The Effects Of Covid-19 On Healthcare Executive Cash Compensation

It is critical to note that while the majority of organizations classify salary reductions as temporary, few have specifically defined when the temporary reductions will be lifted or how they will administer the restoration of salaries. We at Gallagher expect such decisions will be driven by each organization's financial situation, and thus we forecast some uncertainty in the healthcare market for salaries over the next six to nine months. However, based on current market intelligence and experience from other economic downturns, we do not expect a long-term, permanent reduction in base salaries of healthcare executives. More likely, the outcome will be that the pace of increases will slow for the next one to two years.

Incentive Award Uncertainty

By far the greatest impact to executive compensation as a result of COVID-19 is that of incentive pay. The vast majority of incentive programs involve a financial hurdle, or trigger, which must be achieved before any payout is possible. Due to the economic impact of the pandemic, many organizations will struggle to achieve that financial trigger in their current cycle. In addition, COVID-19 has changed the focus of healthcare; many of the strategic priorities set at the beginning of a plan year have become secondary considerations, replaced by each organization's more pressing needs in response to the crisis.

While the full impact of the crisis is yet to be understood, it's likely that many of the more prevalent healthcare organizational goals will be impacted. How has COVID-19 changed your organization's patient population, and how has that impacted patient satisfaction scores? Has COVID-19 affected the acuity of care you provide and has that had an impact on clinical quality measures? How have furloughs, pay cuts, added work, added stress, and added personal risk impacted employee and physician engagement? And, beyond looking internally at pre-established goals, how has COVID-19 impacted the national benchmarks? It may takes months before the data takes shape and provides these answers.

Many clients report that their incentive programs are unlikely to hit their trigger or achieve target level awards. Some organizations are letting their programs play out, while other organizations are still considering and discussing options.

While many organizations report that some sort of payout would be a just reward for the massive efforts given by so many, they do recognize a number of factors in play. Of utmost importance is the organization's financial ability to pay awards. But, there are also a number of other factors to consider. Organizations need to consider the equitable and fair treatment of employees across all levels within the organization, as well as the optics of any disparate treatment. Scrutiny can arise from a number of stakeholders including physicians, staff, community, and local media.

Our recent pulse survey indicates that about 30% of responding healthcare organizations have begun the process to implement changes to their incentive plan for the current cycle, with another 55% discussing potential changes.

Incentive Considerations

The first consideration is the financial wellbeing of the entity. While the majority of our healthcare clients are not-for-profit organizations, each organization's primary responsibility is to sustain itself and to continue operations. The majority of our clients fund incentive payouts from an excess of income over operational expenses. Organizations tend to set a financial trigger below budgeted levels at a point where the enterprise will remain profitable after accounting for the incentive plan cost.

Incentive compensation is an integral part of the total rewards program at most of our healthcare clients. Our 2019 National Healthcare Leadership Compensation Survey² found that 93% of health systems and 94% of hospitals provided short-term incentive programs to their executives. And while one perspective suggests that incentives are additional cash payments that reward for organizational achievements and performance, an alternative view is that incentives represent a carve-out of an executive's compensation, put at risk unless the organization achieves targeted goals Through any lens, incentive pay is a highly valued portion of an executive's total remuneration. The loss of this income component due to COVID-19 may impact the organization's ability to effectively attract, retain, and engage high-quality executive talent.

Boards and compensation committees are questioning the fairness of executives experiencing lost compensation through no fault of their own, and no fault of their organization, especially considering that executives are working harder than ever before. There have been enormous efforts given to change the way healthcare is provided today. Early in the pandemic, healthcare organizations addressed questions about the procurement of personal protective equipment and other critical medical equipment and supplies. Further, organizations have had to implement new practices to fight the spread of infection. Some organizations have built new telehealth operations from scratch. Technology departments have developed IT systems and procedures to support remote work, while human resource departments cope with furloughs or employee infections. Across the board, our clients have had to do so much to respond to this pandemic, delivering herculean efforts worthy of reward.

Another consideration in any decision related to incentive pay is that of internal equity and fairness. Executives have been asked to do so much to respond to this pandemic, but so have all healthcare employees. Not only have staff been tasked to help implement changes, but those on the front lines risk catching the virus, putting their health and that of family members at risk. Gallagher's COVID-19 Healthcare Pulse Survey Report #2, published in May, reported that 69% of 197 respondents had taken cost-saving action concerning non-essential staff. Actions included a mix of furloughs, pay reductions, and layoffs. Organizations paying or considering paying incentives or bonuses to executives must consider the fairness of those payouts if salary reductions are in place or employees remain on furlough. The optics of any unfair practices may bring scrutiny from stakeholders such as employees, volunteers, donors, community members, and board members, and may draw the attention of local media.

Healthcare organizations that pay incentives also must be mindful of IRS guidelines on reasonable compensation. Section 4958 of IRS Code, Intermediate Sanctions Regulations, provides a strict set of standards for reasonable compensation for disqualified executives. The IRS states that “Reasonable compensation is the value of services that would ordinarily be paid for like services by a like enterprise under like circumstances.” Our preliminary data suggests that a number of organizations will pay no incentives for the current cycle, or may pay reduced incentives. As a result, we might expect to see total cash compensation and total compensation figures that are flat or decreasing from the prior year. An organization that can afford to pay executive incentives should be mindful of this potential market fluctuation and should carefully articulate its rationale when making these decisions.

Total Compensation Considerations

Boards and compensation committees must carefully consider all relevant information related to incentives. They must consider the financial health of the organization, but also recognize the need to provide for market competitive compensation. Organizations must factor in the incredible efforts of plan participants against the desire to treat executives and staff fairly, and must be aware of the optics and any resentment or scrutiny they could face for a perceived imbalance. Finally, organizations must consider the impact of any incentive pay on the IRS's requirement for reasonableness of pay. Boards and committees will face a delicate balancing act this year as a result. In such a landscape, Gallagher offers the following recommendations:

Be Creative. So much of the total rewards playbook is consistent among healthcare organizations. Base salary positioning is guided by the organization's philosophy and a structured application of benchmarking and planned positioning within a range. Benefits, aside from certain executive-level benefits, are highly regulated and similar across all levels of an organization. Incentive plans also have shifted toward more consistent goals and metrics among similar organizations, in an effort to conform to industry best practice.

While the pandemic has had an immense impact on all of our healthcare clients, the effect on each client is unique. Certain areas of the country have experienced higher infection rates and varying state mandates. Organizations went into COVID-19 with unique financial positions and the financial impact of the virus has affected organizations differently.

Given the uniqueness of each organization's current financial position, its response to COVID-19, its changing priorities, and its competitive positioning, there has never been a better time to resolve that there is no one-size-fits-all solution to incentive plan design in healthcare. 

Not only are priorities shifting, but traditional incentive plan measures may no longer apply. How has the virus impacted traditional quality measures such as reinfection rates and falls when there has been a significant reduction in elective procedures? How has the virus changed the population of those treated at a facility and how have those changes impacted traditional patient satisfaction scores? How has the stress of change combined with the heightened risk to front- line physicians, mid-level providers, and nurses changed the organization's scores on physician and employee engagement? Not only do we expect to see changes across the board in raw scores, but how will COVID-19 impact industry benchmarks?

We advise our clients to be creative. We partner with our clients to create unique solutions that go beyond traditional incentive plan design to reward the incredible efforts at all levels of the organization. Exhibit B lists a few of the solutions we presented to clients for the current plan year cycle:

Exhibit B

Client Solutions

Be mindful of the competitive landscape. We guide our clients to set goals carefully so that their likelihood of achievement and payout mirrors that of their peers. Our experience is that our clients achieve their goals at target level or better in the range of 40% to 60% of the time; threshold or better is achieved around 80% of the time. For organizations that have had success and pay healthy incentives most years, the lack of a payout for the current year may seem disheartening and may appear to put your organization at a competitive disadvantage.

But, know that you are not alone. While it is too early to fully understand the exact impact to incentives throughout the industry, early indications are that there will be many organizations that fail to make any payments this year; many of those that do will likely pay out at a reduced level. Everyone understands the massive impact this virus has had on economies and industries across the globe. Most realize that we are all in this together. Many are suffering; small business owners are going bankrupt; people are dying.

It's unlikely, then, that valued executives look at their current situation (salary reductions and lack of incentive payout) as a strike against the organization and will use this as a motivation to seek employment elsewhere. Because of plan eligibility rules and service requirements, an executive can't jump to another organization and expect to receive an award. Ultimately, in this particular year, given this pandemic, an organization's lack of incentives should not be viewed as a competitive disadvantage.

As discussed earlier, if an organization has been less impacted by the virus and has otherwise achieved its goals to the point of triggering a plan payout, the organization should be mindful of the IRS requirement that compensation remain reasonable. Again, the IRS states that reasonable compensation is the value of services that would ordinarily be paid for like services by a like enterprise under like circumstances.

When determining the reasonableness of compensation, we look at all relevant facts and circumstances. In a normal year, we might expect to see compensation levels, especially with variable pay, at the very top of the market when an organization delivers exceptional performance and when incentives pay out at maximum levels. Similarly, in a COVID-19 setting, that same rationale can apply where an organization did well enough to pay incentives compared to a market where peer organizations were not able to pay incentives. The hypothetical line in the sand that separates reasonable pay from unreasonable pay will likely be blurred. Perhaps a solution is to adopt more sophisticated peer groups built not only around an organization's size and complexity, but also crafted to match relative performance levels against incentive plan goals.

Ultimately, boards and committees should seek the advice of reputable compensation professionals to provide accurate comparability data. Decision makers should review all facts and circumstances in cases where an incentive award may place a disqualified executive toward the top of the market.

Learn more about custom reward programs to fit your organization's specific needs during this unprecedented time. Gallagher can help protect your organization from unwarranted scrutiny from stakeholders and the IRS. Our advisors will work with you improve organizational wellbeing and face the future with confidence. 

Sources

¹ Gallagher's 2019 National Healthcare Leadership Survey with more than 2,300 responding healthcare organizations

² Gallagher's COVID-19 Pulse Survey #3, published in July, collected data from 160 healthcare organizations across 42 states, focusing on salary, incentive, and benefit changes in response to the COVID-19 crisis.

Disclaimer

© 2020 Arthur J. Gallagher & Co.

Consulting and insurance brokerage services to be provided by Gallagher Benefit Services, Inc. and/or its affiliate Gallagher Benefit Services (Canada) Group Inc. Gallagher Benefit Services, Inc. is a licensed insurance agency that does business in California as "Gallagher Benefit Services of California Insurance Services" and in Massachusetts as "Gallagher Benefit Insurance Services." Neither Arthur J. Gallagher & Co., nor its affiliates provide accounting, legal or tax advice.