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Allocating overhead fairly when paying your members

Group Practice Solutions Discontinued, December 17, 2003

Physician compensation
Allocating overhead fairly when paying your members
No formula is perfect, but you have choices

The overwhelming majority of groups compensate their partners largely (though not always wholly) in proportion to their revenue production. But there’s a second issue lurking behind the scenes: how to allocate practice costs, which does not necessarily truly relate to how the doctors produce revenue.

Of course, some formulas seem to disregard the question by dividing the group’s net income—the bottom line after expenses are already deducted. This is a simple way to compute physician pay since it requires only one calculation, but it causes overhead to be allocated without really considering what is fair in terms of use of costs. That’s why so many formulas call for two calculations. The first divides practice revenues and the second allocates practice expenses.

Geoffrey T. Anders1, medical management consultant and lawyer, addresses these questions in his 168-page book, Playing Fair: Planning Group Practice Compensation. “If life were simple, the relationship between overhead and charges (or revenues) would be clear,” he writes. “We would be able to state without any hesitancy that there is a direct relationship between overhead dollars and revenues. It costs as much to earn the first dollar as it does to earn the millionth. Practice overhead is not volume-sensitive.”

Not that simple
“Some items of overhead are fixed and some are variable, but most are semi-fixed. You pay overhead for a system to handle up to a certain volume of patients. If you want to increase the number of patients seen [over that volume], you must expend another slug of over-head.”
This reality makes allocating expenses in paying physicians more difficult and often more contentious than we’d all like.

You could, of course, undertake true cost-accounting. This system treats each physician as a profit center. The method might seem ideal, says Anders, “but deciding how to treat each and every item of practice expense is a can of worms all by itself.” In addition, it may not make sense for each member of a group to be absolutely independent of the entity’s combined operations, and the politics of allocating general expenses so precisely may lead to more divisiveness than agreement.

Two choices
Anders offers two basic approaches: the “productivity-proportionate overhead allocation” and the “productivity-equal overhead allocation.” The question is whether the overhead should be charged equally because it is equally available, or on productivity because that is how it is used.

Here’s a breakdown of each:
• Productivity allocation. This approach assumes overhead is used and chargeable, or at least properly allocable, directly in relation to physician production. “Of course, that’s a dream world,” says Anders. “In the here and now, there is always a certain point when it costs almost nothing to see that extra patient.” The high producers can be shortchanged by this method since it reduces the reward for incremental production and inadvertently supports others at the low end of productivity.

This approach charges the most productive doctor with an expenditure whether he or she uses it or not, perhaps on the rationale that, if it’s spent or on hand, then the more one produces revenue—no matter how he or she does it—the more of it he or she should pay for.

Sometimes, notes Anders, the approach is eminently fair. He gives an example of two orthopedists, one of whom “works calmly and smoothly” while his partner is a “wild man, ordering assistants hither and yon, racing up and down the corridor and getting his patients into any available exam room.”
That latter physician consumes more of the available resources.

• Equal allocation. This formula has “its own delusional world view,” Anders says. It assumes that each doctor has an equal opportunity to use the facility and services, that each one actually uses an equal share of overhead and that none have any overhead costs directly related to his or her individual practice.

“If the group’s objective is growth and increasing market share, this method may well be the very worst,” says Anders. It favors the senior and most productive doctors and can badly shortchange the younger doctors building up their practices.

This approach has its proponents who argue that practice overhead is equally available to all the users. We often see it forced on groups when the largest producers have the strongest sway in key practice decisions.

Each method has its advantages and its shortcomings. The decision may depend on the dynamics of your group, for no one answer is necessarily the right one. None is perfectly fair, he says, so you have to find the one that works best for your group.

Sometimes a combination approach will work well, charging some portion of overhead equally and another portion on productivity, compromising so there’s a bit of fairness and unfairness for everyone. Still, “you’ve got to pick something,” Anders says.

Dividing overhead equally?

Consultant Geoff Anders1 tells this story about a two-doctor group dividing income equally:
“A senior general surgeon divided facility cost equally with her new partner. Except on surgery days, Dr. Senior held office hours in the morning between 7 a.m. and 11 a.m. Dr. Junior had the office to himself during the afternoon hours between 1 p.m. and 5 p.m., giving them equal use of the facility. This might strike you as a fair arrangement: Equal use, equal cost. But how about if we tell you that the vast majority of patients preferred the morning hours so they could still get in a day’s work?”