Commercial Reasonableness Considerations with Physician Contracts

Determining if a health care organization’s payment to a physician is commercially reasonable can be a challenge. Additionally, people often confuse commercial reasonableness and fair market value, both of which are key compliance tests.

What does "commercially reasonable" mean?

There are two commonly cited definitions of commercial reasonableness:

  • The Department of Health and Human Services has defined the term as “a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals” (“Medicare and Medicaid Programs: Physicians’ Referrals to Health Care Entities with Which They Have Financial Relationships”; Federal Register, Jan 9, 1998).
  • CMS clarified the term in the Stark Phase II final rule as follows: “an arrangement will be considered ‘commercially reasonable’ in the absence of referrals if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician (or family member or group practice) of similar scope and specialty, even if there were no potential DHS referrals.” (69 FR 16093, Mar. 26, 2004).

Both Stark and Anti-Kickback statutes prohibit compensating a physician with money or non-monetary gifts for referring patients to an organization with which the physician has a financial interest. Payments to physicians must remain completely unassociated with the business they bring to your organization. It is important that every payment you make is justified.

Simply put, being commercially reasonable means that it is common business practice for an organization to pay for that particular physician service. For example, is it commercially reasonable for your organization to pay for general surgery call coverage? 81% of MD Ranger subscriber hospitals report paying for general surgery coverage, an objective validation that many hospitals compensate for the service. However, fewer than 1% of hospitals pay for dermatology call coverage and only 1% of MD Ranger subscribers report payment for colorectal surgery coverage. A less clear example is coverage for oncology, with only 16% reporting payment. To assert commercial reasonableness of a payment for such a service may require extra documentation and research on why your hospital requires a coverage contract for a service for which most hospitals do not have to compensate.

How can you determine commercial reasonableness?

The IRS provides guidance on how to evaluate whether an agreement with a physician is commercially reasonable. According to Internal Revenue Manual, §4233.27, specific factors should be considered while determining commercial reasonableness:

  • Duties and responsibilities of the physician.
  • Physician’s background and experience, as well as knowledge of the business.
  • Economic conditions of the marketplace.

You may also consider:

  • Does a physician have to perform the service, or can it be done by another clinician or professional?
  • Is it necessary to have a physician of a certain specialty in the position?
  • Is this a service that hospitals typically pay physicians to provide?

In addition to reviewing these questions, MD Ranger subscribers turn to our “Percent of Subscribers Paying for Service” tables which report the frequency of compensation for over 300 call coverage, direction, and other administrative and hospital-based physician services. We recommend using this number as a starting point in your physician negotiation process.

The following tables illustrate the distribution of subscribers that report paying for a broad range of services included in the MD Ranger benchmarks. As shown below, there are relatively few services for which most hospitals pay physicians. Chief of staff, general surgery call coverage and anesthesia services are among the most common. Other services are more frequently found in trauma or tertiary care centers, and still others are more commonly paid in rural hospitals.


How is commercial reasonableness different from “fair market value”?

Fair market value represents the standard market payment rate in an “arm’s length” negotiation for services performed in the absence of referrals, whereas commercial reasonableness addresses whether or not it is reasonable to pay for the service in the first place. In general, a determination of commercial reasonableness should be made prior to embarking on a FMV analysis. A commercially reasonable service could have payment terms that exceed, equal or fall below fair market value. Here are some examples:

  • Hospital A wants to pay for a second medical director of its Cancer Center. The MD Ranger benchmarks show that 22% of subscribers report paying for a Cancer Center medical director; however 100% of them only report paying for one position. If the second director is a co-director, and the sum of the hours and payments for both positions is with the range for a single director, payment would be reasonable. However, if both directors were paid at the same rate as a single position, and there were not unique, documented program and position requirements to justify a second position, the position and amounts paid may not be commercially reasonable.
  • Hospital B is asked to pay call coverage per diem rates for bariatric surgery. MD Ranger reports that only 1% of subscribers pay for bariatric call coverage; furthermore, as an elective service, the physician would be expected to arrange for after-hours coverage of his own patients. Without strong documentation, this payment may not meet a test for commercial reasonableness.

If something is negotiated at fair market value, is it commercially reasonable?

Not always. Just because a service is paid at a fair rate, it doesn’t mean that the service should be paid. One example is ophthalmology call coverage. For small to moderate sized emergency departments the frequency of calling in an ophthalmologist may be small, and payment for coverage is unusual, particularly if there is a good supply of ophthalmologists in the market. However, there are circumstances, such as an adverse payer mix or a high volume trauma facility, when there is an inadequate supply of community ophthalmologists willing to take call. MD Ranger publishes an ophthalmology coverage per diem that provides market benchmarks for FMV analysis.

MD Ranger encourages subscribers to first document commercial reasonableness then to evaluate the appropriate payment rate. Strong compliance best practice includes a narrative of the reasons to compensate for the service, along with a benchmark to document comparison to market rates and percent paying data.

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