General Practice, Solo & Small Firm DivisionMagazine

Volume 17, Number 6
September 2000



John R. Washlick

Gainsharing describes a variety of compensation arrangements designed to align the economic incentives of hospitals and physicians to provide cost-effective care and to share in the cost savings through some combination of a percentage payment, hourly fee, or fixed fee. Hospital departments targeted for gainsharing consideration are those with high volume, involving procedure-driven specialties, where changes in physician behavior will have the greatest impact on the institution’s bottom line. The gainsharing models discussed are incentive compensation arrangements aimed at independent contractor physicians and not employee compensation models.

Gainsharing models have inherent shortcomings that may limit their effectiveness if employed as the only incentive arrangement. For example, the success of a gainsharing program is dependent on participating physicians changing their practice behavior. Gainsharing programs require sophisticated accounting systems to track the cost savings and measure the improved quality of care. Finally, such programs are not designed to encourage physicians to refer business to the healthcare system or to increase system revenues. Certain legal hurdles also must be negotiated. In addition to the Office of Inspector General’s (OIG) disfavor of gainsharing programs, citing violation of the civil money penalty (CMP) provisions of the Social Security Act, other legal impediments include federal income tax issues and federal and state antikickback and antireferral laws.

Federal Income Tax Issues. The IRA has favorably ruled, in two not-yet-published private letter rulings, that two hospital "gainsharing" arrangements will not adversely affect the hospitals’ tax-exempt status. Under both arrangements, the hospitals agreed to financially reward physicians who contributed to the hospital’s improved medical services and reduced costs. Important factors noted by the IRS were that the participating physician groups will provide valuable services resulting in tangible cost savings, and a third-party appraiser will place a fair market value cap on any physician awards. As long as a bonus arrangement is tied to an improvement in the organization’s delivery of its healthcare services, it should be permissible under the tax laws.

The intermediate sanctions impose an excise tax on a "disqualified person" who engages in an "excess benefit transaction" with an organization like a tax-exempt hospital that is exempt from federal income tax under section 501(c)(3) or (4) of the Code. There is no reason why a gainsharing program cannot be structured to comply with the intermediate sanction rules, particularly since it is designed to encourage physicians to improve medical practices and patient quality outcomes.

If a gainsharing arrangement will involve the use of tax-exempt bond financed space, it must comply with applicable tax-exempt bond rules and IRS guidelines regarding permissible private business use. The program must satisfy the "safe harbor" provided under Revenue Procedure 97-13, which sets forth permissible compensation and maximum terms with respect to the particular compensation arrangement.

Federal Fraud and Abuse Laws. The OIG condemns gainsharing arrangements between hospitals and physicians in which the hospital pays physicians an incentive to reduce or limit clinical services to Medicare and Medicaid beneficiaries. A special advisory bulletin did not address the legality of gainsharing agreements under the antikickback or Stark antireferral statute, but in a footnote to the SAB, the OIG noted that gainsharing arrangements might implicate the antikickback statute and the physician self-referral prohibitions.

According to the SAB, the OIG has taken the position that even though gainsharing arrangements may have significant benefits, such arrangements where hospitals award physicians’ efforts to reduce hospital costs by sharing hospital-based clinical savings are prohibited by federal law and are subject to civil money penalties. After extensive consideration of gainsharing arrangements, the OIG concluded that such programs pose a high risk of abuse because hospitals will be under pressure from competitors and physicians to increase the percentage of savings shared with the physicians, to manipulate the hospital accounts to generate phantom savings, or otherwise to game the arrangement to generate income for referring physicians.

In support of the CMP statutory provisions, the Government Accounting Office (GAO) studied several incentive programs involving payments to physicians by hospitals in exchange for reducing services. The GAO Report identified the characteristics of plans it had reviewed as presenting a high risk of abuse: short assessment and evaluation periods; evaluations based on individuals or small groups of physicians; and payment based on percentages of savings and profits. These risks could be reduced if the incentive plan were based on cost performances of a group of physicians over a long period of time, and not based on profit from any individual patients, and included utilization and quality review.

There is nothing in the SAB that per se prohibits hospitals and physicians from working together to reduce unnecessary hospital costs. What is prohibited, however, is a hospital’s paying physicians a share of hospital-based costs. In consequence, gainsharing ar-rangements should structure financial incentives broadly to reward physicians for the efficiencies they create. For example, the OIG suggests that hospitals and physicians may enter into personal services contracts where hospitals pay physicians based on a fixed fee that is the fair market value of services rendered rather than a share of cost savings to achieve the following objectives: substituting lower cost but equally effective medical supplies, items, or devices; reengineering hospital surgical and medical procedures; reducing utilization of medically unnecessary ancillary services; and reducing unnecessary lengths of stay.

The antikickback statute prohibits anyone from knowingly and willfully offering, paying, soliciting, or receiving any remuneration in exchange for, or to induce, the referral of a patient for an item or service covered by a federal program, or to recommend or arrange for the purchase of such an item or service. Safe harbor regulations protect certain business transactions from prosecution under the antikickback statute. The safe harbor most applicable to a gainsharing arrangement is that covering personal services and management agreements. To comply with the safe harbor, the gainsharing program must: be in writing and signed by the parties; specify the services to be provided; be for a term not less than a year; and have an amount of compensation that is set out in advance and not determined based on the value of volume of referrals or business otherwise generated between the parties. The inherent problem for most gainsharing arrangements qualifying under this safe harbor is that bonuses are determined by a formula and are not determined in advance. Nevertheless, if a gainsharing program fails to comply with a safe harbor, it will not necessarily be illegal. The government must prove that the parties "knowingly and willfully" en-gaged in a payment practice that violated the statute.

The Stark laws may be implicated because the referring physicians will be considered to have a financial interest in the hospital system sponsoring the gainsharing program by virtue of the compensation arrangement itself. To the extent any "designated health services" are provided within the meaning of the Stark laws, such as inpatient and outpatient hospital services, the arrangement must be structured to fall within one of the Stark exceptions. Two available exceptions may apply: the personal service exception and the exception for fair market value compensation.

Before a gainsharing program is implemented, state law should be reviewed to assure that no laws similar to the federal fraud and abuse laws will be implicated.

John R. Washlick is a partner with Morgan, Lewis Bockius LLP, resident in the firm’s Philadelphia office. He directs the firm’s Health Law Practice Group. He represents tax-exempt hospitals, for-profit and nonprofit HMOs, physician groups, and emerging healthcare ventures on a variety of tax and regulatory issues.

This article is an abridged and edited version of one that originally appeared on page 1 of The Health Lawyer, August 1999 (11:6).

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