Rising Hospital Employment of Physicians: Better Quality, Higher Costs?

Issue Brief No. 136

August 2011

Ann S. O'Malley, Amelia M. Bond, Robert A. Berenson

Driven by the desire to expand market share, hospitals have increasingly been hiring physicians in recent years to strengthen referral networks and boost admissions, according to the Center for Studying Health System Change's (HSC) 2010 site visits to 12 nationally representative metropolitan communities. Flat reimbursement levels, escalating overhead costs of running a private practice, and physicians' growing preference for improved work-life balance have all fueled physician interest in hospital employment. Although closer physician-hospital alignment has the potential to enhance quality through improved clinical integration and care coordination, employing physicians does not inherently lead to clinical integration. The growing trend of hospital-employed physicians could also drive up costs via elevated hospital and physician commercial insurance payment rates and institutional pressure on employed physicians to order costlier services. To this point, hospitals' chief motivation for hiring physicians has been capturing market share, often through profitable service-line strategies incentivized by a fee-for-service payment model that rewards higher volume. More recently, hospitals have come to view physician employment as a mechanism for positioning themselves for payment reforms that move away from fee for service toward models holding providers more accountable for both the cost and quality of patient care.

Hospitals Seek Patients and Leverage

Although not a new phenomenon, the rate at which hospitals are employing physicians has accelerated across many communities, propelled primarily by hospitals' drive to grow market share and boost revenue, based on findings from HSC's 2010 site visits to 12 nationally representative metropolitan communities (see Data Source).

In the vast majority of the 12 communities studied, hospital employment of physicians is expanding at a rapid pace. Notable exceptions include Orange County, where California law prohibits hospitals from directly employing physicians, though physicians there tend to be closely affiliated with hospitals through alternative arrangements; Boston, where physician organizations maintain tight alignment of non-employed physicians with the dominant hospital system; and northern New Jersey.

The majority of physicians work in solo or private, community-based group practices, with more than half holding an ownership stake in their practice as of 2008. In exchange for admitting privileges, independent physicians have traditionally served on the voluntary medical staff of one or more hospitals and fulfilled responsibilities such as on-call coverage and committee participation.

However, in recent years, multiple factors have eroded the traditional ties between community-based physicians and hospitals. Advances in technology enabled more care to be delivered in freestanding outpatient facilities, making physicians less dependent on hospitals and less inclined to take emergency call — and in some cases, directly competing with hospitals for profitable specialty services. Hospitals responded by employing specialists to handle on-call duties and to capture market share for lucrative service lines, including cardiac and orthopedic care, that they risked losing to competing physicians. Simultaneously, the growing prevalence of hospitalists who focus exclusively on inpatient care has likely contributed to the increase in hospital-employed physicians.

This recent surge of physician employment is not the first time hospitals have pursued this strategy. During the 1990s, the shift toward managed care and health maintenance organizations triggered a wave of hospital acquisitions of primary care practices designed to lock in referral bases. Hospitals generally lost money as the productivity of newly employed physicians declined, and many eventually divested the practices they had acquired. In contrast to the 1990s, hospitals today typically employ productivity-based compensation rather than straight salary arrangements (see the box below for additional detail on hospital approaches to employing physicians).

While the capacity of hospital-employed physicians to enhance quality and efficiency through improved clinical integration across care settings has garnered considerable attention, from the hospital standpoint, physician employment is usually just one of several strategies aimed at growing market share by driving up admissions, diagnostic testing, and outpatient service volume. Additionally, hospitals typically negotiate health plan contracts on behalf of their employed physicians, securing higher rates that enable them to offer more competitive compensation than independent physicians could obtain through their own negotiations. Physician employment is not the sole strategy hospitals deploy to forge tighter bonds with physicians — in markets where some physicians are less receptive to employment, hospitals are also creating contractual arrangements short of employment, such as physician hospital organizations, to strengthen these relationships.

Although hospitals initially focused their employment efforts on hiring specialists to develop targeted service lines — such as cardiac or cancer care — they have increasingly turned to recruiting primary care physicians to secure referrals for their employed specialists. "There is a mad grab to hire primary care physicians," observed a Greenville market respondent, echoing a sentiment expressed by many interviewees across the study markets.

After the enactment of national health reform in March 2010, hospital leaders also increasingly pointed to physician-hospital integration through employment as essential to preparing for anticipated Medicare payment reforms, including bundled payments, accountable care organizations (ACOs), and penalties for preventable hospital readmissions.

Learning from Experience

In contrast to the previous wave of physician employment during the 1990s, when salaried compensation was standard, hospitals today rely on productivity-based pay structures and have curtailed their purchases of practice capital assets. In the 1990s, hospitals frequently guaranteed physicians nearly 100 percent of the prior year's earnings during the transition to hospital employment.

Today, while hospitals employ the physician and staff, many choose not to purchase practice assets and often lease rather than buy a practice's office space or equipment. Hospital respondents also emphasized that they are more discerning about whom they hire, noting that they no longer acquire practices "for the sake of buying," as they admitted doing in the 1990s, but instead base decisions on "a stricter assessment of quality and service." Similarly, hospitals are retaining control of ancillary services performed by their employed physicians. A Syracuse hospital executive explained, "Last time, we found out the [hospital-employed] doctors were doing ancillary services at their own offices. So we won't be letting them do that this time around. We've learned a lot from that experience."

Even though many newly employed physicians keep their existing offices and do not relocate to the hospital campus, hospitals are stepping up their contractual and administrative oversight and consolidating practices to improve their position in negotiations with insurers and to track productivity and quality. Hospitals are also giving physicians expanded roles in governance and management. Hospital executives maintain that offering physicians greater leadership responsibility makes employment more appealing, strengthens physician loyalty, and helps improve the clinical effectiveness of care. As one Indianapolis hospital chief executive officer (CEO) stated, "I think the whole thing is about seeing physicians more as partners, rather than employees. If we [hospital administration] treat them as employees, they will act that way. And, in my estimation, you don't want employees taking care of patients. You want to be physician led and governed."

At certain hospital systems, employed physicians' compensation also incorporates efficiency incentives, encouraging them to minimize waste in supplies and reach consensus on standardized medical devices. One large hospital system's chief medical officer (CMO) described how orthopedic surgeons' performance on quality and cost metrics is tracked and reported back to them, enabling the system "to standardize [surgical device purchases] to one vendor and to [get the surgical team to] stop opening every piece of packaged surgical equipment on the table that might be needed." Surgeons have not pushed back against these waste-reduction initiatives because a portion of their compensation is linked to efficiency measures.

Physicians Seek Security

Physicians' motivations for pursuing employment — not exclusively with hospitals but with other organizations as well — include stagnating reimbursement rates amid rising practice overhead and a growing desire for better work-life balance. Hospitals are recruiting both primary care and specialist physicians. Primary care physicians (PCPs) face particular challenges sustaining independent practice because flat reimbursement and escalating overhead costs hit their practices harder, as they generally cannot generate substantial revenue from procedures and ancillary services. Even among some specialists, there has been a notable shift in attitude toward employment driven by reimbursement pressures. As an Indianapolis hospital CEO noted, "Specialists make a lot more money than PCPs, so for them to get cold feet about their independence in the future is monumental."

Further motivations for physicians include the need to navigate the complexities of evolving insurance and delivery systems under health care reform, implementing costly but increasingly essential health information technology, and avoiding steep malpractice insurance premiums, which hospitals absorb for their employed physicians.

For physicians entering practice for the first time, hospital employment is also appealing because of the perceived financial stability and work-life balance it provides. Data on medical residents' first-choice employment preferences bear this out — in 2003, just 4 percent indicated they would be "most open" to hospital employment, but by 2008, that figure had risen to approximately 22 percent. For instance, recruiting younger physicians to Syracuse is difficult without extending an employment offer given their substantial medical school debt. "They see the writing on the wall, where they can't buy into a practice, and joining a practice might not help with their loan forgiveness. Therefore, they're going to the highest bidder," a Syracuse hospital chief financial officer explained.

Hospital Consolidation Spurs Employment

Hospital consolidation remains a significant driver of physician employment by hospitals. In markets characterized by high hospital concentration, physicians face pressure to closely align with one hospital system or another. While hospital employment of physicians is more prominent in areas with elevated levels of hospital consolidation — such as Cleveland, Greenville, Indianapolis, and Lansing — it is also occurring in less-consolidated hospital markets, including Seattle, Little Rock, Phoenix, Syracuse, and Miami.

In certain markets, such as northern New Jersey and Miami, the local culture of physician independence shapes physicians' willingness to accept hospital employment. And if they are sufficiently large, some single-specialty and multispecialty groups can sustain their independence because they possess adequate leverage with payers.

Coordinated, Higher-Quality Care?

In theory, hospital employment of physicians can elevate quality by fostering better integration of care and communication among clinicians, but respondents indicated that clinical integration does not happen automatically once physicians become employees. Reflecting the views of many hospital CMOs across the 12 markets, a Lansing respondent observed, "Being able to bring all physicians together with a unified focus on quality, service and access is a challenge." At present, most clinical-process integration appears concentrated on single diagnoses or conditions rather than spanning all of a patient's medical needs. For example, according to numerous hospital CMOs, hospitals are targeting the "low-hanging fruit," such as reducing preventable readmissions among congestive heart failure patients.

Communication between inpatient and outpatient providers — even those employed by the same hospital system — continues to be problematic. As a Lansing hospital respondent noted, "Coordination of care, pre- and post-hospital, needs to be better. Care processes and pathways need to be integrated." Achieving genuine clinical integration, including improved communication, is difficult in the prevailing fee-for-service environment, according to respondents across the 12 markets studied. Hospital systems and clinicians vary widely in how far they have progressed in developing integrated care processes and deploying interoperable electronic health records (EHRs).

For instance, Cleveland Clinic, with a large share of employed physicians using a unified EHR, is further along the spectrum of information exchange for care integration than many other systems. Other markets remain at an earlier stage. As a Phoenix hospital CMO stated, "The lack of communication between outpatient and inpatient physicians is problematic. We know we need to start addressing it."

Potential for Higher Costs

Although hospital-employed physicians may catalyze clinical integration that eventually enhances efficiency and helps restrain costs, in the near term they are more likely to push costs upward. First, hospitals and their employed physicians continue to operate within a predominantly fee-for-service system that incentivizes delivering a greater volume of services. Productivity-based compensation structures used by many hospitals for employed physicians further reinforce these incentives. Multiple physician respondents reported that employed physicians face hospital pressure to order more expensive testing options. In one market, at least two cardiologists turned down hospital employment offers because they felt the pressure to increase volume was greater than what they experienced in their mid-sized, independent cardiology group.

Moreover, hospitals routinely impose facility fees for office visits and procedures conducted in formerly independent physicians' offices once those physicians have converted to hospital employment. The designations "hospital-based facility" or "provider-based facility" refer to a facility or office that is part of a hospital but may be located off the hospital campus. This provider-based status generates substantially higher Medicare payments than when physicians remain in independent practice, because there are now separate payments for professional services and for hospital outpatient facility fees. In effect, a physician practice can be acquired by a hospital without changing its location or even its operational practices, yet the hospital receives significantly higher Medicare payments if it meets the criteria for provider-based status. Because most commercial insurers follow the Medicare fee schedule with modifications, this practice can affect not only Medicare patients but privately insured patients as well.

Hospitals' practice of charging facility fees for physician visits not only drives up costs for payers but also for patients, since facility fees are subject to deductibles and coinsurance. In isolated instances, litigation has ensued, and institutions have reimbursed insurers and patients for facility fees under consumer protection laws, with hospitals subsequently posting their pricing practices.

Furthermore, the growing alignment between hospitals and physicians is providing them with increased leverage over health plans regarding payment rates. In markets with especially high levels of physician employment, such as Greenville and Indianapolis, insurers reported mounting difficulty in containing both hospital and physician payment rate increases.

Finally, respondents in several markets voiced concern that the employment of certain specialists — particularly those in geographic areas served by multiple hospital systems — contributes to higher costs because of artificially inflated compensation driven by bidding wars. An Indianapolis physician stated, "Hospitals are paying cardiologists over $1 million a year. Hospital costs are going up dramatically in our market. You are seeing a number of compensation offers that are multiples of what physicians had made historically."

Mixed Effects on Access to Care

The growing hospital employment of physicians seems to affect patients' access to care in varied ways. From the patient's perspective, a physician's employment by a hospital may go unnoticed, as many employed physicians continue to practice in the same offices they occupied when they were independent.

One potential advantage of physician-hospital alignment is improved access to employed specialists for low-income patients, especially those covered by Medicaid, who have historically faced difficulties accessing independent specialists. At the same time, as hospital employment of physicians expands, access to care can shift significantly for patients when a major hospital system withdraws from a health plan network.

Policy Implications

While the potential of hospital-employed physicians to improve quality and efficiency has attracted considerable attention, the possibility of higher costs has received comparatively little scrutiny. The prevailing fee-for-service payment system, which incentivizes hospital strategies that leverage employed physicians to drive referrals and admissions, combined with hospitals' market power to secure higher payment rates, risks overshadowing any potential quality improvements.

In essence, physician employment appeals to both hospitals and physicians within a volume-driven fee-for-service framework, and the expanding employment trend does not ensure that clinical integration will follow. The recent acceleration in hospital employment of physicians carries the risk of inflating costs without enhancing quality of care, unless broader payment reform diminishes incentives to increase volume and creates incentives for providers to transform care delivery in ways that achieve genuine efficiencies and higher quality.

Notes

1. Boukus, Ellyn R., Alwyn Cassil and Ann S. O'Malley, A Snapshot of U.S. Physicians: Key Findings from the 2008 Health Tracking Physician Survey, Data Bulletin No. 35, Center for Studying Health System Change, Washington, D.C. (September 2009).

2. Kocher, Robert, and Nikhil R. Sahni, "Hospitals' Race to Employ Physicians — The Logic Behind a Money-Losing Proposition," New England Journal of Medicine, Vol. 364, No. 19 (May 12, 2011).

3. Felland, Laurie E., Joy M. Grossman and Ha T. Tu, Key Findings from HSC's 2010 Site Visits: Health Care Markets Weather Economic Downturn, Brace for Health Reform, Issue Brief No. 135, Center for Studying Health System Change, Washington, D.C. (May 2011).

4. Merritt Hawkins and Associates, 2008 Survey of Final Year Medical Residents, Irving, Texas (2008).

5. Casalino, Lawrence P., et al., "Hospital-Physician Relations: Two Tracks and the Decline of the Voluntary Medical Staff Model," Health Affairs, Vol. 27, No. 5 (September-October 2008).

6. Berenson, Robert A., Paul B. Ginsburg and Nicole Kemper, "Unchecked Provider Clout in California Foreshadows Challenges to Health Reform," Health Affairs, Vol. 29, No. 4 (April 2010).

7. Boodman, Sandra G., "That'll Be $418 for Use of the Examining Room," The Washington Post (Oct. 6, 2009); and Suchetka, Diane, "Patients Fume over Cleveland Clinic Fee; Hospital Not Alone in Levying Facility Charge," The Plain Dealer (June 16, 2009).

8. O'Malley, Ann S., et al., Greenville & Spartanburg: Surging Hospital Employment of Physicians Poses Opportunities and Challenges, Community Report No. 6, Center for Studying Health System Change, Washington, D.C. (February 2011).

Data Source

HSC periodically conducts site visits to 12 nationally representative metropolitan communities as part of the Community Tracking Study, interviewing health care leaders about the local health care market and how it has evolved. The communities are Boston; Cleveland; Greenville, S.C.; Indianapolis; Lansing, Mich.; Little Rock, Ark.; Miami; northern New Jersey; Orange County, Calif.; Phoenix; Seattle; and Syracuse, N.Y. During the seventh round of site visits, nearly 550 interviews were conducted across the 12 communities between March and October 2010. This Issue Brief draws primarily on responses from hospital representatives — chief executive officers, chief financial officers, and chief medical officers — as well as physician organizations, health plans, and other knowledgeable market observers.

Funding Acknowledgement

The 2010 Community Tracking Study site visits and resulting research and publications were funded jointly by the Robert Wood Johnson Foundation and the National Institute for Health Care Reform.

Sources and Further Reading

NEJM: Hospitals' Race to Employ Physicians — Kocher and Sahni's analysis of the financial dynamics behind hospital acquisition of physician practices and its implications for health care costs.

Health Affairs: Hospital-Physician Relations — Casalino et al. on the decline of the voluntary medical staff model and the emergence of two distinct tracks in hospital-physician relationships.

CMS Medicare Physician Fee Schedule — Official CMS resource on Medicare payment rates for physician services, including provider-based billing rules discussed in this study.

Robert Wood Johnson Foundation — Co-funder of HSC's Community Tracking Study site visits and research on physician workforce trends and health care market dynamics.

AMA: Physician Employment Trends — American Medical Association data and analysis on the shift from independent practice to employed physician arrangements across the United States.