The IRS, OIG and valuation industry have set well-defined standards for FMV (Fair Market Value) in typical physician/hospital transactions. That said, in our consulting practice, we often encounter situations that can cause problems when handled incorrectly.
Reaching the Upper Limits
Most FMV physician compensation arrangements are based on national data broken down geographically and into percentiles — 25th, 50th, 75th and 90th, as well as median. Typically, FMV physician compensation falls between the 25th and 75th percentile. When compensation above the 75th percentile is proposed, it’s critical to document why, using at least one and preferably more of the following criteria:
- The physician has the qualifications, experience and credentials to support the upper limit of compensation.
- A limited pool of qualified candidates exists and candidates are unwilling to relocate to the area to fill the position.
- The position and job requirements are unique to the market served by the hospital.
Establishing a compensation level above the 90th percentile carries an inherent risk of an external review, since it very likely exceeds the FMV threshold. In this case, the best approach is structuring the compensation package with a base plus incentive.
Situation: A cardiologist from a large teaching hospital in a major metropolitan area wanted to relocate to a much smaller community in his home state. The hospital employing him planned to start a cardiology program and hire him as the director. Although he was willing to take a pay cut, his compensation still fell between the 75th and 90th percentile. To be on the safe side, HSG recommended the hospital structure his compensation package as a base with incentive, even though the cardiologist met all three criteria for compensation above the 75th percentile.
It’s Fair, but Is It Reasonable?
The two key criteria in FMV compensation arrangements are commercial reasonableness and fair market value:
- Commercial reasonableness means that the transaction (arrangement) would make commercial sense, if it were transacted between reasonable parties of similar size and scope in their business interests.
- Fair market value is the compensation arrangement that is negotiated between well-informed parties, who are not otherwise in a position to generate business for each other.
Physician compensation must meet both of these standards, and it’s possible to meet one and not the other.
Situation: One of our clients hired a physician to serve as medical director of their cardiology program and offered to compensate her at $200 an hour. The pay met the standard for FMV. However, upon further investigation, HSG discovered the hospital already had two physicians serving in the same capacity and was paying them at the same rate. Paying for three medical directors with the same job duties doesn’t meet the “commercially reasonable” standard; therefore, we recommended a lower hourly compensation rate for the new physician – and a decision on which of the two previously employed cardiologists was actually serving as the medical director.
Quality and Quantity:
Work Relative Value Units (wRVUs) have become the standard for measuring physician productivity and can also be utilized to support FMV compensation. Today, many hospitals want to add a quality metric to the compensation package. That can be harder than it sounds. To establish a usable quality metric, make sure:
- The criteria are verifiable and medically-supported.
- A valid historical baseline is available.
- National benchmarks are utilized as targets.
- The quality indicators are clear and separately identified.
- The indicators relate to the hospital’s patient population.
Situation: A hospital asked HSG to add a quality component to existing physician contracts to improve the hospital’s overall quality. A maximum target of $25,000 was established and then five quality indicators were chosen, ranked on importance to the hospital. One of the indicators was: “PCI procedures with vascular access site injury requiring treatment.” The physician’s current performance was 3.30 percent and the national performance level at the 50th percentile was 1.10 percent. Reaching the national 50th percentile was set as the goal. Each of the four remaining indicators was similarly defined. The physician could only reach the incentive by meeting or exceeding the targeted benchmark. We recommended an all-or-nothing approach, so if the physician achieved improvement at the national 25th percentile, he did not earn any of the incentive.
Waiting By the Phone
For hospital executives and their medical staffs, on-call compensation is more than a financial issue. It can be political, as well. The FMV model most utilized for on-call services is derived by applying a discount – typically 10-30 percent — to national benchmark rates and converting that to hourly compensation. Factors to take into account include:
- The frequency of the call;
- How necessary call coverage is to the hospital’s operations; and
- The physician’s ability to generate professional fee income when called upon to provide services.
Moving Too Fast
One of the worst mistakes we see when hospitals are putting together physician compensation packages is moving too fast to seal the deal. When compensation fails to meet the FMV tests, the resultant need to renegotiate can break down trust between the parties.
Any negotiations or term sheets should state that they are conditional and dependent on an independent review by a third party as to the FMV of the compensation. This simple step can avoid the destruction of an important hospital/physician relationship.