FMV of Physician Compensation: the Devil is in the Details

Hospitals are investing more in creating outpatient service departments to meet rising patient demand while simultaneously reducing inpatient surgical procedures and generating new sources of revenue. In many cases, the creation of these departments involves the acquisition of private physician practices’ ancillary service lines. Often, the hospital enters into an employment arrangement with the physicians of the once physician-owned private medical practice.

As discussed in a previous post, Practice "Bifurcation" Can be Risky Business, the Stark law is implicated in these post-acquisition employment arrangements because physician compensation is required to be consistent with fair market value.

Furthermore, the federal anti-kickback statute is also implicated because of the referral relationship between the newly employed physician and the hospital/employer. To mitigate compliance risk and document the determination of FMV physician compensation, most hospital internal processes and some third-party independent appraisers rely primarily on published survey data to assess the relative value of the physician’s service. Widely available physician compensation surveys assist with benchmarking and evaluating compensation and provide a look at physician compensation and production in an array of metrics.
However, these surveys are not without their weaknesses, and simple reliance on compensation and production survey data to create a FMV compensation model is often not enough to derive FMV physician compensation.

One of the issues with physician compensation data, as reported in some of the market surveys, is that this self-reported information includes some portion of ancillary technical component profits. Consider, for example, a physician group practice that internally distributes profits from in-office ancillary services, such as imaging or clinical lab services, versus a hospital-controlled group that retains the billings and profits from the same services. In this example, physicians from the group practice would report higher compensation due to the "baked in" ancillary profit, while physicians employed by the hospital-controlled group would report lower compensation.  However, the market surveys simply average the responses together regardless of the clear differences in the organization of the practices which in effect creates a challenge for administrators relying on market data to determine compensation levels where no ancillary technical component profits are present, such as in direct hospital employment of physicians. The market data does not self-adjust for this obvious discrepancy, nor does it provide information to help assess TC-free adjusted rates.  The market, however, gravitates toward unadjusted survey numbers, as the hypothetical physician considering employment amongst other available alternatives, would generally not be expected to accept employment at adjusted, TC-free rates.

Prudent practice indicates the use of multiple valuation approaches and methods in determining FMV physician compensation, a practice that is advantageous when considering the shortcomings pointed out by many thought leaders regarding the use of market data only.

In one such approach, the income approach, the valuator analyzes the historical and expected financial statements. Adjustments to account for non-professional services—such as ancillary income which is now retained by the hospital-employer outside the practice’s operations—are applied to reflect the true operation of the physician’s practice. Adjustments to arrive at the applicable basis of accounting, as well as normalizing adjustments to account for non-recurring or extraordinary items, are also applied to yield net professional economic earnings, which is the income the physician is able to generate from professional services and what is used as the basis of compensation. A significant by-product in the application of the income approach is in recognizing specific economic dynamics present within the practice and local market, including rates paid by payers specific to the local practice.

The application of multiple approaches culminates in the synthesis and reconciliation process, at which point all methods are assessed as more or less reliable based on such factors as reliability of data and pertinence to the subject arrangement.

A position taken solely in reliance on surveys can be weakened by nature of the data. A deeper dive to understand the survey data, coupled with the use of other approaches and methods, can help mitigate the risk of miscalculating FMV compensation. The income approach in particular adds additional credibility to the analysis when executed correctly. Experienced valuators can play a vital role by assisting hospitals in navigating the complex FMV physician compensation process.

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