Why Physician Compensation 'Caps' Exist

February 4, 2015

The law can limit a physician’s potential income by placing a cap on earnings. Here's when, why, and what physicians should know.

Most doctors believe the harder they work, the more they will see the financial benefit of such hard work.  This is generally a true statement.  To incent physicians to work hard, physician contracts typically reward physicians based on their clinical production and other contributions made to the success of their employer.  There are situations, however, where the law can limit a physician’s potential income by placing a “cap” on earnings. 

There are many reasons why “caps” on compensation exist. This is seen most often with non-profit hospital employers which, under the Internal Revenue Code, qualify as exempt from federal income taxation.  There are certain rules such hospitals must follow, which do not allow a tax exempt hospital to pay a physician more than “reasonable compensation” for services rendered to the organization.  Violating this requirement can cause a hospital to lose its tax exempt status and result in civil sanctions.  To make sure no violation occurs, hospitals commonly cap physician income after going through an extensive process of trying to establish “reasonable compensation.”

Another limitation to physician compensation are laws such as Stark and Anti-Kickback laws.  Stark prohibits a physician from referring a federal patient for designated health service (DHS) to an entity with which the physician or an immediate family member has a financial relationship.  Since physicians have a financial relationship with their hospital employer, referrals of DHS to employers can implicate Stark. 

Generally, physicians fall within the “bonafide employment arrangement exception,” which allows physicians to be compensated, as long as the amount paid is for identifiable services, consistent with fair market value and not determined in a manner that takes into account volume or value of referrals by the referring physician to the hospital.  Remuneration between the hospital and physician must also be commercially reasonable, even if no referrals were made. 

The definition of “fair market value” for Stark purposes is typically obtained by published surveys.  In its commentary to Stark, CMS recommended the use of multiple, objective, independent published surveys to evaluate the fair market value of physician compensation. 
Setting compensation at a level that is not supported by these surveys would arguably violate Stark, and thus caps are typically set using this data to assure no more than fair market value is paid.

Similarly, the Anti-Kickback statute is also concerned about whether compensation paid to physicians is really disguised kickbacks for referrals to the hospital.  Meeting the bona fide employment safe harbor to the statute can again resolve these concerns. 

There are quite a few cases out there that have made hospitals increasingly nervous about physician compensation. For example, Covenant Medical Center in Iowa allegedly violated Stark by paying commercially unreasonable compensation to physicians in exchange for referrals. The physicians were supposedly among the highest paid hospital-employed physicians in the entire country.  The hospital settled for $4.5 million. 

In my experience, there is a wide range of compensation paid to physicians across the country. Although most hospitals seem to compensate physicians at the median for their specialty and region, others will compensate physicians at much higher or lower rates. 

Typically, I see caps on physician compensation at approximately 90 percent to 95 percent based on an average of national and regional data.  For many physicians, this is a cap they will never come close to reaching; however, for specialties where physicians are very highly compensated, this cap can limit earning potential. 

In handling these situations, it’s always advisable to scrutinize the data to makes sure everyone agrees what data is to be used for the cap (some data pushes the cap higher than others).  Some hospitals may be willing to review compensation annually where a cap is exceeded in order to determine (and document) that amounts were actually earned and should be paid.  However, this approach is far from the norm.

Physicians with concerns about caps placed on their compensation should be aware of the reasons behind such limitations, but should also not be afraid to question data and to seek advice on whether established caps are fair and reasonable.  

Whether concerned about a cap or not, all physicians should understand where their compensation falls based on national data in order to be sure they are being fairly compensated.