Understanding Physician Compensation Components

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Recognizing the interplay of external and institutional internal economic factors is crucial to successfully negotiating an equitable compensation package. An appreciation of payer dynamics, compensation models, e.g., cash collections versus relative value units (RVUs), ownership, demographics, malpractice, and regulatory environments is essential if a physician is to avoid the pitfall of accepting a seductively high starting salary, only to find that such an earning level is longitudinally unsustainable. If in doubt, seek the assistance of the physician recruiter and physicians who recently joined the practice.

John A. Fromson, M.D.

The offer a job-seeking physician receives from a prospective employer takes into account myriad factors, from practice ownership and composition, institutional policy, and regional health care market issues to national compensation-survey data and federal and state regulatory requirements. All of these factors affect the total compensation employers can offer and how compensation-package components are structured. Residents may be unfamiliar with these factors, understandably, but they should obtain a basic grasp of both compensation components and the issues employers face before they start their job search.

By Bonnie Darves

For residents operating in total-immersion mode trying to master their chosen specialty, familiarizing themselves with the nuances of the compensation package they might receive two years down the road is likely low on the to-do list.

A reluctance to take on a low-priority learning curve is understandable, but residents should at least have a basic understanding of the various components that figure in physician payment structures before they start their job search. In the compensation realm, making an under-informed decision about a practice opportunity can, unfortunately, have far-reaching ramifications for the physician.

“It’s not uncommon to see residents who accepted a position primarily because of the high initial compensation finding out a year later that their earning level is unsustainable, for example, because the income guarantee converted to an all-productivity compensation basis,” said Ken Hertz, a principal with the health care consulting group of the Medical Group Management Association (MGMA), which publishes the annual Physician Compensation and Production Survey, often widely used as a benchmark in setting salaries. “It’s important to not only read the employment offer fine print but also to understand what the numbers mean and how the various compensation components fit together.”

On the positive side, residents today are generally fairly well-informed about starting salary ranges for their specialties, Mr. Hertz observed, because the survey data from MGMA, the American Medical Group Association (AMGA), and other entities that track physician compensation is readily accessible. And most young physicians, he and other sources interviewed for this article concurred, are adept at networking with their colleagues to find out what is going on in the hiring marketplace.

Myriad factors come into play “Most residents have a ballpark idea about what they should be earning and realistic expectations of what they will be offered. What they don’t understand so well is the compensation models themselves and the factors that employers take into account when they set compensation,” said Shelley Tudor, vice president of research for the Association of Staff Physician Recruiters and a strategic recruiter with Humana, Inc.

For instance, the hiring health care system, hospital, or physician practice must address external factors such as competition, national and regional physician supply and demand, and, from the economic perspective, the local (insurer) payer mix and regional reimbursement trends. Internally, prospective employers must consider their organization’s compensation methodology and philosophy, its revenue sources, the patient population, and the incoming physician’s practice scope and job responsibilities, among other factors.

Of the many factors that influence the final compensation picture, the payer dynamics — how much insurers pay physicians for physician services and what percentage of physicians’ professional charges makes its way into the practice revenue stream — is perhaps one of the most difficult for residents to grasp, several sources said. That’s largely because residents are typically shielded from the underlying practice economics during training, and thus have no experience in this area. Essentially, the hiring practice — whether it’s private, hospital-owned, or even academic — often uses a complex formula when factoring its revenue stream into the compensation offer.

“Many health care organizations use a compensation model based primarily on cash and collections, in which income is heavily dependent upon the payer mix within the community,” explained David Knocke, FACHE, president of BJC Medical Group in St. Louis, Missouri. Such models essentially emulate private practice, in which a share of expenses allocated to the physician based on a standard methodology — plus physician-direct expenses for items such as malpractice coverage — is subtracted from physician-specific revenue. That revenue includes collections from professional services and cash from patients’ copayments, for example, and possibly credit for revenue generated by nurse practitioners who support the physician.

The interplay of these compensation components may seem relatively unimportant to the new physician who joins the practice under a one- or two-year income guarantee, but they directly affect future earnings. “Under these models, depending on the community, physicians can experience lower collection rates and thus lower income,” Mr. Knocke said. “As a result, some physicians are at risk of experiencing a steep decline in income after the initial salary guarantee ends.”

At the other end of the spectrum, some organizations use a compensation structure in which income is based primarily or solely on actual physician production, Mr. Knocke explained, by multiplying work relative value units (RVUs) by a market-based conversion factor based on national benchmarks. “This achieves payer neutrality,” he noted, enabling physicians to earn the same amount for a work RVU regardless of the patient’s insurance.

Demographics and practice foundation influence compensation structure
The ownership of the practice, and its demographics, also influence the compensation structure. “When it’s a hospital-owned practice, the economics are different — sometimes markedly different — than in a private practice,” said Peter Cebulka, director of recruiting development for Merritt Hawkins, a leading national recruiting firm. “Hospital-employed positions tend to pay more than private practice opportunities, at least initially, because of the economics. The cash outlay required to ramp up the new physician in a private practice hurts the partners’ [income], while the hospital has professional collections, and the inpatient and outpatient revenue,” he said, to draw on when it supports the new physician.

The makeup of the practice — the number of physicians in total and within each specialty in the case of multispecialty practices — affects compensation structures as well because of the workload effect. Generally, the fewer the physicians, the higher the compensation, Mr. Cebulka observes, because smaller numbers typically mean more call duty and overall responsibility per physician.

Faculty practices use many of the same components that hospitals and private practices do when they set compensation, but academic medical centers (AMCs) have other factors to accommodate — primarily regarding their funding stream. The AMC that relies heavily on state funding may have far less flexibility in setting compensation than one that has a large endowment, for example, or one that receives a steady influx of research dollars. “All academic centers have different structures and resources, so it’s difficult to compare them. Basically, if you have seen one medical school’s [compensation] structure, you’ve seen one school’s structure,” said Karen Novielli, MD, vice dean for faculty affairs and professional development at Thomas Jefferson University in Philadelphia, Pennsylvania. “Increasingly, however, medical schools are looking at using mission-based salaries — even if they use AAMC [Association of American Medical Colleges] survey data as a starting point or benchmark against MGMA.”

Dr. Novielli adds that academic centers are hardly immune from the economic factors that their non-teaching organization counterparts face when setting compensation, such as the local payer mix and reimbursement practices. “Sources of revenue — clinical dollars, tuition, NIH [National Institutes of Health] funding, and philanthropy — are all facing downward pressure or declining,” she said, so medical schools must continually revisit their compensation structures. For that reason, residents who want to practice in the AMC setting are well-advised to ask questions about the components of their prospective compensation. “They should be asking about the [practice’s] sources of revenue and the earnings incentives — and what they must do to be eligible for those incentives,” she explained.

Residents considering faculty practice should also keep in mind that unlike private practice or other employed situations, a faculty member’s employment is usually governed by an institution’s bylaws or other governance documents, Dr. Novielli noted. “Prospective faculty members should review and understand how these documents govern their employment,” she said, adding that “increasingly, faculty compensation is likely tied to outcomes that are important to the organization such as quality of care, patient satisfaction, and patient access metrics.”

Even such considerations as how busy the employer expects the physician to be and future compensation components related to physicians’ performance on internal or governmental quality measures are finding their way into the compensation structures in all settings, Mr. Cebulka pointed out. Because of the increasing complexity of compensation arrangements, he adds, residents should seek the counsel of a knowledgeable, experienced recruiter on the various compensation models, and do their own homework before they start evaluating opportunities. “Residents won’t be able to understand all the moving pieces in the health care economy that affect physician compensation, but they should get a grasp of the basics — and they definitely should know the [surveys’] 25th, 50th, and 75th percentile earnings for their specialty,” he said.

Residents should also be aware of the overall regional compensation differences that have persisted for more than a decade, all sources agreed: Physicians who choose to practice in the South and the Midwest, regardless of whether they’re newly trained or experienced, will generally earn more than their counterparts on the East and West coasts.

Regulatory issues also play role
Finally, regardless of the marketplace dynamics that affect the physician compensation environment, all hiring organizations must comply with the national and state laws and the Internal Revenue Service (IRS) regulations that govern how, and how much physicians can be compensated.

“Most of us are dealing with local market factors and competition when we recruit. But all of us have to care about the IRS regulations that govern physician compensation — fair market value in particular,” said Frank Gallagher, an ASPR board member who is vice president of governance and director of physician recruitment for New Jersey-based AtlantiCare health system, which includes more than 600 physicians. “That [fair market value] is a big one for us when we craft an offer, but the other factors are important, too, in determining how much we can pay. It’s important that residents have at least a basic understanding of these economic and regulatory issues.”

Three key laws regulate fair market valuations in physician compensation arrangements: the Stark Law, the federal Anti-Kickback Statute, and IRS guidelines. All dictate that physician compensation cannot exceed fair market value thresholds for the particular specialty, and many states have instituted their own laws to control physician compensation to deter offering of substantially above-market earnings.

The current regulatory environment is predicated on an attempt to ensure that physician market supply and demand, and competitive factors, don’t unduly influence compensation. Some highly recruited physicians who aren’t aware of these regulatory constraints may think that there’s more wiggle room than actually exists, regarding the compensation they can command, if they are willing to practice outside urban areas, according to veteran recruiter Craig Telegra, vice president of physician and clinical services for Divine Savior Healthcare in Portage, Wisconsin.

“We clearly must fall within the IRS regulations in the compensation we offer, so we use the survey data as a benchmark, and we won’t go outside that figure,” he said. That doesn’t prevent the employer from offering compensation incentives beyond the base salary to make the offer more attractive but still legal, Mr. Telegra notes. For example, his organization, located in the upper Midwest, offers incentives such as a residency stipend during the final year. Increasingly, employers in challenging recruiting environments also add incentives such as medical-education loan repayment, or potentially lucrative productivity structures or an attractive partnership track for physicians who stay with the practice beyond the first few years.

“These compensation models can be pretty complex, so residents who come out of training and simply earn X amount, need to understand how their income will be structured” after their first year, Mr. Telegra cautioned. A generous starting salary that converts to production-only income in year two is very different from a structure that allows a more gradual transition to production-based compensation. Divine Savior, for example, uses a three-year compensation agreement to ensure physicians have sufficient time to build their practice before the revenue-generating pressures begin.

Kathy McBrearty, a senior consultant with the national recruiting firm Cejka Search, explains how survey data and compensation factors and components tend to come together. “An offer should start at the [AMGA survey] 25th percentile for a new resident, and can go as high as the 50th percentile for exceptional candidates,” she said, referring to physicians who train at premier institutions and have exceptional references. “Unless the market is truly difficult and there is a very small candidate pool, it is unlikely many residents will see offers beyond 50th percentile. Everyone has to adhere to the Stark Law and can’t appear to be ‘buying a physician.’”

Most hiring organizations, Ms. McBrearty added, have in mind a total dollar value and “bucket” of funds to work with when they recruit a physician, but they might package that sum in different ways. “Many organizations would prefer to give a higher signing bonus to help the new physician transition to practice and their new location, versus a higher starting salary,” she said. “In major metro areas where there are a lot of candidates, salaries are usually lower because that’s what the market dictates. In rural areas, employers tend to offer more enticements such as higher signing bonuses, residency stipends, and productivity or RVU incentives.”

Generally speaking, physicians who accept offers to practice in rural or remote areas can expect to earn an additional 20 percent more than their counterparts in so-called “desirable” urban areas. That compensation component — a differential for practicing in rural areas — doesn’t always entail practicing many hours from a major urban center, Mr. Cebulka explained, and other factors beyond survey data will influence total rural compensation. He cites the recent example of a search for an internal medicine subspecialist to practice in a rural location about an hour from Atlanta. If only specialty and geographic location survey data were taken into account, the specialist would expect compensation of roughly 20 percent more than his counterparts in the city. In this particular case, however, the physician will practice as the only one in his specialty in the area.

“Because of the nature of the position — the additional responsibility of being the only physician in that particular specialty — the physician can command higher compensation. If he only went by survey benchmark data for the Southeast, he would have been under-selling himself,” Mr. Cebulka said.

'Microeconomic' factors matter, too
Beyond the basic components that organizations incorporate into their physician compensation structures, practices often make allowances for fluctuating economic factors. For example, the malpractice environment in a particular state, particularly one where premiums are especially high because of the medico-legal climate, may affect compensation structure, observed Lee A. Meyer, RN, manager of physician recruitment and credentialing for Dreyer Medical Clinic in Aurora, Illinois.

“We’re seeing some changes in malpractice [premium] trends and tail coverage that is giving us more flexibility,” she said, in structuring compensation at the 175-physician group. Nationally, malpractice premiums have leveled off, and even declined in some areas in the past two years, so some practices are revising their budgets and compensation accordingly, reports have indicated.

Other minor marketplace trends — even short-lived or region-specific ones — can influence physician compensation components’ structures and relative weights, Ms. Meyer notes. “We are seeing elevated compensation numbers in the physician salary surveys because of the merger and acquisition mode in the industry right now, and that’s inflating starting salaries relative to what physicians can expect to bring in,” she said, in revenues or collections. “I think we’ll see those [compensation] numbers go down later, after the merger activity levels off.”

Precisely because of such short-term trends, Dreyer Medical Clinic takes a longer view when it sets physician compensation in the context of survey findings, Ms. Meyer explains. Rather than using a single survey or only current-year data to set base compensation, the group’s methodology incorporates data from both the AMGA and MGMA surveys, and over two consecutive years. “That way we have four data points when we set compensation,” she said. “If you only use one survey, and only for one year, things can get fuzzy because the [survey] numbers sometimes lag behind what’s going on in the market.”

Compensation Survey Resources:
American Medical Group Association (amga.org)
Medical Group Management Association (mgma.org)
Merritt Hawkins (merritthawkins.com/compensation-surveys.aspx)


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