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    Timothy Smith, CPA, ABV

    Part 3 of the Series: Examining Losses in Health System Physician Practices

    In this series, we’ve been examining the question of why physician-owned practices usually breakeven or make a profit and hospital/IDS-owned practices mostly lose money. We noted in the prior article that physician compensation in physician-owned practices is self-adjusting, resulting in practice net income that avoids red ink.

    Using “eat what you catch” as the compensation model—physician compensation equals the net earnings generated by the practice—simply means the practice doesn’t lose money. Physician compensation goes up or down based on the available net earnings of the practice. Physician-owned practices, therefore, do not typically lose money.

    When we examine health system ownership and operation of physician practices, a different picture emerges. Health systems frequently change the operational and economic focus of a physician practice. They introduce business and strategic goals that are not related to the economic optimization of a practice as a separate business enterprise. Rather, the larger concerns and objectives of a healthcare organization often override goals and plans that would otherwise serve to maximize physician practice earnings.

    From the strategic perspective of a health system, physician practices are simply one resource or service line within a larger continuum of services and product lines. Consequently, outcomes for the total organization frequently take precedence over the impact on physician practices. For example, hospital/IDS priorities can influence decisions related to group practice operations such as:

    • The number of physicians in the group
    • The specialty/subspecialty of the physicians
    • Use of nonphysician providers, such as advanced practice clinicians
    • Hospital emergency department and inpatient call coverage levels
    • Practice locations
    • Offering in-office ancillaries
    • Payer mix, such as the levels of Medicaid and charity care
    • Commercial payer contract rates

    Decisions in these areas can affect practice operations and economics in ways that are both favorable and unfavorable to the income statement of a physician practice. In many cases, these choices will negatively impact the practice’s bottom-line.

    In short, a hospital/IDS-owned practice may not be financially optimized from the perspective of the practice as an operational or accounting unit. Losses in health system practices, therefore, may result from strategic and operational objectives that are imposed on the practice and its economics for the benefit of other parts of the organization. They may reflect choices the health system made in how to best utilize physician practices within the delivery of care priorities for the integrated delivery system.

    Another critical factor in the economic changes from hospital/IDS ownership is a shift in the compensation paradigm for physicians. Many, if not most, health systems replace earnings-based physician compensation models with pay levels tied to physician compensation survey data. It is very common for health systems to peg physician compensation to specific percentile levels in survey data. Popular approaches include using the median compensation-to-wRVU ratio or matching a physician’s percentile ranking for wRVU production with the corresponding percentile for total compensation (e.g., a physician producing at the 65th percentile should make the 65th percentile in total compensation).

    Whatever approach is used, as long as the survey-based compensation is considered to be fair market value, health systems generally believe the compensation is appropriate. In some cases, use of survey-based compensation will give physicians a pay increase over what they have been making in their private practices.

    The economic impact on the practice’s net income from using these survey-based models, however, is frequently ignored and not analyzed. In addition, adjusting physician compensation to the level of net practice earnings is generally set aside as a compensation design concept. “Eat what you catch” does not apply when it comes to hospital/IDS practices for the reasons noted.

    When practice losses do occur, health systems have to underwrite the losses with funding from other financial resources available to the organization, such as the net earnings from other service lines. The physician enterprise is not self-sustaining or margin-making for the organization. Rather, physician practices become a source of continual red ink in the monthly financial reporting cycle, offsetting contribution margins from other service lines within the IDS.

    Reaction to such underwriting of practice losses varies. Many view such underwriting as a cost of doing business. The physician practice loss is simply overhead to be absorbed by enterprise earnings for the entire health system or IDS. Others shrug their shoulders noting that “everyone loses money on their physicians,” while being perplexed about this industry-wide phenomenon.

    A few will go further and question how physician compensation can be fair market value or commercially reasonable when practices incur significant losses year after year. In recent years, more industry participants are questioning the long-term sustainability of practice losses as health systems face lower reimbursement for other service lines.

    In a contrary trend, some industry participants are now dismissing the issue of practice losses because they believe the industry is moving toward integration models in which physician practices as distinct operating and accounting units will no longer exist in the continuum of patient care. The move toward payment for value at the level of population health will eliminate separately identifiable revenue streams associated with physician services.

    As reimbursement moves towards a mixture of ACOs, bundled payments, and other value-based models, physician services will become one resource input for a global payment encompassing all providers in the care continuum. In addition, health systems will eventually employ all physicians. Thus, the concepts of a physician practice and a practice loss go away under this new paradigm of value-based global payments.

    In light of these conflicting currents, the unique tendency of hospital/IDS physician practices to lose money warrants further investigation. Over the next several articles in this series, we’ll explore and evaluation each of these areas in further detail. We’ll look at the impact of health system decision-making on practice revenues, expenses, and physician compensation. We’ll also evaluate the financial and regulatory risks associated with incurring them. One article will focus on practice losses as an issue in the move from volume to value.

    For the next installment, we’ll look at revenue factors contributing to practice losses, touching on issues such as payer mix and commercial payer rates.

    The following links will take you to the previous articles in the series:

    Part 1 Physician practice losses: A tale of two owners

    Part 2 Physician practice losses: Why physician-owned practices break even or make a profit

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