Finding the Sweet Spot: What’s the Best Option for Affiliation Between Physicians and Hospitals?

Many physicians are considering affiliation with hospitals in order to more effectively serve patients, manage risk, and reduce the stress associated with running a highly regulated small business while simultaneously practicing medicine. Over time, several different alignment models have evolved. Some physicians sell their practices to hospitals and become employees. Others work out various types of affiliation agreements with hospitals to share costs and risks going forward. Each of these models has pros and cons for the doctors and the hospitals involved. To make the best decision for your practice, you’ll need to understand the alignment strategies discussed below and evaluate which model makes the most sense for your business.

Employment

Perhaps the most comprehensive realignment strategy is the sale of a medical practice to a local hospital or healthcare system. This option typically provides the greatest amount of relief for physicians who want to step away from the stress of operating a business while they practice medicine, but it will also potentially come at the greatest cost both in terms of income and control of their work environment. On the income side, physicians in this arrangement usually look to the predictability of a stable income and the elimination of downside risk as benefits that balance out the potential reduction in future cash flows.

Hospitals in this arrangement derive benefit from the ability to staff their institutions with experienced physicians. They bear more upfront capital costs in this model than the various affiliation agreements discussed below, and they also assume more of the financial risks involved in the physicians’ practice of medicine.

The key for both parties is the negotiation of the fair market value of the practice and the go-forward compensation methodology for the physician(s). The employment agreements usually have a duration between three to five years, and hospitals will often require a noncompete clause to protect the value of the practice they purchase if the physician chooses not to renew.

Affiliation Strategies

Physicians who are looking to offload some of the stress, costs, and risks of their businesses without relinquishing full control of their practices typically consider one of three different affiliation models: a professional services agreement, a co-management arrangement, or a joint venture. These models can be used independently or together.

Professional Services Agreement

In a professional services agreement (PSA), a physician group agrees to assign billing to the hospital in exchange for an alternative compensation model, typically based on a “work relative value unit” (wRVU). The hospital may purchase ancillary equipment and consolidate the practice into a hospital outpatient department, and it may even absorb practice support staff into the hospital payroll. The hospital bears the risk of reimbursement for services, while the physician group remains at risk for rises and falls in patient volume. This model also allows the physician group to redistribute compensation among themselves, and it gives the doctors flexibility to stay independent and potentially enter multiple PSAs with several healthcare providers.

The PSA offers some of the compensation stability that the employment model delivers without requiring the physicians to sacrifice as much control. Hospitals in this model get more performance accountability from the physicians, as their pay is not guaranteed and will vary based on the number of patients they see. The agreement can be a complicated legal document, and the relationship between the hospital and the physician group can be subject to practice restrictions, fair market value, and regulatory constraints.

Co-Management Arrangement

In a co-management arrangement, physicians agree with a hospital to jointly manage a defined set of services, typically a clinical area, specialty, or service line like oncology, cardiology, surgery, orthopedics, neuroscience, OB/GYN, or urology. Physicians retain the income from their respective practices and receive compensation from the hospital for time spent managing the service line. These agreements can be made with a specific physician group or with multiple physician groups (either independent or employed with the hospital) specifically for purposes of managing the service line for the hospital.

These agreements offer flexibility to the participants, allowing physicians to operate independently or as employees, and they require less upfront capital investment than traditional joint venture models. The administrative functions tend to require significant time commitments from physicians, sometimes leading to concerns that the financial return is not worth the additional work that must be performed. It is recommended that hospitals and physicians receive a third-party valuation to ensure that the reimbursement model does not run afoul of laws that govern physician compensation and prohibit kickbacks.

Joint Venture

Lastly, hospitals and physicians may consider creating a joint venture to provide ambulatory services in a freestanding structure that may be on or off of the hospital campus. The hospital and physicians jointly own all of the physical assets of the newly formed entity and share in the bottom-line financial performance based on individual ownership.

Of the three affiliation models, the joint venture offers perhaps the most effective sharing of risks and costs among the parties and provides favorable opportunities for collaboration and shared expertise. From the physician’s side, this model tends to require more upfront capital investment than any other affiliation option, and it can present the greatest challenges when it comes to integrating multiple workplace cultures and working styles. The joint venture option has been around for some time now, and there are many success stories that new groups can look to for potential solutions.

Choosing the Right Option

While the affiliation models fall into some basic categories, the specifics of each agreement will be as unique and different as each party involved in the arrangement. Modeling out the potential alternatives can be a complex process given that there are many terms subject to negotiation and modification by the doctors and the hospitals involved.

Most participants in these transactions can benefit from an independent third-party advisor with experience modeling out potential alternatives to help the parties arrive at an agreement that best meets their needs. Ideally, that advisor should also have the technical expertise to handle administrative details and filings necessary to create new business structures, employment arrangements, fair market value capabilities, and other related tasks that bring the new entities online.

Whether you’re a physician looking to align with a hospital or a hospital considering an agreement with physicians, our team of experienced healthcare consultants is here to help. Please contact us to learn more about how we can help you.