Put another way, 85 percent of the physicians practicing in California who trained in the Northeast came from just three states. Of the 10.2 percent who trained in the Midwest, 3.3 percent—nearly a third of that total—came from Illinois, while 2.3 percent came from Michigan and 2.1 percent came from Ohio. Those three states account for 75 percent of the physicians practicing in California who trained in the Midwest. l Here again, as a net importer of physicians, California requires external data on recruiting and compensation data—yet that information cannot be gleaned from national survey medians or, more specifically, the western region in a survey.
Impact on Physician Practice Valuation
The key element of valuing a physician practice for purchase/sale is the assumption of reasonable or replacement compensation for the owner(s) of the practice, which needs to exclude from the historic and forecasted compensation the return on equity ownership. The earnings of any physician practice are almost solely related to two factors:
- The rates they receive from insurers in their local market
- The level of cost they incur in delivering those services
Because it is not possible to make that core distinction from a survey median or other percentile, these sources are irrelevant.
Impact on Physician Employment Compensation Valuation
The findings of this analysis point to four categories of physician compensation valuation:
- Recruitment of a physician who has just completed GME
- Recruitment of a physician who is already in practice and must relocate
- Hiring of a physician who already is located in the employing entity’s service area
- Hiring of a physician who already is located in the employing entity’s service area where intangible value is being paid for the physician practice at the same time.
Following are summaries of the key factors within each of these categories that make national surveys, as currently structured, inadequate for providing a sound basis for determining fair market value of physician compensation.
Recruiting a physician who has just completed GME. California, as previously noted, is the largest importer of physicians and confronts a more national market. With 12.1 percent (98,397) of all practicing physicians in the country, 55,842 of whom completed their GME in California, nearly 48,000 had to be imported from elsewhere in the country. Most come from the Northeast (16.78 percent) and Midwest (10.20 percent), as one would expect due to excess supply in those regions, whereas only 6 percent come from the South, and many of those are from Texas. The Northeast states are substantially underrepresented in the MGMA survey, however, with only 13 percent of providers, compared with 22 percent of all practicing physicians and 31 percent of all GME slots. As such, expressing an opinion on fair market compensation requires more than survey information, including contacting physician recruitment firms about the current compensation packages being offered.
Recruitment of a physician already in practice and relocating. The critical difference between this category and that of the physician who has just completed GME is that this type of recruitment occurs very rarely because, as the AAMC data and the findings of the 2008 Health Affairs study demonstrate, physicians tend not to be mobile once they establish their practice. If there were a statistically valid survey sample of what other physicians in a particular specialty are paid when recruited to a new market, it would certainly be relevant to the expression of fair market value. The reason here is obvious: It is the local practice market that determines what a physician needs to be paid to practice there. The relevance of the physician’s existing compensation is primarily in contributing to the new compensation necessary to get him or her to relocate.
Hiring of a physician who already is located in the employing entity’s service area. Using a practice in New York as an example of practice valuation, the relevant recruitment market in New York is the Northeast region and only a handful of states in that region, as described earlier herein. The determination of fair market value for New York, therefore, would be more soundly based on data that reflect the unique dynamics of the Northeast region than on a survey that provides disproportionate data from two Midwestern states.
The use of survey data that is inconsistent with local market conditions has been shown to be a significant risk factor in regulatory actions where the commercial reasonableness of physician practice losses is challenged. In the 2005 case of Drakeford v. Tuomey Healthcare Systems Inc., for example, although expert testimony for the government relied upon MGMA median and 75th percentile compensation to work RVU ratios to claim that physicians were overcompensated, that same expert testimony observed that the recruited physicians testified in deposition they had no intent to relocate. m Clearly, these two positions are incongruous.
Hiring of a physician in the employing entity’s service area in connection with a purchase. Where the practice is being purchased, it is generally accepted that the physician compensation included in the business valuation model must be equivalent to the post-transaction compensation the physician will receive.
The most common defense of physician compensation survey usage for fair market value in the face of strong evidence that they lack statistical validity is that this is an accepted common practice. However, it’s high time that healthcare finance professionals more critically examine this practice. If nothing else, those charged with establishing fair market value should take a deeper dive into the available data and attempt to account for local market practices and conditions.
There are circumstances, to be sure, where a national search may need to be undertaken for a given physician, such as a neurosurgeon who trained in the Northeast and is needed in the South, or for a Department Chief in a teaching hospital anywhere in the country. Although not presented due to space limitations, the research on which this article is based also finds the expected challenges for recruiting physicians to practice in a rural location. That does not mean, however, that every physician should be compensated in the local market where they practice on the basis of survey results that incorrectly are accepted as representative of a homogenous national market for established physicians. Such a homogenous national market simply does not exist.
The routine use of such surveys as the basis for paying physicians already practicing in a given market when they become hospital or health system employees or for the valuation of a medical practice for sale in that local market is indefensible, and would be indefensible even if the surveys represented a statistically valid sample of what physicians earn nationally, given the evidence of regionalization and micro-regionalization of post-GME practice, and the vast differences in insurer payment rates. The latter are a primary indicator of local fair market value, at least for private practice physicians who are willing to work for them and do not relocate.
Physicians are not mobile once established, and that establishment commences at completion of graduate medical education. Employers, physicians, and appraisers need to focus on their local market conditions, including payment rates from health insurers, and disabuse themselves of the notion that existing survey data are an appropriate basis for determining fair market value. This, in turn, will guard against regulatory attacks on the commercial reasonableness of practice losses. Where recruitment from outside the local market area is required, hospitals and health systems should proactively measure any loss likely to be incurred by comparing local market rates per RVU to the expected compensation per RVU and include this in part of their documentation of the need for the physician.
Mark O. Dietrich, CPA/ABV, is an independent CPA practicing in Framingham, Mass., and author/co-author of a number of texts on healthcare valuation.
a. Centers for Medicare & Medicaid Services, “Medicare Program; Physicians' Referrals to Health Care Entities with Which They Have Financial Relationships (Phase II); Interim Final Rule,” Federal Register, March 26, 2004.
b. Association of American Medical Colleges, 2015 State Physician Workforce Data Book , 2015.
c. See, for example, Ricketts, T.C., and Randolph, R., “The Diffusion of Physicians,” Health Affairs, September/October 2008.
d. See, for example, Dietrich, M.O., “Using Work RVUs and ‘Particular Market’ Rates to Establish Fair Market Value Physician Compensation,” Chapter 17, BVR/AHLA Guide to Healthcare Industry Finance and Valuation , 2016; Center for Studying Health System Change, “Wide Variation in Hospital and Physician Payment Rates Evidence of Provider Market Power,” Research Brief No. 16, November 2010; Cordaro, E., and Smith, T., “How Local-Market Payer Rates Impact Physician Compensation: A Study of Midwestern Markets ,” Chapter 43, BVR/AHLA Guide to Valuing Physician Compensation and Healthcare Service Arrangements, 2017.
e. The focus on the Midwest here is intended simply to limit the scope of this discussion. The author has conducted the same in-depth analysis on each region and almost all states.
f. Of the total of 195,290 physicians reported as practicing in the region by AAMC, it was not possible to identify 33,330 of them from the publicly available data.
g. Of AAMC’s reported total of 246,725, only 15,796 could not be identified from the publicly available data.
h. Readers should recognize that the count of active physicians in a state of necessity differs from the count of physicians who completed their GME in a state. New York, for example, “graduates” considerably more residents than it has active physicians.
i. Polsky, D., Kletke, P.R., Wozniak, G.D., and Escarce, J.J., “Initial Practice Locations of International Medical Graduates,” Health Services Research, August 2002.
j. Of AAMC’s reported total of 172,926, only 28,189 could not be identified from the publicly available data.
k. MGMA states have been re-grouped by the regions used in this study.
l. It is likely that additional analysis would find that some physicians who have left a state after having received their GME there have moved to the state where they grew up or completed their UME.
m. United States ex rel. Drakeford v. Tuomey Healthcare Systems, Inc., No. 3:05-cv-02858 (D. S.C. 2010), ECF No. 358-3.