Less risk, more retention: How the COVID-19 pandemic has changed how healthcare execs get paid

The COVID-19 pandemic has pushed healthcare leaders to rethink just about every aspect of their operations—even how they pay people.

Several investor-owned healthcare companies have reformulated how they calculate their biggest category of executive compensation: long-term incentive plans. Compensation experts say the crisis has accelerated the shift toward a form of stock award that retains value even during volatility and only pays out if executives stick around. And with financial results more up in the air, some have eased up on the use of performance goals.

“The world has changed pretty quickly,” said Michael Halloran, a senior partner with Mercer who specializes in executive compensation.

By the time the first COVID-19 spike hit the U.S. in March 2020, many publicly traded companies had already approved their 2020 executive compensation plans. The crisis was still in full force when they crafted their 2021 plans. Although those plans won’t be made public until next year, compensation consultants said the pandemic had a definite influence on how they structured LTIPs.

Long-term incentives are a bigger deal in healthcare than other industries. They constituted almost 70% of healthcare executive officers’ total direct compensation in 2019—75% for CEOs—compared with a median of 56% across 11 other industries, according to consultancy Gallagher.

This year, many companies decided to weight more heavily toward what are called restricted stock units, said James Reda, a managing director at Gallagher and leader of its executive compensation practice. In rarer cases, they shifted entirely to RSUs.

Restricted stock units are granted to executives in increments over a specified number of years. Executives only get the awards if they still work for the company. In that way, it’s a retention tactic.

“People are going to start jumping jobs,” Reda said, “so having restricted stock that’s unvested is going to be a speed bump.”

It doesn’t always work, though. Tenet Healthcare’s former chief human resources officer, Sandi Karrmann, gave up RSUs worth $975,000 at their February 2020 grant date when she resigned from the Dallas-based hospital chain in October 2020 to fill the same role at Kimberly-Clark. In cases like that, the company doing the poaching often agrees to pay their new employee the value of the RSUs they were scheduled to receive.

Healthcare—and most other industries—for years had been evolving toward using stock awards that vest based on time or meeting performance goals and away from stock options as compensation.

Stock options give executives the right to buy or sell stocks at set prices within a specific time period. But the pandemic laid bare their fatal flaws: Their value is the same whether executives stay with the company or seek greener pastures. And when stock prices bottomed out at the height of the pandemic, the value of executives’ stock options plummeted right along with them. Even though the losses were temporary, they still wiped out years’ worth of gains in some cases.

Roughly 15 years ago, long-term incentive pay was comprised almost entirely of stock options, Reda said. Today it’s more like 20%.

“Stock options are not in vogue right now,” he said.

Healthcare has been a holdout on stock options, making up 43% of LTIP for CEOs in 2019, compared with 16% across all other industries Gallagher studied.

RSUs are also a good choice for companies that predict their stock will be either volatile or flat. If the stock value drops, stock option holders could lose all of their value, whereas restricted stock units are almost always worth something.

Tenet is somewhat of an outlier in the investor-owned hospital world in that half of its LTIP is time-vested RSUs—more than its peers—and none is options. The company in February 2020 switched plans for most of its top executives entirely to time- and performance-based stock awards. Tenet wrote in its proxy that its “simplified, equity-only program provides stronger alignment of management’s incentives with shareholder interests.”

Such a plan buffers Tenet’s executives somewhat from the significant share price volatility that happened during the pandemic. Tenet’s stock started 2020 priced at $38 before plummeting to as low as $11 at the height of the pandemic’s first wave in March. It eventually recovered to almost $40 by the year’s end, but not before more highs and lows.

Retail clothing was perhaps an even more unpredictable industry during the pandemic. In that vein, Ralph Lauren—whose fiscal year happened to begin around the time the pandemic hit—moved to entirely time-based RSUs for its top executives in lieu of making them hit financial performance goals. The company noted in its proxy that the change was temporary, and it planned to return to performance-based equity awards in 2022.

Nashville-based HCA Healthcare, by contrast, has seen significant growth in its stock value and profit in recent years. Half of HCA’s LTIP takes the form of stock appreciation rights, which are similar to stock options but don’t require payment to exercise them for cash. HCA started the year with a share value of $146. Like Tenet, it hit a low in mid-March of about $68 before climbing to almost $162 by the year’s end.

Spokespeople for Tenet and HCA said their compensation committees consult with third-party advisers.

The biggest LTIP category by far is stocks that vest based on meeting performance goals, such as earnings per share or shareholder return. This is most commonly done in the form of performance share units, which are like RSUs except they vest in accordance with meeting financial goals instead of time-based goals.

Companies started to add performance-based awards about 15 years ago when large institutional investors started to call RSUs “pay for pulse” and demanded they add performance conditions, Reda said.

Pharmaceutical giants weight incentive pay heavily toward performance, mostly because they’re confident about the strength of their financial returns. Pfizer had an LTIP that was 100% performance-based in 2020, although one-quarter of that was time-based RSUs, which some companies categorize as performance based. Bristol Myers Squibb was also 100% performance-based last year, although its plan did not include RSUs. In a statement, the company said it aims to align compensation with shareholder interests and to attract and retain executives who can lead in a competitive environment.

At hospital chains, performance stock units represent half of LTIP. There’s more variation across insurers, from 37% at UnitedHealth Group, the parent company of UnitedHealthcare, to 75% at CVS Health.

Compensation experts say the pandemic triggered a—likely temporary—shift away from performance-based stock awards in favor of RSUs. That’s because suddenly the financial outlook became unpredictable, so it no longer made sense to hold executives’ LTIP to meeting performance goals.

A similar temporary shift happened after the Affordable Care Act became law and companies weren’t sure how it would affect their operations, said Patrick Haggerty, a partner with the executive pay advisory firm Pay Governance. On a broader level, companies have been upping their performance-based awards over the past decade in response to investor demands.

Some companies added flexibility into how they interpreted their 2020 plans that had already been in place when the pandemic struck. Walgreens omitted the six months that fell within calendar 2020 from the three-year performance period it uses to calculate incentive pay.

“I don’t think I’ve ever in my career in over 25 years seen companies take such a drastic step,” Haggerty said, adding companies that made those moves got negative feedback from proxy advisers.

Bill Dixon, a managing director with compensation consultancy Pearl Meyer, said the most notable compensation change he observed coming from the pandemic was the injection of discretion into existing packages—in some cases issuing awards where plans as outlined in proxies would not have done so.

“Because of the challenges we faced and our ability to overcome that and stay healthy financially, the board used discretion more this year than in any time we’ve seen previously, even during the recession,” Dixon said.

Dixon said he views that as applying good judgment when the goals that were set pre-pandemic suddenly became irrelevant. Most companies had already set their profit, performance and patient experience goals by the time the pandemic hit in March, he said.

Source: modernhealthcare.com

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