Nonclinical-related services are those services where the tasks, duties, responsibilities, and accountabilities (TDRAs) associated with the position are not directly related to the treatment of patients. Examples of nonclinical-related roles include: (1) chief executive officer; (2) chief financial officer; (3) chief information officer; (4) chief legal counsel; and, (5) other “C-suite” executives, as well as numerous strategic and operational management positions, such as, practice administrators, billing managers, payor contracting managers, and other nonclinical-related support staff. The progression of the corporatization of medicine has resulted in the transformation of the provision of healthcare services from a “cottage industry” where physicians have a more direct personal relationship with their patients, to a more commercial endeavor, where a patient may have multiple physicians, specializing in various fields, who may or may not collaborate together to provide for an episode of care. This trend toward corporatization has caused an expansion in the TDRAs of physicians, enhancing the traditional role of focusing solely on clinical-related activities, such as the production of professional physician services, by adding roles which include the provision of nonclinical-related services, e.g., administrative, strategic management, and/or executive roles.

This second installment in the four-part Health Capital Topics series on the classification and valuation of compensation for healthcare services will provide a brief overview of the valuation process for physician executive services.

The economic value analysis for determining the fair market value (FMV) of administrative, management, and executive services is governed by the economic principles of Utility and Substitution.¹ In the past, compensation for administrative, management, and executive services performed by physicians may have been based on the physician’s historical clinical practice earnings,² which are similar to compensation arrangements that include physician clinical services.³ However, there is increasing concern from regulators that compensating physician administrators based on the “opportunity cost” for the physician executive may raise regulatory concerns under the Stark Law. Physician executive compensation should instead be based on the value of the actual services performed.⁴ (For a further discussion of compensation based on actual services performed, see the December 2014 Health Capital Topics article, “Threshold of Commercial Reasonableness: The Qualitative Analysis.”)

While, in most circumstances, the opportunity cost of a physician provider of clinical-related services should not serve as the sole basis for determining physician executive compensation for the performance of administrative, management, and/or executive services, it is nevertheless important for the valuation analyst providing an opinion as to the FMV and commercial reasonableness of an administrative, management, and/or executive compensation arrangement to appropriately apply the economic concepts found in the Principle of Substitution and the Principle of Utility (which were also discussed in Part One of this four-part series) in performing their analysis.⁵ It should be noted that compensation for nonclinical-related services provided by nonphysicians should also be based on the actual services performed (which are distinguished by the TDRAs related to each position).⁶

In developing a certified opinion of value regarding nonclinical-related services, a valuation analyst should request and obtain all of the requisite documents related to the proposed compensation arrangement(s). These documents may involve the following:⁷

1. The proposed employment agreement(s) for the provision of administrative, management, and executive services (including a detailed description of all TDRAs related to the services to be performed);
2. Employment agreements for other similar positions at the employer entity, including the scope of services to be performed under each of those agreements;
3. Documentation as to the board certification, qualifications, and tenure of those individuals performing administrative, management, and executive services under similar agreements;
4. Documentation of offers made to previous (or other, current) professionals/executives for similar positions;
5. Documentation as to the medical staff’s need for administrative direction (based on the scope of the employer’s activities, research efforts, community outreach programs, etc.);
6. The employer’s medical staff bylaws and roster of employees (both clinical and non-clinical);
7. The employer’s administrative/management/executive employment agreement(s), with annual hour requirements and annual compensation paid to each professional/executive;
8. Time sheet records documenting the actual time spent and actual work performed by the individual on each administrative function and service related to the position;
9. Information related to the size of the employer, revenue,  number of patients, acuity levels of patients, and the specific needs of the employer;
10. Information related to the number of committees/meetings that require the professional/executive’s involvement and/or attendance, as well as the average frequency and duration of each committee/meeting;
11. Documentation that the employer, at a minimum, annually assesses the effectiveness of the professional/executive in performing the specified tasks, duties, responsibilities, and accountabilities; and,
12. A description of quality programs, including Centers of Excellence and “Never Event” Committees, in which the individual may participate.⁸

Once the requisite documentation is collected, a detailed examination of the attributes of the subject nonclinical position should be undertaken, with each element of the attributes of the role first identified as to their existence and then classified as to the specific factors and traits (i.e., the TDRAs) related to each attribute. This classification would exhibit the means by which the subject services could reasonably be expected to provide utility, i.e., usefulness, to the employer contracting for the professional/executive services to be performed going forward.⁹

After the administrative, management, and/or executive TDRAs to be provided are established, the proposed compensation arrangement should be compared to applicable, external benchmarking sources reflecting similar TDRAs, in order to determine whether the compensation arrangement meets the regulatory thresholds of FMV and commercial reasonableness. This “benchmarking analysis” for nonclinical-related services should include the following steps to ensure that the most relevant external benchmarking data is used for the comparison:¹⁰

1. Determine the specific characteristics of the arrangement, including:

   1. Applicable job training and education level of the professional/executive that is relevant to the position;
   2. Number of years of experience and reputation of the provider;
   3. Size of the organization (e.g., revenue, number of employees);
   4. Site of service (e.g., hospital, office-based physician practice, hospital service line, ambulatory surgery center); and,
   5. Geographic location where the subject services are to be provided;
2. Establish the homogenous units of economic contribution to be used as the metric(s) of comparability (e.g., annual, monthly, hourly, per employee, per dollar of revenue); and,
3. Develop the range of applicable, industry normative benchmark data, which should include measures within the range, (e.g., 10th percentile, 25th percentile, 75th percentile, 90th percentile), as well as measures of central tendency (e.g., mean, median) and measures of dispersion (e.g., standard deviation).¹¹ The range of industry normative benchmark data is typically compiled by taking a weighted average of the selected external benchmark data sources that report the specified metric(s) of comparability. The percentage of consideration assigned to each data source, used to compile the range of industry normative benchmark data, should include consideration of the following statistical and descriptive survey characteristics:

   1. Size of the data population sample included in the external benchmark survey;
   2. Dispersion of the data; it should be noted that a useful metric for comparing the relative dispersion between data sets for the purposes of determining an applicable weight of consideration in calculating a range of applicable, normative benchmark industry data is the coefficient of variation;¹²
   3. Geographic proximity in relation to the area in which the subject services will be provided; and,
   4. Other areas of comparability between the external benchmark data source and the subject services (e.g., whether the external benchmark data source includes information specific to the subject nonclinical-related services position, the date the external benchmark data was compiled).¹³

While normative benchmark industry survey data may be sufficient to establish FMV compensation rates, further analysis should be performed to determine whether the arrangement meets the related threshold of commercial reasonableness.¹⁴ Significantly, even though a proposed compensation amount for administrative, management, and/or executive services may be deemed to be within the range of FMV, the related administrative, management, and/or executive TDRAs should be analyzed to determine whether they are reduplicate or redundant. TDRAs for an executive position that exactly mirror the TDRAs already being provided to the organization by an alternative position, i.e., reduplicative, may not meet the threshold of commercial reasonableness. Further, TDRAs that are similar to TDRAs already being provided to the organization by an alternative position, also may not meet the threshold of commercial reasonableness. However, these reduplicative and redundant services may be justified in those circumstances where the size and scope of the organization necessitate a greater level of service than could be provided by a single individual.¹⁵

A certified opinion as to whether the proposed executive compensation agreement is both within the range of FMV and commercially reasonable, prepared by an independent, certified valuation professional, working with competent healthcare legal counsel as to the pertinent regulatory thresholds, and supported by adequate due diligence and documentation, will significantly enhance the efforts of healthcare providers to establish a defensible position that the proposed compensation arrangement is in compliance.¹⁶ This is particularly important in the heightened and ever-changing regulatory environment in which healthcare providers operate, with the potential severity of penalties, as well as related business consequences of entering into transactions and arrangements that may subsequently be found to be legally impermissible.¹⁷

The third article in this four-part series on the valuation of compensation for healthcare services will discuss the valuation of compensation for call coverage services in the healthcare industry.