed to be effective as of time the arrangement actually commenced. In the case of leases, personal service arrangements and certain other contracts, the parties would be required to maintain written correspondence or course-of-dealings documentation from the first 90 days demonstrating that the terms of the subsequent agreement match the interaction of the parties in the initial period of the arrangement. 

Third, CMS creates a new exception by which a hospital or other DHS provider can protect payments aggregating up to $5,000 per calendar year that are made to a physician for items or services the physician (or his or her employee or locum tenens physician) has provided as part of a commercially reasonable, fair market value arrangement. Such compensation can be paid even in the absence of a written agreement, and the annual $5,000 limitation will be indexed for inflation. This exception should provide a useful option when a hospital or other DHS provider realizes that a physician has been providing periodic call coverage or administrative services, but the required written agreement does not exist, the 90-day window to retroactively memorialize the arrangement has passed and there is a lack of detailed comprehensive ordinary-course documentation collectively reflecting signed business terms. 



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