Defensible by Design: A Framework for Physician Compensation in Today’s Regulatory Environment

In today’s increasingly rigorous regulatory environment, hospitals and health systems must ensure physician compensation arrangements are “defensible by design,” meaning they are proactively structured to withstand legal scrutiny rather than requiring reactive remediation. Enforcement of the federal Physician Self-Referral Law (“Stark Law”) and Anti-Kickback Stature (“AKS”), often pursued under the False Claims Act (“FCA”), has intensified, with unprecedented settlements and elevated whistleblower activity¹. Regulators and whistleblowers are increasingly focused on whether physician payments exceed fair market value (“FMV”), lack commercial reasonableness (“CR”) or vary with referrals. Any of these factors may trigger costly investigations and penalties.

The stakes for non-compliance are rising. In fiscal year 2025, FCA settlements and judgments exceeded $6.8B, the highest in FCA history. Of that $6.8B, over $5.7B related to matters involving the health care industry². Whistleblowers can emerge at any level of an organization, from compensation analysts to former executives, driving investigations into suspect physician deals³. In response, hospital and health system leaders must move beyond ad-hoc compliance fixes to a strategic, proactive approach. The objective is to embed compliance within compensation design, aligning arrangements with regulatory requirements and organization strategy from inception. 

Regulatory Imperatives

At a foundational level, physician compensation arrangements involving referral sources must satisfy an applicable Stark Law exception and, where relevant, an AKS safe harbor. In practice, that requires compensation:

• Be consistent with FMV
• Not be determined in a manner that takes into account the volume or value of referrals
• Be CR even in the absence of referrals.

These principles are not merely technical requirements. They reflect a core regulatory expectation that physicians are compensated for bona fide services, at levels commensurate with those services and supported by legitimate business purposes.

Failure to meet these standards can lead to severe penalties, including treble damages under the FCA, per-claim civil fines, and potential exclusion from Medicare programs⁴. Recent enforcement actions illustrate the risks: hospitals have paid tens or even hundreds of millions of dollars for employing physicians at outsized salaries above FMV or paying improper bonuses tied to referrals, as seen in cases like Community Health Network ($480 million)⁵, Covenant Health ($69 million)⁶ and St. Francis Health ($36.5 million)⁷. Even smaller providers are not immune. For example, Trinity Hospital disclosed and settled Stark violations for $1.7 million over above market office lease rates with referring physicians⁸. In short, government scrutiny spans organizations of all sizes, and no arrangement is too small to avoid attention in today’s climate.

Given this landscape, designing defensible physician compensation requires more than just hitting a survey benchmark; it demands a holistic framework that integrates compliance governance, documentation, valuation discipline, strategic alignment, and ongoing monitoring. Below is a practical framework hospital and health system leaders can apply to ensure physician compensation arrangements are built to be defensible from the outset.

Framework for Designing Defensible Physician Compensation

Strong Governance and Oversight

A disciplined governance structure serves as the first line of defense against regulatory risk.

Organizations should:

• Establish formal governance processes for physician compensation decisions
• Utilize multidisciplinary review structures, such as dedicated committees including compliance, legal, finance, and physician leadership to review and approve all significant compensation arrangements.
• Apply consistent system-wide compensation policies.
• Foster a culture of compliance and transparency that encourages early identification and escalation of concerns.

Effective governance, oversight, and standardized policies enable organizations to address potential issues before they escalate into compliance or whistleblower matters.

Alignment with Operational Needs and Commercial Reasonableness 

Compensation arrangements must be grounded in legitimate business and clinical needs. If a medical director stipend is proposed, for instance, ensure there is a genuine need and defined duties and a documented time log; paying for an unnecessary title or duplicative role raises red flags. Avoid purely nominal roles or vague responsibilities that could be seen as pretexts to funnel compensation. Instead, clearly delineate the services being compensated (clinical work, administrative tasks, on-call coverage, etc.) and how those services advance the hospital’s mission or fill a bona fide need. Align incentive components with quality, patient satisfaction, or efficiency goals so that physician pay supports strategic objectives, not just volume.

• Each compensation element should clearly align with a definable business or clinical purpose, such as expanding patient access, meeting coverage gaps, quality improvement, or leadership needs.
• Roles and responsibilities should be clearly defined and supported by documentation.
• Arrangements involving stipends or administrative roles should reflect genuine need and measurable services.

Clearly articulating the business rationale for each arrangement helps demonstrate that compensation is tied to bona fide services rather than referral generation.

 Rigorous FMV Analysis and Valuation Discipline

Ensuring compensation is and remains consistent with FMV is a cornerstone of defensible design.

Organizations should:

• Establish a disciplined valuation process for each compensation arrangement supported by objective market data and sound application methodologies.
• Engage independent third-party valuation expertise where appropriate.
• Apply valuation discipline before finalizing deals so that base salaries, productivity bonuses, call pay, and stipends all fall within supportable market ranges.
• Ensure that inputs provided for valuation analyses are accurate, complete, and supportable.

A well-documented FMV analysis for each component of compensation is crucial in demonstrating that compensation decisions are deliberate, supported, and non-referral based.

Comprehensive Documentation and Transparent Process 

Robust documentation is essential to defensible compensation design.

Organizations should:

• Maintain current, written agreements that clearly define services, compensation methodology, and payment terms.
• Avoid reliance on expired contracts or informal arrangements.
• Clearly define duties and expectations for services performed.
• Establish documentation protocols including supporting valuation analyses, assumptions, and decision-making processes.
• Maintain records of approvals, including committee materials and meeting minutes.

A clear and contemporaneous record demonstrating the rationale, process, and supporting data underlying compensation decisions can significantly strengthen defensibility in the event of regulatory review.  

Ongoing Monitoring and Adaptation 

Physician compensation should not follow a “set and forget” approach. Continuous oversight is critical.

Organizations should:

• Conduct periodic reviews of compensation levels, productivity, and performance.
• Identify and evaluate outliers relative to internal metrics and market benchmarks.
• Update arrangements as roles, responsibilities, or market conditions evolve.
• Perform regular audits of agreements, payments, and supporting documentation.
• Implement controls such as contract expiration tracking and escalation thresholds for compensation review.

By continuously measuring physician compensation against work performed, market norms, and evolving rules, health systems can ensure arrangements remain defensible year after year.  

Conclusion

Recent enforcement activity demonstrates how missteps in physician compensation can lead to costly consequences. However, these cases also provide actionable lessons.

A “defensible by design” approach requires weaving compliance principles into every facet of compensation decision-making, from governance and valuation to documentation and monitoring. By implementing strong governance, thorough documentation, disciplined analysis, strategic alignment, and active monitoring, hospitals and health systems can create compensation arrangements that are inherently defensible. This not only reduces legal risk and avoids the pain of multi-year investigations and settlements, but also builds trust among physicians, executives, and regulators.

In an era of heightened enforcement, proactive compliance is essential. A well-designed and well-documented physician compensation framework enables leadership to pursue organizational goals confidently, knowing that intent, process, and outcome are all aligned, making the arrangement defensible by design.

Contact a healthcare valuation specialist to learn more about physician compensation.