How to Develop a Fair Physician Compensation Plan

By Daniel M. Bernick, Esq., M.B.A

When I first started as a health care attorney and consultant, 20 years ago, my mentor remarked that compensation planning for physician groups was probably the most challenging type of consulting assignment that our firm handled.  In the years since, after performing many such assignments, I agree.

On its face, choosing a compensation formula may appear to be a simple task.  It is not a highly technical problem.  There a number of standard formulas (see addendum to this article) and virtually all groups use one of these formulas, or a variant on them.  What makes compensation planning challenging are the high stakes involved, i.e., W-2 pay.  This is the stuff that funds mortgages, vacations, private school and college tuitions, and all other “lifestyle” choices.  There aren’t many more important issues than that, from a business perspective.

It’s true that many factors – not just the compensation formula — affect a doctor’s compensation, such as cuts in reimbursement, increases in overhead, increased competition, or a general economic recession (especially for elective services).  However, such marketplace factors can’t be controlled, very much, and thus are accepted as “life.”  By contrast, a change in compensation formula is self-administered.  This makes all the difference.  When it comes to a change in formula, each shareholder wants — and generally gets — a say.

In new group practices (e.g., solo adding first partner), the choice of compensation formula can often be made without too much angst.  First, the choice of compensation formula is often overshadowed by the hugely emotional negotiation of the buy-in amount and terms. Second, the existing owner holds the keys to partnership, and therefore typically has more leverage than the new partner, when choosing the formula.  Third, some choice must be made; the “status quo” (100% of profit to the senior physician) is no longer an option. All of these factors typically conspire to help force a choice of compensation formula within a reasonable period of time.

When the two partners add a third or fourth partner, inertia and history begin to play a role.  The existing formula becomes the starting point, and changes to that formula must be justified by some pressing need.  However, the existing owners likely still have more leverage than the new partner, because they hold the keys to partnership, and because their production (oftentimes) exceeds that of the new partner.  This again helps force a resolution.

For practices with five or more senior partners, change becomes much more difficult.  Typically, the group has become more “democratic”, in that voting rights are no longer controlled by a senior “benevolent dictator” shareholder or small group of “founders.”  Thus, the senior partners may no longer have the leverage to impose a resolution on the younger partners.  In addition, time has passed; a practice culture has been established; and there is much “history”.  By “history” I mean such things as the way people were treated in the past (“I never got a bonus for higher production”), or  financial or work-personal life balancing decisions or choice-of-practice decisions made by a shareholder in the past in reliance on the existing formula and the compensation that it generated for him or her. Any change in this established formula means that there will be “winners” and “losers”.

For such larger, more mature practices, the impetus for change is usually one or two physicians who are outliers in terms of production.  I haven’t done a survey, but my educated guess is that 90% of the time, the reason that a consultant is specially retained to examine the compensation formula is because the high producer is unhappy, and is perhaps threatening to leave.

Theoretically, the decision whether to adopt a new formula —  and what that new formula should be — could be made with the help of the consultant in a single sit-down meeting with all of the shareholders.  However, that is not realistic.  The stakes are too high; there is too much soft information to be gathered; and there is too much financial information to be processed, to make a good decision, or really any decision.  In the end, any one physician who thinks that he may be hurt by change will demand a proforma of the new formula, as applied to existing financials, so that the potential pay cut can be quantified and considered.  This can’t be done on the spot.

The better way to approach the process involves the following:

• The consultant is provided with Practice financial information, including profit and loss statements, physician productivity, and other data.
• Each shareholder provides the consultant with responses to a confidential questionnaire.
• The consultant visits the Practice office and interviews the shareholders individually and privately.
• The consultant prepares a report outlining a recommended new formula, the reasons for same, and proforma of the new formula, as applied to the last year’s financials.
• The consultant comes back to the office to meet with the group, discuss, and hopefully make a decision.

What this process does is allow the individual physicians to express their concerns privately.  The weaker members of the group will certainly not offer their unvarnished views in a group meeting, for fear of retaliation by the dominant members.  The stronger members of the group may not fear “blow back” to the same extent, but they too want to maintain friendly relationships with their partners.  No one will be fully candid in a group setting.

The role of the consultant is to privately process all of the confidential information, and then discuss the sentiments expressed by the doctors selected on a non-attributed basis, as necessary to support his or her recommendations to the group.

A well drafted report, with proforma, will serve to get the issues “out in the open” in a manner in which they can be discussed and resolved with a minimum of hostility and negativity.  In fact, the core issues underlying the group’s internal conflict are already known to the shareholders.  It is the proverbial “elephant in the room.” What is needed is the consultant’s experienced, professional evaluation and support or rejection of these competing viewpoints, so that one viewpoint prevails and guides the group to selection of a single, agreed formula.

The consultant can also help correct misunderstandings that have created conflict in a group.

For example, in a recent compensation consulting engagement, for a group of six-shareholder group, the high producer — a subspecialist – demanded a new formula with greater productivity credit.  Other shareholders resented this demand in part because they believed that the subspecialist’s allocable overhead was far higher than that of the other doctors, thus offsetting the subspecialist’s higher production.

In fact, it turned out that the Practice’s financial statements presented a distorted picture of the subspecialist’s allocable overhead, which was higher than that of the other doctors, as a percentage of personal collections, but not by that much.   A longstanding misperception was corrected.  This discovery helped lower the level of resentment towards the high producer’s demands, and helped facilitate a resolution.

Other important aspects of the process described above are:

• The individual interviews, followed by discussion of the key internal dynamics of the group, on a non-attributed basis, in the consultant’s report, all serve to allow the shareholders to “vent” their frustrations and concerns (at first privately, and then, in the group setting, on a more limited basis) and are thus “therapeutic.”
• The proforma quantifies the new formula’s impact on each shareholder.  A pay cut which is quantified — even if the cut is significant — is often less threatening than a pay cut whose dimensions are unknown.
• The perspective and credibility of an experienced outsider, who has been involved with other medical groups, can help tip the scale towards one approach or another, for a group that has become paralyzed by the compensation-related conflict.
• By allowing expressions of individual views, in confidential interviews and questionnaires, there is a greater chance that the new formula will have “buy-in” by each shareholder.  It’s a little bit like an election.  You vote, you have your say, but if the process has validity, you must abide by and accept the outcome, which in this case the consultant’s recommendations.
• The consultant, having been educated on the inner workings of the Practice, can suggest remedial measures that the “loser” under the new formula can take to improve his financial outcome under the new formula.  This can include financial support from the group.  For instance, if the new formula introduces a greater production component, perhaps the low producer needs additional outside training to enable him to do a new lucrative procedure.  Perhaps he needs a greater marketing budget, to develop a stronger flow of patients.  Perhaps he is being shorted in terms of technical staff support. The consultant can evaluate these various possibilities and help convert a “win-lose” change in the formula to a “win-and-stay even” outcome, or even (hopefully) a “win-win” (total compensation pool grows, so that all members of the group make more money).
• By educating the consultant on your practice dynamics and internal workings, you will have a ready resource to help with any problems that may arise in the future, without the time and expense of repeating the process described above.

In the end, the challenge of compensation planning is not devising an intricate formula with lots of bells and whistles.  This is not rocket science. A good formula will be easy to understand and implement.  The challenge is determining which of the basic formulas is best suited to the group’s unique history, current situation, and physician personalities, and getting everyone to truly “buy-into” this new formula.

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Addendum

List of Common Compensation Formulae for Private Medical Groups

• Equal sharing of revenue and overhead;
• Productivity division of revenue and overhead;
• Combination of equal and productivity sharing of revenue and overhead (e.g., 30% equal, and 70% on production);
• Revenue divided on production, and overhead split equally (high producer’s favorite);
• Revenue divided on production, and cost allocation of overhead (e.g., fixed expenses divided equally, and variable expenses divided on production);
• Equal base salaries, and productivity division of bonus money;
• Percentage of collections, for clinical work performed, with leftover bonus money divided on percentage ownership

Daniel M. Bernick,, Esq., M.B.A. is an Attorney, Consultant, and Principal of  The Health Care Group and Health Care Law Associates, P.C. in Plymouth Meeting, Pennsylvania