April 1997 Bulletin

What you need to know about a bonus

Two common formulas to reward, motivate

by Daniel M. Bernick, JD

Daniel M. Bernick, JD, is an attorney and consultant with The Health Care Group.®

Many practices negotiating contracts for newly-trained residents want to offer a bonus to make the practice's offer financially attractive and to motivate the associate to work hard. If your orthopaedic practice is in this situation, consider what kind of bonus-if any-you should offer. Recognize that, in many situations, you need not offer a bonus to compensate the new associate fairly. Providing a market-competitive, guaranteed salary- together with the potential for future partnership-entitles your orthopaedic practice to expect good performance from the associate.

On the other hand, there are situations in which a bonus is appropriate, or perhaps even necessary, to achieve your objectives. There are many good reasons to offer a bonus, including:

Two common bonus formulas are the "percentage-of-collections" method and the "net income" method.

Probably, the most frequently employed approach is a "percentage-of-collections" bonus. A typical formulation is that the employee receives a bonus equal to one-third of his or her net collections in excess of two times the cost of his or her base salary and benefits costs.

Formula: Bonus = [N - 2 x (S + B)]/3, where N = net collections, S = base salary, and B = benefits. Thus, in a hypothetical situation in which N = $550,000, S = $175,000, and B = $25,000, the bonus would be equal to $550,000 - 2 x ($175,000 + $25,000)/3 or $550,000 - $400,000/3 = $150,000/3 = $50,000.

A practice may decide to establish a higher bonus threshold. That is accomplished by multiplying the new associate's base salary and benefits costs by a number higher than 2. When the multiplier is 2.5, the bonus would be equal to $550,000 - 2.5 x ($175,000 + $25,000)/3 or $550,000 - $500,000/3 = $50,000/3 = $16,666.

The idea behind the percentage-of-collections bonus is that once the associate has "covered" his or her salary, benefits and overhead costs, he or she should get a piece of the practice's "excess" revenues, or the "profit" on his or her work.

Advantages of this method are that the formula is easy to understand and the method often is very attractive to candidates, provided they consider the bonus threshold to be attainable.

The primary disadvantage of this method is that it tends to penalize the practice's senior physician(s) for shifting work to the new physician. This drawback is especially pronounced for solo practices, because there is only one physician to bear the burden of funding the new associate's bonus.

Especially during the new associate's early tenure with the practice, the practice's established physicians will provide the new associate with most of his or her patients. Thus, the established physicians may need to reduce their volume to keep the new associate busy. The corollary is that the new associate's bonus, fueled by these internal referrals, will be funded, in essence, by cutting the established physicians' pay.

This drawback of the percentage-of-collections method may not be an issue in some situations, such as:

However, even if hiring the new associate enables the practice to expand, it is unlikely that this expansion can be achieved during the associate's bonus period, which is his or her first year or two of employment.

Another problem with the percentage-of-collections bonus may not be as obvious, but is potentially damaging. If the formula uses a multiplier larger than 2, it may set the bonus threshold too high for the new associate to reasonably expect to achieve, especially in the first year. Once the new associate plugs realistic numbers into the equation, it will be readily apparent that the goal will be difficult, if not impossible, to achieve.

The main alternative to the percentage of collections method is the "net income" formula. In this alternate approach, "net income" is defined as the practice's net receipts minus all tax-deductible practice expenses, including the new associate's salary and benefits, but excluding the salary, bonus and retirement plan contributions for the established physician(s).

Using the above definition, this approach works as follows: if the established physician's cash-basis net income during the new associate's first 12 months of employment exceeds the established physician's net income in the year preceding the arrival of the new associate, the new associate receives a bonus equal to 40 percent of the excess (the difference between the two figures).

If the established physician's cash-basis net income during the new associate's second 12 months of employment exceeds 105 percent of the established physician's net income in the 12 months preceding the new associate's starting date, the new associate receives a bonus equal to 45 percent of that excess.

To make the net income bonus easier to attain, adjust the bonus threshold in the preceding steps to 95 percent, 90 percent (or less) of past income, rather than using the 100 percent or 105 percent mark, as indicated above.

The main advantage of the "net income" formula is that it guarantees the senior physician will not fund the new associate's bonus through a cut in his or her own pay. The net income approach realigns incentives so that the established physician is financially rewarded, rather than penalized, for internally referring work to the new associate.

The established physician internally refers as many patients as possible to the new associate, and works with the new associate to expand the practice. If, as planned, practice expansion results in increased income for the established physician, the net income bonus formula automatically triggers a bonus for the new associate. If, however, the established physician's income remains the same as it was before the new associate joined, or if it shrinks, then the new associate receives no bonus.

No bonus formula is perfect. Determining what is best for your particular practice requires an assessment of your practice, including a review of the goals, needs, and desires of the practice's established physician(s).

©1997 The Health Care Group®

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