The Boomerang Effect: Hospital Employment of Physicians Coming Back Around

 By Steven A. Eisenberg

“Doc are you telling me you built a time machine . . . out of a Delorean?  The way I see it, if you’re gonna build a time machine into a car, why not do it with some style.”  Exchange between Dr. Emmett L. Brown and Marty McFly, Back to the Future.

 

For lawyers representing health care providers, there are days where we feel like we are getting into our Delorean, ready to take a trip back in time.  Why?  Because the landscape is looking very much like the mid-90s, where health care systems moved to employ as many physicians as possible in as much of a defensive mechanism rather than an offensive strategy.  But like Marty McFly learned when he traveled from 1985 to 1955 and back, hospitals, physicians and health care lawyers have learned that many things are different in 2008 as compared to the mid-90s.

The early proliferation of hospital-owned physician practices was prompted largely by two factors, one predominately rural and the other predominately urban. The first motivating factor was cost-based reimbursed rural health clinics in the late 1980’s.  Cost reimbursement largely transferred the fiscal risk associated with such ventures to the federal government until cost containment efforts began in the 1990’s. 

The second and much larger factor, was the attempt by hospital systems to control and expand their market share in the 1990’s.  Hospitals wanted to vertically and horizontally integrate health care service delivery in response to the “managed care” threat.  Hospitals largely assumed they would be able to improve profitability of physician practices based upon three assumptions: (a) physician practices were grossly mismanaged, (b) improved economies of scale that hospitals could bring to the table, and (c) hospitals had lower costs of capital, especially in the case of non-profit hospitals.

Many of the early generation hospital-owned physician practices, which included a large proportion of primary care physicians, resulted in substantial losses for hospitals and healthcare systems.  Losses were frequently in excess of $100,000 per employed physician.  As a result, many of the practices were divested by hospitals within a few short years of their acquisition, often accompanied by bitter litigation. 

However, the long-term trend, at present, again favors continued growth of hospital-owned physician practices.  The basic character of the acquisitions is changing, however.  Physicians and physician practices are being acquired by hospitals and integrated delivery systems where they have both a strategic need for the physicians in their communities and the sophistication to manage physicians, financially and culturally.  And the compensation models are changing.  Rather than large salaries and bonuses that were not supported (and in some cases could not be supported) by productivity, compensation is now more focused on both strategy and productivity.

What is the cause behind this trend?  And what in the acquisition has changed to avoid the pitfalls of earlier practice employment and acquisitions?  There are many drivers, the most important of which is that both physicians and hospitals need each other more than ever.

Physician Drivers

The new trend toward hospital employment of physicians is different from the 1990s, when physicians approached hospitals about employment opportunities rather than the reverse. Today, physicians are becoming increasingly interested in the employment model.  Many physicians, specialists in particular, are seeking hospital employment to relieve the stress of administrative duties and the general risks and hassles of private practice.  There are many drivers, including:

(1)           Reimbursement.  Reimbursement has become stagnant for both government and commercial payors.  For instance, in 2007, the Centers for Medicare and Medicaid Services proposed a 10%, across the board, cut to physician reimbursement.  At the last minute, in December, 2007, Congress acted to instead provide physicians with a 0.5% increase.  Reimbursement uncertainties make practice management very difficult for independent physician practices.  And the more recent trend of uninsured and underinsured is making this issue worse.  Additionally, because hospitals typically employ a greater number of physicians then a private practice employs, it may be able to negotiate better reimbursement rates.

(2)           Curbing Ancillary Revenue.  Potential decreases in ancillary revenue, expansion of the Stark Law limitations, and the need for costly equipment to provide those ancillary services.  While at the same time many of those same ancillary services, if provided in a provider-based setting, yield greater revenue (at least temporarily).

(3)           Rising Practice Expenses.  Health care insurance costs are rising between 5-10% annually.  Cost of living is increasing between 3-4% annually.  When reimbursement is only increasing by 0.5% annually, something has to give. 

(4)           Greater Need for Scale.  The expectations for electronic medical records are growing, yet most independent practices, both large and small, lack the resources and skills to implement electronic records.  When implemented at a physician’s office site of care, the value of the electronic record is not optimized for the patient if the electronic physician record is not connected to the broader information network that includes all sites of clinical care.  As reimbursement introduces pay-for-performance, an electronic medical record system may become a necessity.  Besides electronic medical records, scale provides great benefit in terms of coverage, back-office support, purchasing power and, most importantly, frees the physician to provide patient care rather than run the practice.

Hospital Drivers

Unlike the 1990s, which was driven by financials as much as anything, physician employment is now symbiotic. Hospitals are recruiting physicians for employment not just so their competitor does not employ the physician, but because of the benefit the physician provides to the hospital.  The factors supporting this interest include:

(1)           Demand.  Hospitals need to employ physicians to help them keep up with demand, especially in areas experiencing population decline or little population.  Nationally, we are facing a shortage of healthcare providers. From 1980 – 2000, the U.S. population grew by 24% while the number of U.S. medical school graduates only grew by 12%. Today, there are not enough openings to create the number of providers needed to meet the needs of the population and the aging of the population. Although the federal government is beginning to seek ways to address these facts, experts are still predicting that by 2020, there will be a deficit of 150,000 to 200,000 physicians. Shortages are expected in the areas of critical care, radiology, endocrinology, allergy and immunology, psychiatry, geriatrics, neurosurgery, anesthesiology, cardiology and gastroenterology.

(2)           Quality; Access.  Employing physicians allows for a greater ability to control quality.  Current regulations make it very difficult to pay for quality improvement.  It is almost impossible to get an appraiser to value quality improvement.  Current programs value quality only as an afterthought.  Appraisers typically compare physician management contracts to standard management contracts to calculate fair market value.    Also, employment allows a hospital to ensure access to specialties where there is a critical shortage, such as neonatology.

(3)           Financial Improvement. Aligning incentives should produce improved financial performance for the hospitals.  Having physicians who have a vested interest in the financial performance of their hospital product line and the management clout to make changes should cause substantial positive impact on the bottom line.  The improvements should come from more judicious use of hospital recourses, reduction in duplication of services and the provision of services in the location that will yield the best reimbursement.

(4)           Specialist Trends.  Hospitals are being much more deliberative in their hiring of physicians, hiring specialists needed to balance medical staffs and meet community needs.  In the early 1990s hospitals focused on employing primary care physicians to meet managed care demands, as opposed to recognizing and promoting the synergies between the hospital and hospital using physicians.  The general shift to a more balanced complement of physicians, together with more rational compensation structures not linked to capitation payments, has allowed hospitals to reduce the loss on employed physicians from approximately $100,000 per annum per physician to $20,000 to $40,000 per annum per physician. It also makes it easier for the hospital to have the necessary call available to the community. 

Models

The compensation models used now differ greatly from the models used previously.  In the 90s, the physicians often profited from both the sale of the practice business and a compensation model that provided a high fixed compensation for a number of years.  Hospitals incurred losses and became frustrated with this model, because they were never able to recoup enough of their investment to justify the initial purchase.  Today, hospitals are employing physicians much more conservatively. 

The traditional hospital employment model in the mid-90s involved a 5-year income guaranty.  Today, the guaranty length is also much shorter, potentially just a year.  Instead, hospitals and physicians have moved to a more aligned model, using a combination of guaranty and productivity bonuses and, where appropriate, subsidies for mission-based practices.

Additionally, some operating models are different.  Whereas hospitals used to employ all physicians in a single entity, today the employed physicians often have significant input on the employer’s governance and providing significant operational controls.  In some structures, the hospital leases the existing practice’s space, equipment and employees, which provides the physicians who are becoming employees both an income stream and some comfort if the physicians want to separate employment. 

One thing is clear, hospitals and physicians have many options with respect to compensation and operational models, as critical thought should be given to what model will best allow them to achieve goals. 

Will It Work?

Only time will tell whether the new breed of physician employment will succeed.  It is clear that the relationship between physicians and hospitals has changed, with external factors other than competition and compensation supporting the employment relationship.  Also, counsel are approaching these relationship much differently, greatly streamlining the transaction process.  Let’s just hope the flux capacitor does not malfunction. 

Mr. Eisenberg is an attorney on the Health Care Industry Team of Baker Hostetler.