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Combatting Patient Leakage by Directing Physician Referrals: What is Permitted under the Stark Law?

For many health care systems, patient leakage – when patients leave a health care system’s network in favor of out-of-network providers – is a rampant problem that results in substantial lost revenue.  While sometimes patient leakage is just a result of patient choice, often the issue lies with employed or contracted physicians referring patients for services outside the network.  Many health care systems may be wary of including in their physician contracts requirements that physicians refer patients exclusively within the network (otherwise known as directed referral requirements) based on concerns with interfering with physicians’ medical judgment and/or the common misconception that the Stark Law prohibits directed referral requirements.

To the contrary, the Stark Law actually permits directed referral requirements, provided that certain conditions are met.  CMS recently enacted changes to the Stark Law regulations, effective January 19, 2021, that provide additional clarity on how health care providers can permissibly use directed referral requirements.  These recent changes have seemingly triggered new awareness and interest in how health care systems can utilize directed referral requirements to combat patient leakage.

This article includes a discussion on (i) whether and how health care systems are currently using directed referral requirements; (ii) how directed referral requirements can be implemented in compliance with the Stark Law; and (iii) some best practices for health care systems interested in using, monitoring, and enforcing directed referral requirements.

Benchmarking Data: How Do Health Care Systems Use Directed Referral Requirements to Combat Patient Leakage?

In an effort to assess to what extent health care systems are managing patient leakage and whether they are utilizing directed referral requirements, Mintz reached out to clients and contacts at various health care systems to compile anonymous data.  This issue appears to be a timely and sensitive topic in the industry, trending with health care systems.   

Surprisingly, a slight majority of respondents answered that their health care systems do not include directed referral requirements in their physician contracts.  Some indicated that their health care system’s leadership is concerned that placing directed referral requirements on physicians poses risk, or is outright prohibited, under the Stark Law.  Others expressed concern about the optics; they would rather physicians choose to refer within the network because the network is the best, not because referrals are required.

On the other hand, some health care system respondents answered that their health care systems do include directed referral requirements in their physician agreements.  A small number of respondents – seemingly those in more urban areas where health care system competition is likely high – reported that they include directed referral requirements in their physician agreements; actively monitor compliance; require physicians to document in the EMR their rationale for any out-of-network referrals; and have in place methods, including disciplinary action and termination, to enforce directed referral provisions.  But a handful of these respondents stated that compliance with the directed referral requirements is not monitored, and there are no mechanisms in place to enforce them.  Overwhelmingly, respondents stated that they have never invoked disciplinary measures or termination to enforce directed referral requirements, nor did anyone indicate that they offer physicians any financial incentives to comply with directed referral requirements.

Directed Referrals under the Stark Law

Though it seems that health care systems infrequently use or enforce directed referral requirements, the Stark Law contains a special rule on compensation that does, in fact, permit health care organizations to require physicians to refer patients to particular providers or suppliers as a condition of their employment or independent contractor arrangement, provided certain conditions are fully met.

The directed referral provisions are not new; they were implemented back in 1998 in the Stark Law’s Phase I regulations.  However, CMS recently enacted important changes to the directed referral provisions, effective January 19, 2021.

First, CMS deleted the condition that the payment cannot take into account the volume or value of anticipated or required referrals because CMS adopted new mathematical formulas for determining whether an arrangement takes into account the volume or value of referrals.  According to CMS, applying the new formulas would not sufficiently identify directed referral requirements that could lead to program or patient abuse.  Instead, CMS replaced the volume/value requirement with a condition that neither the existence of the compensation arrangement nor the amount of the compensation can be contingent on the number or value of the physician’s referrals to a particular provider or supplier.  However, a percentage or ratio may be established.

Second, CMS expanded the number of Stark Law exceptions that require compliance with the directed referral provisions.  Previously, the directed referral provisions applied only to the exceptions for employment relationships, personal service arrangements, or managed care contracts, but they now apply under the following Stark Law exceptions:

  • academic medical centers,
  • physician incentive plan,
  • group practice arrangements with a hospital,
  • fair market value compensation,
  • indirect compensation arrangement, and
  • limited remuneration to a physician (which is a new exception).

Ultimately, the Stark Law’s directed referral provisions give health care organizations plenty of leeway to use, monitor, and enforce directed referral requirements in their physician contracts.  Below are a few examples.

Example 1 – Physician Contracts Contingent on the Number or Value of Physician Referrals.  A health care system includes directed referral requirements in its physician contracts and monitors physician referrals to ensure compliance.  The health care system determines that one physician has made a substantially lower number of referrals within the system than her colleagues and that her referrals have not generated a sufficient profit to the health care system.  However, the health care system cannot terminate the physician’s compensation arrangement solely on that basis because the existence of the arrangement would be contingent on the number and value of the physician’s referrals to the health care system.

Example 2 – Physician Contracts Contingent on a Percentage or Ratio of Physician Referrals.  A health care system uses directed referral requirements in its physician contracts and has set an established percentage or ratio of referrals. Specifically, the health care system requires that all physicians refer at least 90% of their referrals within the health care system.  The health care system monitors physician referrals and determines that one physician only referred 80% of his referrals within the network.  The health care system is permitted to terminate its arrangement with this physician as he failed to achieve the established 90% target.

Example 3 – Physician Contracts that Utilize Financial Incentives to Encourage Physicians to Comply with Directed Referral Requirements.  To incentivize physician compliance with directed referral requirements within its physician contracts, the health care system pays physicians a stipulated bonus contingent on the percentage of the physician’s referrals that are in network.  Physicians who refer 80% of their referrals within the network are eligible for a bonus equal to 5% of their total compensation, and physicians who refer 90% of their referrals within the network are eligible for a bonus equal to 10% of their total compensation.  This is permitted under the Stark Law’s directed referral provisions.  However, the health care system would need to take caution that any bonus pool used does not include referrals of designated health services, as defined by the Stark Law, or other business generated by the physician, which is generally not permissible under the employment and personal service arrangements exceptions.

Recommendations for Health Care Systems Implementing Directed Referral Requirements

Below is a list of recommendations for health care systems interested in utilizing directed referral requirements in their physician agreements:

  • Directed referral requirements must be in a signed writing.  A core requirement of the directed referral provisions is that any directed referral requirement must be in a signed writing, which can be easily effectuated by including it in physician contracts.  However, some health care providers employ the majority of their physicians and do not use physician contracts for their employed physicians.  (A signed, written contract is not a requirement of the employment exception).  In this case, we recommend health care providers create a form documenting the directed referral requirement and having employed physicians sign the form, perhaps as part of on-boarding.  The compliance or human resources department could facilitate this process.
  • Allow physicians to refer outside the network if the patient expresses a preference for a different provider or supplier, the patient’s insurer determines the provider or supplier, or the referral is not in the patient’s best interest.  Health care systems sometimes utilize directed referral requirements without specifying that such requirements do not apply in these situations. Such an omission poses risk under the Stark Law as one of the key requirements of the directed referral provisions is that directed referral requirements cannot apply in these narrow situations.  We also recommend setting up a process to operationalize this concept.  One straightforward method is to require physicians to document justification for out-of-network referrals in the EMR.  Another option is to require approval of any out-of-network referrals by a chief medical officer or department head, which would allow greater control to limit patient leakage, but also may present more of an administrative headache.
  • Determine how to monitor compliance with referral requirements.  From an operational perspective, monitoring referral data to ensure physicians are complying with their contractual directed referral requirements can be a challenge.  But this information can be captured through most EMR systems, and there are also specialized referral management programs on the market.  In addition, affirmative requirements for physicians to document their reason for an out-of-network referral can flag the referral for additional scrutiny.  Health care systems should consider designating a physician leader, compliance officer, or other personnel to monitor the referral data and engage with non-compliant physicians, as appropriate.
  • Consider establishing targets based on a percentage or ratio of referrals.  To the extent that a health care system wants to incentivize or enforce compliance with directed referral requirements, targets based on a percentage or ratio of referrals should be established.   Crucially, the targets should not be based on the number or value of referrals, but rather should be based on a percentage or ratio of referrals.
  • Consider bonuses or other financial incentives to encourage physician compliance with directed referral requirements.  Health care systems can also set up permissible financial incentives to encourage compliance with directed referral requirements without running afoul of the Stark Law.  Again, these bonuses cannot be contingent on the number or value of a physicians’ referrals, but they can be conditioned on physicians referring an established percentage of their total referrals within network.  But we advise proceeding with caution and, in particular, analyzing whether any bonus pools impermissibly take into account the volume or value of physicians’ referrals or other business generated – a common pitfall resulting in Stark Law noncompliance.
  • Ensure any disciplinary actions or terminations resulting from non-compliance with referral requirements comply with the Stark Law.  While CMS makes clear that health care providers may terminate arrangements with physicians that breach directed referral requirements, these terminations cannot be based on a physician making an insufficient number or value of referrals.  Terminations should only be used in situations where physicians failed to satisfy established targets based on a percentage or ratio of referrals.


The changes to the directed referral provisions are just one of a number of historic changes to the Stark Law and Anti-Kickback Statute regulations that went into effect earlier this year.  For additional information on these significant changes, you can access our full blog series and a recording of our webinar in which we reviewed key provisions from the new regulations and provided practical examples of how the industry can take advantage of these significant changes. We have also provided two comparison charts – one on the AKS and the Beneficiary Inducements CMP and another on the Stark Law – that offer an easy-to-read comparison between the current, proposed, and final regulations. 

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Karen S. Lovitch

Chair, Health Law Practice & Co-Chair, Health Care Enforcement Defense Practice

Karen advises industry clients on regulatory, transactional, operational, and enforcement matters. She has deep experience handling FCA investigations and qui tam litigation for laboratories and diagnostics companies.
Rachel Yount is a Mintz attorney who focuses her practice on health care industry transactions. Her clients include hospitals, health systems and plans, physician organizations, and pharmacy benefit managers.