Data Mine: What is driving physician compensation?

What drives physician compensation? The answer was a relatively simple equation for years: total practice revenue minus total practice expenses.

This calculation can still be used for a physician-owned medical group, since the practice functions as a closed financial entity and the amount available to pay the physician-owners is limited to the practice’s ability to generate profits. But these traditional market drivers are evolving now that more physicians are employed by hospitals.

Hospital-owned practices function very differently from their physician-owned peers. A practice that is part of a larger health system can draw on the resources of its parent organization for common expenses such as utilities, executive management, contracting or information technology. A hospital-owned practice can also draw on its health system to subsidize unique practice expenses such as physician compensation.

Hospital-owned practices are not constrained by internal financial performance; however, they do have to comply with complex legal and regulatory rules that affect physician pay. In general, hospital-owned practices determine a target amount based on multiple national physician compensation surveys and apply a productivity-based compensation formula aligned with productivity goals to determine target compensation, rewarding high producers with greater compensation while penalizing doctors with lower productivity.

Examining the multiyear data available in MGMA DataDive Provider Compensation, the trends in compensation for physician- and hospital-owned practices vary, depending on the outcome of different economic drivers.

Figure 1 and Figure 2 provide insights into those compensation changes. Figure 1 shows median compensation in 2013 and 2017 and the five-year change in compensation for six specialties. As shown in the five-year trend section, compensation in hospital-owned practices increased at a much greater rate (and in some specialties, at a rate three to four times greater) than in physician-owned practices.

The slow growth in physician-owned practices reflects the general economic stagnation of government and commercial payers limiting increases in payment, while operating costs continue to increase. Since these practices are self-supporting financially, increases in physician compensation are generally earned through increased productivity and introducing new service lines, but the increases are self-limited. Hospital-based practices do not have the same restraints when competing with other hospitals in their markets. As a result, hospitals have an option to “bid up” physician compensation to recruit new doctors and to stay competitive with the competition.

An even more interesting view of how compensation has changed is displayed in Figure 2, which shows how five years ago compensation in hospital-owned practices was generally slightly less than the compensation of doctors who owned their practices. Five years ago, the strategy for hospitals was to base physician compensation targets on an aggregate of published survey data. Since survey data covers the previous year, and the hospital was generally projecting its target for its next fiscal year, compensation levels lagged behind what private practice doctors earned. The lag is mirrored in the payment levels being lower than 100%.

There were several exceptions to this observed lag, even five years ago. Several years earlier, cardiology underwent significant changes in how government payers compensated cardiology imaging and related ancillary services in doctor’s offices. These changes were responsible for reducing the amount paid to doctor-owned practices under Medicare Part B compared to hospital-owned practices, which had different payment rules. Consequently, many hospitals entered a strategy of acquiring cardiology practices, paying their newly employed cardiologists competitive salaries and reaping the financial benefit of providing the cardiology ancillary services in another part of their system. A similar situation existed in urology: Many health systems created specialized departments and either acquired urology practices or recruited doctors, thereby increasing the demand for urologists and driving up market compensation levels.

As Figure 2 shows, in 2017, hospitals paid higher compensation than private-practice physicians earned. While observed in many specialties, the premium has not yet occurred in family practice without OB, probably due to the large number of physicians in the specialty and the relative ease of recruiting compared to the other specialties.

The economic environment for physicians is complex. As more physicians are employed by health systems, the economic dynamics driving physician compensation will become even more complicated. Where once private practices drove compensation levels, now it’s health systems with their ability to apply unrestrained resources to recruit and retain providers that seem to be the force affecting the market.