American College of Physicians: Internal Medicine — Doctors for Adults ®


How the new Stark II regulations will affect doctor pay

From the March 1998 ACP Observer, copyright 1998 by the American College of Physicians.

By D. Louis Glaser, JD and Christine E. Bloomquist, JD

HCFA has finally provided long-awaited, detailed guidance on when physicians can legally invest in and have financial ties to health care companies. The details come in the form of proposed guidelines released Jan. 9, 1998, under the amended Ethics in Patient Referrals Act, known as "Stark II." The regulations are in proposed form at this time, but they shed light on how the government is likely to interpret the confusing Stark II law.

Specifically, HCFA's proposed regulations describe how group practices can pay their physicians who provide "designated health services," which are detailed below. Although Stark II provides leeway to medical groups that provide designated health services in their own offices, the new regulations will still change the way group practices can distribute profits from those services. Accordingly, this article summarizes key changes that will affect physician compensation. Because the proposed regulations are so complex, however, physicians should consult their attorneys to determine how the regulations might affect their specific compensation arrangements.


Under Stark II, physicians cannot refer their Medicare/Medicaid patients for designated health services to an entity in which they have an ownership or investment interest or some other compensation arrangement. Compensation arrangements are broadly defined and include employment arrangements and just about any form of independent contractor arrangement.

The law defines designated health services as clinical laboratory services; durable medical equipment (DME) and supplies; home health services; inpatient and outpatient hospital services; occupational therapy services; outpatient prescription drugs; parenteral and enteral nutrients, equipment and supplies; physical therapy services; prosthetics, orthotics and prosthetic devices and supplies; radiation therapy services and supplies; and radiology services, including magnetic resonance imaging, computerized axial tomography scans and ultrasound services.

Because of Stark II's breadth, it applies to a physician's ownership interest in a medical group and to a physician's employment by a group, hospital or other organization. Therefore, if the group or employer provides any designated health services to Medicare/Medicaid patients, the physician's relationship must be structured to comply with an exception under Stark II.

Exceptions are available under Stark II for the provision of certain designated health services in a group practice's office (the "in-office exception") and under certain employment arrangements (the "employment exception"). Although Stark II created these exceptions nearly three years ago, the new HCFA regulations provide significant guidance on how medical groups may use them.

The in-office exception

Under the in-office exception, a physician's ownership or employment by a group practice that provides designated health services is permitted, but only under certain circumstances. Referring DME services (other than infusion pumps) and parenteral and enteral nutrients, equipment and supplies are not covered under the exception, but referrals of other designated health services are permitted if:

  • The designated health service is furnished by the referring physician, by a physician who is a member of the same group practice as the referring physician, or by individuals who are directly supervised by a physician in the group.
  • The service is provided in a building in which other non-designated health services are furnished. If a referring physician who is also a member of a group practice provides the service, it can be provided in another building used by the group practice for the centralized provision of the group's designated health services.
  • The service must be billed by the physician performing or supervising the services, by a group practice that the physician belongs to (the group's billing number must be used) or by an entity that is wholly owned by the physician or the group.

A key component of the in-office exception is Stark II's definition of a group practice. One element of the definition requires that a physician who is a member of the group cannot "directly or indirectly receive compensation based on the volume or value of referrals by the physician." A physician, however, can be paid a share of the group's overall profits or a productivity bonus as long as it is not directly related to the volume or value of the physician's referrals.

The employment exception

Under the employment exception in Stark II, a physician's bona fide employment by an entity to which he/she refers designated health services is not prohibited if:

  • The employment is for identifiable services.
  • The compensation is consistent with the fair-market value of the services rendered and does not take into account, directly or indirectly, the volume or value of the physician's referrals.
  • The physician's employment contract would be commercially reasonable even if no referrals were made to the employer.

Under the statute, however, the second requirement does not prohibit the payment of a productivity bonus based on services performed personally by the physician.

Compensation arrangements

HCFA's proposed regulations significantly affect both the in-office ancillary services exception and the employment exception. Prior to publication of the regulations, the employment exception allowed groups to pay bonuses based on individual physicians' personal productivity. For example, a physician arguably could be paid a bonus equal to a percentage of collections from designated health services the physician actually performed (as opposed to services the physician ordered but did not personally provide).

Under the statute, the in-office exception permits groups to pay a physician a bonus based on profits or productivity, but only if they are not directly related to the physician's volume or value of referrals. For example, the physicians in a group could receive bonuses based upon an equal share of the profits from Medicare/Medicaid designated health services, but the group could not base an individual's bonus on the volume or value of designated health services the individual physician referred.

Despite the difference between these two exceptions, HCFA's regulations interpreting the exceptions bring the employment exception in line with the in-office exception by requiring that productivity bonuses not be directly related to the volume or value of a physician's own referrals. Under this interpretation, employers can no longer pay bonuses based on a percentage of cash collections derived from designated health services actually performed by the physician for his/her own Medicare or Medicaid patients (including the professional component of designated health services). An employer could pay a bonus based on services performed by an employed physician for patients referred to him/her by other members of the group.

How can groups award bonuses if the regulations are finalized with the interpretation discussed above? The employment exception no longer provides any advantage for a group that can meet the requirements of the in-office ancillary services exception. Therefore, unless a group or employer fails to meet the definition of a "group practice," the in-office ancillary services exception will provide the greatest flexibility to pay bonuses.

One method of rewarding a physician for productivity would be to pool the proceeds among all physicians who personally perform designated health services and pay each physician a share. The share could not be based on each individual's volume or value of referrals, but could be based on some other formula, such as dividing shares equally or basing shares on the number of hours worked or seniority.

A second method is to base a bonus on the overall profits of the group. If a group plans to award profit-based bonuses, it must decide how those profits are to be distributed before the services are performed and the profits earned. In addition, the group must determine its profits across all sites and specialties. A group with multiple sites cannot pay bonuses based on an individual site's profits from designated health services of an individual site. Similarly, multi-specialty practices cannot pay bonuses based on an individual specialty's profits from those services. Once the profits are determined, a bonus may be paid based on a manner that is not directly related to each physician's volume or value of referrals.

Finally, the new regulations also more narrowly define the term "referral." The term now pertains only to items or services that are designated health services that are paid for by Medicare Part B. Based on this change, group practices may be able to pay bonuses based on a physician's volume or value of referrals for non-designated health services and non-Medicare and Medicaid services.


The proposed regulations significantly affect the interpretation of Stark II. As a result, the in-office ancillary exception may give physicians greater flexibility in structuring compensation arrangements than the employment exception. Physicians, whether employed or members of a group practice, should therefore re-examine their compensation arrangements in light of the guidance provided in the proposed regulations.

D. Louis Glaser is a partner in the Chicago office of Gardner, Carton & Douglas and co-chairman of the firm's health law department. Christine E. Bloomquist is an associate in the Washington, D.C., office of Gardner, Carton & Douglas and a member of the firm's health law department.

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