Valuation of Compensation for Physician Services

Clinical Services (Part I of IV)

In the March/April 2017 issue of The Value Examiner, the authors gave a detailed description of how clinical services for physicians can be calculated. QuickRead is pleased to present an overview of this series, which will be presented in four parts. Please look for the more detailed analysis in The Value Examiner.

[su_pullquote align=”right”]Resources:

The Value Examiner

Trending Matters in Business Valuation and Healthcare Valuation

Valuing Physician and Executive Compensation Agreements: Fair Market Value and Commercial Reasonableness

Advanced FMV Compensation Issues Under the Stark Group Practice Definition

Understanding Physician Compensation Models and a Look at Current Trends

Emerging Issues in Physician Compensation: Metrics, Competition, Intangible Assets, Other Non-Clinical Measures, and Their Effect on FMV

[/su_pullquote]

In the March/April 2017 issue of The Value Examiner, the authors give a detailed description of how clinical services for physicians can be calculated.  QuickRead is pleased to present an overview of this series, which will be presented in four parts.  Please look for the more detailed analysis in The Value Examiner.

Physician services may be divided into two general categories, i.e., clinical related and nonclinical related, with nonclinical-related activities further divided into three generalized subcategories: administrative, management, and/or executive.  These categories may be defined by the specific tasks, duties, responsibilities, and accountabilities (TDRAs) involved in each.[1]  The challenge for valuation professionals is identifying and separating the various TDRAs for clinical services from those to be provided for administrative, management, and/or executive functions, in order to ensure that compensation for each service complies with the legal requirements of the Stark Law, the Anti-Kickback Statute, and, for non-profit entities, excess benefit/inurement of benefit regulations promulgated by the Internal Revenue Service (IRS).[2]

Before beginning a valuation analysis of compensation for physician services, it is important to understand the economic principles that support the entire valuation endeavor.  The dynamics of how economic value is created may be understood within the context of four basic principles related to the economic benefits to be derived from the right to control the subject services to be performed under the contractual arrangement.[3]  First, the Principle of Scarcity “influences market participants to assign relative value to goods and services in order to choose between the limited amounts available.”[4]  Scarcity of goods and services leads to the concept that economic value derives from economic usefulness, also termed utility, which arises from the benefits and/or satisfaction to be derived from the use or ownership of goods and services.[5]  Second, the Principle of Substitution asserts, “what normally sets the limit of what would be paid for property is the cost of an equally desirable substitute or one of equal utility.”[6]  This principle is the basis for the decision as to whether to “buy or build” a product or service.[7]  Third, the Principle of Diminishing Marginal Utility asserts, “…the additional benefit which a person derives from a given increase of his stock of a thing, diminishes with every increase in the stock that he already has.”[8]  Fourth, and perhaps most important, the Principle of Anticipation asserts:

“The economic benefits of ownership of, or the contractual rights to control, the subject services to be performed under the contractual agreement are created from the expectation of those benefits or rights to be derived in the future; therefore, all economic value is forward looking.”[9] [Emphasis Added]

Consequently, the economic value analysis for determining fair market value (FMV) should be focused on the economic benefits reasonably expected to be derived from the use or utility of the services in the future, bounded by the cost of an equally desirable substitute, or one of equal utility, for each of the elements of economic benefit (or utility) to be derived from the right to control the services to be performed.[10]

There are several steps necessary to develop the valuation of physician clinical services.  First, the valuation analyst must obtain the appropriate documents related to the proposed compensation arrangements(s).  Next, to develop the valuation opinion, this data must be identified and classified according to tasks and duties, along with the level of responsibility and accountability, associated with the subject agreement for services.[11]

The various types of compensation plans for clinical-related services may include, but are not limited to, combinations of the following elements:[12]

• Base salary (i.e., equal compensation paid to each physician)
• Productivity-based compensation (e.g., cap compensation and a given productivity percentile by specialty)
• Compensation based on a per wRVU method
• Incentive bonus based on productivity[13]
• An annual stipend for the performance of administrative services e.g., medical directorships, departmental management, and oversight (which services will be discussed in parts II and IV of this series)
• Incentive payments based on achieving quality of patient and beneficial outcomes gauged by agreed-upon measures and benchmarks
• Incentive payments based on specified legally permissible gainsharing arrangements (e.g., achieving certain cost savings and efficiencies)
• Incentive payments based on the contributions and economic input of the employed physician(s) to achieve specified enhancement of the performance of the enterprise (e.g., the development of a “Center of Excellence.”[14]

In developing a FMV analysis regarding physician clinical services, the value of services rendered should consider the four provider-specific drivers of clinical productivity: 1) time; 2) efficiency; 3) volume; and 4) quality performance, either in comparison to internal sources or outside industry normative data.[15]  First, the amount of time a provider dedicates to clinical activity will work to establish the bounds of that provider’s volume of clinical productivity.[16]  In accordance with the Principle of Substitution, the provider has a finite limitation on both the number of hours and the volume of clinical-related services per hour that they can provide.[17]  Second, variances in the level of provider efficiency typically account for differences in total volume once adjustments for the incongruity introduced by nonclinical time worked, as well as for the variability introduced by fewer hours worked by part-time providers, have been accounted for.[18]  Third, volume, i.e., the amount of clinical productivity possible, may be limited by the time spent on nonclinical activities, in a manner similar to that of time and efficiency.[19]  Therefore, the extent to which the potential volume of clinical production is limited should be taken into consideration when calculating productivity.[20]   Fourth, quality metrics are playing an increasingly important role in measuring a provider’s performance for purposes of determining FMV compensation.[21]

Another component of a compensation plan that should be considered by a valuation analyst when assessing the FMV of the total compensation to be paid for a set of physician services is the amount of fringe benefits included within the total compensation arrangement.[22]  As set forth in the definitions of the Stark Law, any remuneration, whether in cash or in kind, is considered to be compensation for the purpose of determining FMV and commercial reasonableness.[23]

After an assessment of the four value drivers of clinical productivity, the proposed compensation arrangement should be compared to applicable, normative benchmark industry sources reflecting similar TDRAs, to determine whether the compensation arrangement meets the regulatory thresholds of FMV and commercial reasonableness.[24]  This “benchmarking analysis” should include the following steps to ensure that the most relevant external benchmarking data is used for comparison purposes:

• Determination of the specific characteristics of the arrangement.
• Establish the homogenous units of economic contribution to be used as the metric(s) of comparability.
• Development of the range of applicable, normative benchmark industry data, which should include measures within the range, (e.g., tenth percentile, twenty-fifth percentile, seventy-fifth percentile, ninetieth percentile), as well as measures of central tendency (e.g., mean, median) and measures of dispersion (e.g., standard deviation). The range of normative benchmark industry data is typically compiled by taking a weighted average of the selected external benchmark data sources.  While industry normative benchmark industry survey data can be used to establish FMV compensation rates, further analysis should be performed to meet the related threshold of commercial reasonableness.[25]

The second article in this four-part series on the valuation of compensation for physician services will discuss the valuation of executive compensation agreements in the healthcare industry.  The third installment will examine the valuation of compensation for call coverage.  The fourth and final article of the series will discuss the valuation of compensation healthcare executive services in the healthcare industry.

This article, in its entirety, is published in The Value Examiner, March/April 2017.

[1]     “Healthcare Valuation: Financial Appraisal of Enterprise, Assets, and Services” By Robert James Cimasi, MHA, ASA, FRICS, MCBA, CVA, CM&AA, Volume 2, Hoboken, NJ: John Wiley and Sons, 2014, p. 863.

[2]     Ibid, p. 866.

[3]     Ibid, p. 894.

[4]     Ibid, p. 893; “Economics” 8^th ed. By Michael Parkin, Boston: Pearson Addison Wesley, 2008, p. 2.

[5]     “Appraisal and Valuation: An Interdisciplinary Approach” By Richard Rickert, American Society of Appraisers Washington, DC: International Valuation Sciences Institute, 1987, p. 6.

[6]     Cimasi, 2014, p. 894.

[7]     Ibid.

[8]     “Principles of Economics” By Alfred Marshall, Eighth Edition, New York, NY: Cosimo, Inc., 2009 (originally published in 1890), p. 79.

[9]     Cimasi, 2014, p. 894; Rickert, 1987, p. 47.

[10]   Cimasi, 2014, p. 895.

[11]   Ibid, p. 896.

[12]   Ibid.

[13]   It should be noted, compensation based on productivity (wRVUs), even if not directly tied to an “incentive bonus,” may be viewed by the IRS as an “incentive compensation arrangement” as it can vary based on performance.

[14]   “Fair Market Value: Analysis and Tools to Comply with Stark and Anti-Kickback Rule” By Robert A. Wade, Esq., and Marcie Rose Levine, Esq., Audio Conference, HC Pro, Inc. (March 19, 2008), p. 33; Cimasi, 2014, p. 896–897.

[15]   “Measuring Physician Work and Effort” By Bruce A. Johnson and Deborah Keegan, in Physician Compensation Plans: State-of-the-Art Strategies, Medical Group Management Association, 2006, p. 114.

[16]   Cimasi, 2014, p. 908–909.

[17]   Ibid.

[18]   Ibid, p. 910.

[19]   Ibid, p. 910–911.

[20]   Ibid, p. 911.

[21]   “Pay for Performance: Quality- and Value-Based Reimbursement” By Norman (Chip) Harbaugh Jr., Pediatric Clinics of North America 56, No. 4 (2009): p. 997–998; Johnson Keegan, 2006, p. 114.

[22]   Ibid.

[23]   “Definitions” 42 C.F.R. § 411.351 (October 1, 2014).

[24]   Ibid, p. 913–914.

[25]   Ibid, p. 915.

Robert James Cimasi, MHA, ASA, FRICS, MCBA, CVA, CM&AA, is a nationally known speaker on healthcare industry topics and the author of several books, the latest of which include: “The Adviser’s Guide to Healthcare—2nd Edition,” co-authored with Todd Zigrang, MBA, MHA, FACHE, ASA [2015—AICPA]; “Healthcare Valuation: The Financial Appraisal of Enterprises, Assets, and Services” [2014—John Wiley & Sons]; “Accountable Care Organizations: Value Metrics and Capital Formation” [2013—Taylor & Francis, a division of CRC Press]; and, “The U.S. Healthcare Certificate of Need Sourcebook” [2005—Beard Books]. In 2016, Mr. Cimasi was named a “Pioneer of the Profession” as part of the recognition of the NACVA “Industry Titans” awards, which distinguishes those whom have had the greatest impact on the profession. Mr. Cimasi has developed, and will be presenting, the Institute for Healthcare Valuation (IHV) and Consultants’ Training Institute (CTI) Certificate of Educational Achievement for Advanced Education in Healthcare Valuation. The program will bridge the interdisciplinary nature of healthcare valuation to include: the Four Pillars of Healthcare (regulatory, reimbursement, competition, and technology); the market forces shaping the U.S. healthcare industry; and the valuation of healthcare enterprises, assets, and services.
Mr. Cimasi can be reached at (800) 394-8258, or by e-mail to rcimasi@healthcapital.com.

Todd A. Zigrang, MBA, MHA, ASA, FACHE, is the co-author of “The Adviser’s Guide to Healthcare—2nd Edition” [AICPA—2015], numerous chapters in legal treatises and anthologies, and peer-reviewed and industry articles in publications such as: The Accountant’s Business Manual (AICPA); Valuing Professional Practices and Licenses (Aspen Publishers); Valuation Strategies; Business Appraisal Practice; Business Valuation Review (ASA); The Value Examiner (NACVA); and, QuickRead (NACVA). Mr. Zigrang has developed, and will be presenting, the IHV and CTI’s Certificate of Educational Achievement (CEA) for Advanced Education in Healthcare Valuation. The program will bridge the interdisciplinary nature of healthcare valuation to include: the Four Pillars of Healthcare (regulatory, reimbursement, competition, and technology); the market forces shaping the U.S. healthcare industry; and the valuation of healthcare enterprises, assets, and services.
Mr. Zigrang can be reached at (800) 394-8258, or by e-mail to tzigrang@healthcapital.com.