Hospital/Physician Relations: How do you know if your organization is paying fair market value for services rendered?

(PYA Alert dated June 28, 2006)

The term “fair market value” has become increasingly important within the healthcare industry, particularly after the Stark II Phase II regulations were finalized on July 26, 2004.  However, what exactly does “fair market value” mean and how is it determined to ensure compliance for hospitals, clinics, and other healthcare entities?

Fair market value may be defined as, “The price at which the property or service would change hands between a willing buyer and a willing seller, neither being under a compulsion to buy or sell and both having reasonable knowledge of the relevant facts.”¹ 

However, as it relates to Stark II, the term “fair market value” is defined as the value in arm’s-length transactions, consistent with the “general market value.”  General market value is the price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party, or the compensation that would be included in a service agreement as the result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party, on the date of acquisition of the asset or at the time of the service agreement.²

At this time, the transactions most commonly evaluated for “fair market value” include, but are not limited to the following:

• Medical directorships;

• Call coverage arrangements;

• Financial support or subsidy agreements;

• Hospital/physician employment arrangements;

• Income guarantees;

• Real estate leases; and,

• Equipment leases.

The “fair market value” for these arrangements may vary significantly due to unique circumstances and services rendered, however, Stark II Phase II regulations provide guidance for establishing a “Safe Harbor” for physician compensation.  While Stark regulations recognize that “fair market value” may be determined in several different ways, there are two (2) methodologies as described below for establishing a “Safe Harbor” hourly rate for physician services:

1. the hourly rate is less than or equal to the average hourly rate for an emergency room physician services in the market, or;

2. the hourly rate is calculated utilizing the average of the 50th percentile of national compensation level for physicians with the same specialty in at least four surveys (as specifically acknowledged in the regulations) divided by 2,000 hours.³

If the market rate for emergency room physicians (Method 1) is not available, we would average the median emergency medicine compensation from four of the six surveys stipulated in the Stark II Phase II regulations (as listed below) to determine the “Safe Harbor” for an emergency medicine physician as follows: 

Dividing the average of the survey medians by 2,000 hours, the “Safe Harbor” hourly rate for an emergency medicine physician approximates $110.  However, outside of this “Safe Harbor” fair market value calculation methodology, Stark II clarifies that you may use other methods (as are appropriate under the given circumstances of the situation) to determine fair market value. These methods may include, but are not limited to:

• An examination of the costs associated with building or replacing the service being evaluated;

• A survey of available industry data (e.g. comparable service agreements in a relevant market under similar circumstances); and,

• An analysis of the specific circumstances (e.g., payor mix, patient volume, sub-specialization requirements, time requirements, etc.) surrounding the service or agreement being evaluated.

Because it is expected that the estimates determined by the various methods listed above for such arrangements will not be in exact agreement, a professional often uses objectivity, experience, informed judgment and reasonableness to determine an estimate (or range) of “fair market value.” 

If your organization has questions regarding Stark II regulations and how to determine “fair market value” for certain physician arrangements, please contact Marty Brown or Lyle Oelrich at Pershing Yoakley & Associates at (800) 270-9629.

1 Estate Tax Reg. 20.2031.1-1(b); Revenue Ruling 59-60, 1959-1, C.B. 237.
2 Federal Register / Vol. 69, No. 59 / Friday, March 26, 2004 / Rules and Regulations
3 Ibid.

The information provided via PYA Alert, Tax Planning Alert, or Audit and Accounting Alert should not be construed as accounting, auditing, consulting, or legal advice on any specific facts or circumstances. The contents are intended for general information purposes only.  Please contact us at (800) 270-9629 to discuss your specific situation or to discuss any specific questions you may have.

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