The health care industry’s complex reimbursement landscape coupled with physician contracting has left hospital and health system leaders without critical intelligence into physician profitability and losses. According to the American Medical Group Association (AMGA) 2017 Medical Group Operations and Finance Survey, physician losses increased 7.5 percent between 2016 and 2017 to $140,856 per physician.
Understanding physician practice economics is crucial and the following formulas and methodologies will outline common analyses and highlight a stronger option for improving physician profitability, preparing for risk-based contracts and reducing physician burnout.
What Are the Existing Physician Practice Economics?
Physician services are reimbursed through Medicare’s Part B Physician Fee Schedule (PFS), and other payors often set physician fees in relation to Medicare’s PFS. Medicare bases PFS amounts on its defined Total Work Relative Value Unit (TRVU), which is associated with a Current Procedural Terminology (CPT) code and adjusted annually with a conversion factor rate that accounts for geographic area. One of the reimbursement components for the physician services provided is a work Relative Value Unit (wRVU), which represents the value of the physician’s work and bears a strong correlation to time—but it’s not an exclusive factor.
Understanding Marginal Profit & Controllable Losses
The first step in improving physician profitability is understanding loss—both controllable and uncontrollable. A controlled loss is fixed and does not increase on a per-unit basis, while an uncontrolled loss is variable and increases on a per-unit basis.
Figure 1 is a straightforward characterization of practice expenses in fixed- and variable-cost pools and serves to illustrate marginal profit. As revenue increases, the per-unit fixed cost decreases and the per-unit variable cost remains constant.
The “Next Visit” column is the marginal visit and the key to effectively controlling losses. When marginal revenue exceeds variable costs, the marginal visit is profitable and reduces the practice loss. However, this simplistic example of a controlled loss is somewhat unrealistic because it fails to reflect the additional provider compensation for the additional physician work.
Because hospitals and health systems want to increase access to care and profitability, many physician compensation plans include productivity bonus paid on a per-unit basis. Figure 2 illustrates this more complex compensation and realistic payment structure by including a fixed and variable physician compensation component.
For this example, the threshold for bonus compensation is set at 4,000 visits. Because the Total column also is 4,000 visits, no variable provider expense is included and physician compensation is effectively $50 per visit. Figure 2 shows how total net income is affected by the marginal physician payment for their work for the last visit.
What’s the Key to Managing Controlled Losses?
The structure of productivity bonus compensation is the key to controlling and predicting physician losses and is unfortunately overlooked. The following charts illustrate how an increase in physician clinical work effort impacts the practice financial performance, which is determined entirely by collection rates, operating leverage and the physician productivity bonus marginal rate.
A marginal rate needs to be sustained, but often declines as productivity rises.
The mix of fixed and variable costs changes over time and at varying productivity levels.
PHYSICIAN PRODUCTIVITY BONUS MARGINAL RATE
A contractual arrangement that should set rates that create predictable “win-win” financial results for both the provider and the practice’s economics.
The ideal goal is to create a productivity bonus compensation arrangement that keeps total variable cost per unit equal to or less than the revenue per unit. Uncontrolled losses are difficult to budget and occur when contribution margin is negative. Physician compensation arrangements that create negative contribution margins not only create uncontrollable losses and increase the practice’s loss per unit level, they also create misaligned incentives that create myriad financial and compliance risks and contribute to physician burnout.
Complex Marginal Analysis
Figure 2 illustrates the effect of a simple productivity bonus structure and Figure 3 builds on the model by including the cost of additional physician work effort in the analysis. Figure 3 is built on the same assumption of 4,000 base visits.
Figure 3 illustrates a flat productivity incentive for all visits above 4,000 at $60 per visit ($55 in compensation + $5 per visit in related benefit cost). As the favorable payor mix declines, it reduces the marginal revenue, which is a common effect of productivity increases.
Figure 3 shows the physician’s marginal compensation per visit ($60.00) exceeds the marginal practice net income before physician expenses per visit ($52.50) and creates a marginal practice net loss of $7.50 per visit. As the marginal value of the last visit is negative, this is another example of an uncontrolled loss.
Figure 4 illustrates a base plus tiered-increase bonus model. The rationale for these models is similar to overtime pay rates in that the harder a physician works, the more there is worth at the margins; however, this structure gives uncontrollable losses an exponential power and heightens practice losses.
Figure 4 assumes a three-tiered system that pays an effective productivity bonus of:
- $60 for visits 4,000 > 5,000
- $65 for visits 5,000 > 6,000
- $70 for visits < 6,000
The marginal analysis in Figure 4 highlights the exponential danger of these plans. Because the contribution margin is negative, the more the provider works, the greater the total practice loss, and the bonus tier model accelerates the loss with additional productivity. Effectively, the harder the physician works, the greater the total practice loss, and it incentivizes productivity levels that contribute to physician burnout—a key driver of turnover in employed physician groups.
So What Does a Strong Model Look Like?
The solution to improving physician profitability is to work toward productivity compensation terms that have an inverse relationship between units produced and compensation per unit. Creating a sustainable contribution margin for that final compensation tier is the key to designing positive, controlled marginal practice income.
Figure 5 illustrates this arrangement by showing productivity bonus pay of:
- $62 for visits 4,000 > 5,000
- $57 for visits 5,000 > 6,000
- $52 for visits < 6,000
It’s especially crucial to note that while the net practice income is substantially different under the three approaches, the physician compensation per visit is not.
Regardless of tiered amounts, setting a compensation cap limiting the productivity bonus to a sustainable percentage of collections at the margins can help further control losses.
Physician Compensation Examples Summarized per Visit
- Flat productivity: $53.33
- Increasing tiers: $55.00
- Decreasing tiers: $53.17
Investing in physician compensation redesign can produce more predictable, sustainable compensation terms with employed physicians. While it’s not feasible to arrive at a positive marginal net income in every situation, a decreasing tiered production model can give you stronger control over losses and a more sustainable model.
If improving physician profitability or participating in a value-based payment model is on your priority list this year, contact Randy or your trusted BKD advisor.