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When is a Physician Compensation Valuation Out-of-Date?
Physician Compensation Valuation
For many appraisers, questions about the effective period of a valuation opinion are fairly uncommon. A business enterprise valuation for traditional purposes (i.e., transactional, tax, divorce, litigation, among others) is typically dated as of a specific point in time and based on data that is reasonably available as of the date of the report. These opinions are generally not utilized for a period of time, but rather for a specific purpose such as the purchase of a business or the calculation of a tax liability.
The valuation of a specific financial arrangement within a professional service arrangement (“PSA”) requires the appraiser to assign a reasonable effective period to the opinion. This is due to two primary factors:
- The financial term will be valid until the expiration of the PSA (or until such time as the financial term must be reassessed per the terms of the PSA)
- The financial term will be utilized numerous times throughout the life of the PSA
For example, consider a physician employment agreement with a two-year term through which a hospital pays a physician a rate for each work RVU performed. It is impractical to re-value the rate per work RVU each month when the compensation is calculated.
So at what point in time will the valuation opinion expire?
First, there is no set professional standard that places a specific time frame on the effective period of a compensation valuation. Ultimately, the duration of the effective period is the decision of the appraiser and therefore should be based on professional judgment. Appraisers should consider the specific facts and circumstances surrounding the assignment.
Many appraisers will limit the effective period of their physician compensation valuation to one or two years. Although there is no “one-size-fits-all” answer, the following outlines several factors that should be considered by the appraiser:
The evolving healthcare environment
The US government’s focus on improving the quality of healthcare while reducing total costs continues to cause changes in how and for what the market will pay physicians. Specifically, there has been and continues to be an ongoing shift in paying for quality over quantity. Assessing the role that market trends play in determining the value of physician compensation and predicting these trends are challenging.
For example, assume a seven-year compensation arrangement guaranteed a physician a fixed payment for quality improvement services. Three years into the agreement, quality payments were no longer occurring in the market. In this situation, the valuation opinion may no longer be reasonable or valid.
Changes in market survey data
Data from objective, market compensation surveys plays a vital role in determining the value of physician services. These surveys typically are comprised of data that is at least one year old in the current edition of each survey. Utilizing this data as a proxy to predict physician compensation in the future may be challenging: new survey data may be materially different due to changes in healthcare environment and numerous other economic factors. Importantly, if major changes occur in in the underlying market survey data, the FMV compensation determined in previous years may no longer be at current FMV levels.
Changes in reimbursement
Cash collections play an integral role in the determination of FMV compensation for physician services (specifically clinical services). Reimbursement changes by government payors are often difficult to predict and will vary year over year. Additionally, commercial reimbursement levels will often mirror changes in government reimbursement (1) . The uncertainty with future reimbursement levels is a primary challenge with issuing a valuation opinion for more than one or two years.
Changes in payor mix
In determining the FMV of physician clinical services, the payor mix of the patient population served by the physician is another important factor. Payor mix, similar to reimbursement, has a direct impact on the collections of a physician. Changes in local demographics, a hospital’s mission, or commercial reimbursement rates will all have a direct impact on the physician compensation valuation and are often challenging trends to predict.
Lack of a discount rate to offset projection risk
When an appraiser performs a valuation opinion of a business enterprise, a projection of cash flows is often utilized as a basis for value. In determining the present value of these cash flows, a discount rate is used. If the cash flow projections are more risky (i.e., high growth levels, historical volatility, uncertainty in the industry on future reimbursements, etc.) a higher discount rate is utilized and vice versa. In determining the value of physician compensation (using generally accepted valuation methods), there is no discount rate or other convention that can be utilized to gauge and address the risk of future projections such as collection levels, work RVU levels, or service composition.
Although the aforementioned list is not exhaustive, material changes in one or more of these factors during the life of a physician compensation valuation could significantly reduce the integrity of the concluded value. Due to the challenges faced with predicting how these factors will change over time, many appraisers will limit the effective period of their compensation valuation to one or two years.
1 It is common for commercial contracts to be set based on Medicare reimbursement levels (i.e., set as a percentage of Medicare, etc.).