Executive Compensation

Executive compensation strategy is changing as providers realign their plans to reflect the impact of value-based care on their organizational goals.

This article first appeared in the November 2016 issue of HealthLeaders magazine.

The shift from fee-for-service to value-based care is impacting executive compensation along several different tracks. Change is occurring along financial and clinical lines, as compensation models evolve to mirror a greater focus on value and quality. Incentives and total compensation are being modified to account for risk-based models and to better align them with organizational strategy. And total compensation is being adjusted modestly upward to ensure that healthcare providers are able to attract executive talent with the types of new skills that value-based care requires.

Executive Compensation: Aligning Clinical and Financial Strategy for Value-Based Care

The good news for the industry is that the majority of providers are embracing the need for executive compensation realignment in light of the fundamental changes engendered by value-based care, and momentum is building. In fact, 51% of respondents in the 2016 HealthLeaders Media Executive Compensation Survey say that they have modified or expect to modify their group or team incentives in consideration of the shift from fee-for-service to pay-for-value, up from 37% in our 2015 survey.

Looking at executive compensation more broadly, it is also encouraging that only 2% of respondents indicate they have made a change regarding both financial or patient care objectives, and say that this change is in the wrong direction. When change has been made, it has generally been on the right track.

Executive compensation strategy
Traditionally, executive compensation discussions usually begin with financial objectives, given that this is a core responsibility of senior leadership. But the changes being wrought by value-based care influence both financial as well as patient care/clinical strategy in important ways, and the two aspects are more closely linked than ever before.

According to the majority of respondents in our survey, executive compensation is clearly in need of an adjustment. Seventy-five percent say that change is needed or have made a change to executive compensation strategy to address the financial objectives of healthcare now, and only 17% say that no change is needed. The data reflects the extent to which the industry is changing, and the corresponding need to refine executive compensation to maintain optimal alignment.

Perhaps because of the uncertainty surrounding these industry changes, approximately one-third (30%) say that their organization's executive compensation strategy needs to change but have no plan in place. The good news is that 21% of respondents say that change has been made and that it's in the right direction. The jury is still out for 9% of respondents, who have made a change and don't know yet if it's in the right or wrong direction.

The responses for executive compensation strategy that address the patient care objectives of healthcare now are somewhat similar to the results for financial objectives. Seventy-eight percent of respondents say that change is needed or have made a change, and only 17% say that no change is needed. Industry uncertainty also exists in the patient care area, with 26% saying that their organization's executive compensation strategy needs to change, but they have no plan in place.

Note that a greater percentage of respondents say that their organization has made a change in the right direction for executive compensation strategy to address patient care objectives (27%) than a change in the right direction for financial objectives (21%), an indication of the more challenging nature of achieving financial objectives in the current healthcare environment.

Incentives and compensation
The survey results for incentive compensation show a mix of old and new influences, evidence that the transition to value-based care is still in its early stages. As one would expect, responses for individual executive incentive payments show that the majority of respondents (69%) have operating margin or cash flow targets among their individual incentives, down from 76% in last year's survey. However, population health management targets (23%) and growth in lives under risk contracts (6%) receive the lowest responses, an indication of the deliberate pace providers are taking in the adoption of value-based models and their use as incentives in executive compensation.

As with individual incentives, the results for team executive incentive payments indicate that nearly three-quarters (73%) of respondents have operating margin or cash flow targets among their incentives, showing similar results (71%) to last year's survey. The results for team executive incentive payments are close to those for individual executive incentive payments, and the two sets of incentives have the same order of categories for the top five responses: operating margin or cash flow targets (73% team vs. 69% individual), patient engagement or satisfaction targets (66% vs. 62%), clinical performance targets (59% vs. 57%), staff engagement or satisfaction targets (53% vs. 48%), and financial growth targets (52% vs. 47%).

As with individual incentives, population health management targets (26%) and growth in lives under risk contracts (6%) had the lowest survey responses for team executive incentive payments, suggesting that the adoption of value-based models and their use as incentives in executive compensation are still in the early stages.

Mike Wiltermood is president and CEO at Enloe Medical Center, a nonprofit hospital with 225 staffed beds located in Chico, California, and the lead advisor for this Intelligence Report. Interestingly, not all executive compensation change is related to value-based care, and sometimes more fundamental adjustments to strategy become necessary. For example, in 2009, Enloe Medical Center opted to eliminate individual incentives, and now relies only on a team-based incentive plan.

"All of our goals are team-based. But we develop individual goals that form the basis for those broader issues," says Wiltermood. "There's certainly times, of course, when one executive might do yeoman's work in a particular area on a team goal, but the collaboration that this has achieved has been extraordinary. I just don't have people on my team that aren't willing to sacrifice for the success of somebody else, and this compensation model really encourages that team approach."

"When we had individual goals that were tied to bonus compensation, it was just too easy for some people to lowball goals in order to achieve a certain bonus. And it just wasn't effective at all."

In general, the current alignment between executive compensation and organizational strategy is a positive one, with 61% of respondents reporting that their organization's executive compensation packages are either perfectly aligned (8%) or pretty well aligned (53%) with their organization's strategies. However, this is down from 68% in last year's survey, and the response for seriously misaligned (14%) is up five percentage points, perhaps indicating that executive compensation is lagging behind changes in organizational strategy.

It is worth noting that among respondents who say their organization's executive compensation packages are perfectly aligned, a greater percentage say their organizations have modified group or team incentives in consideration of the shift from fee-for-service to pay-for-value (19%) than those who expect to modify incentives (5%) and those who have not modified them (6%).

Likewise, among respondents who indicate that their organization's executive compensation packages are pretty well aligned, a greater percentage have modified group or team incentives in consideration of the shift from fee-for-service to pay-for-value (67%) than those who expect to modify incentives (55%) and those who have not modified them (44%).

These results point to value-based care as one of the main alignment challenges for executive compensation.

Value-based impacts
As stated earlier, 51% of respondents say that they have modified or expect to modify their group or team incentives in consideration of the shift from fee-for-service to pay-for-value, up from 37% in our 2015 survey. The response breakout is 19% of respondents indicate that their organization has modified its group or team incentives, and 32% say their organization expects to modify them. Clearly, the transition to value-based care is gaining momentum, and executive compensation is being refined to reflect the new reality.

As an example, among respondents who have modified incentives to reflect the shift to value-based purchasing, nearly half (48%) say their organization's executive compensation packages are perfectly aligned with their organization's strategies, and one-quarter (25%) say this is pretty well aligned. Only 5% of this group say their organization's executive compensation packages are seriously misaligned and 9% say this is slightly misaligned.

A closer examination of team-based incentives is revealing. The top three group or team incentives in which respondents say their organization has made, or is expected to make, modifications to align executive compensation with the shift to pay-for-value are patient engagement or satisfaction targets (87%), clinical performance targets (86%), and staff engagement or satisfaction targets (65%). Note that finance-related incentives did not make the top three responses: operating margin or cash flow targets (60%) ranked fourth, financial growth targets (50%) tied for sixth, and business expansion targets (34%) was seventh.

Another aspect of executive compensation impacted by value-based care is the amount of compensation exposed to risk. Nearly half (47%) of respondents indicate that 10% or more of their total compensation is at risk for value-based activities that have exposure to profit and loss, and 70% have at least some portion of total compensation at risk. Thirty percent have no compensation at risk at all.

Interestingly, there appears to be a correlation between organizations that offer risk-based compensation plans for value-based activities and increases in total compensation when trying to attract and recruit executive leaders with value-based purchasing expertise. For example, among respondents who say they have at least some portion of compensation at risk for value-based activities, a greater percentage report that their organizations have experienced an increase in total compensation (80%) than those who have not (60%). Alternatively, among respondents who say they have no compensation at risk, a greater percentage report that they have not experienced an increase in compensation (40%) than those who have (20%).

Note that 38% of respondents indicate that their organizations have experienced an increase in total compensation when trying to attract and recruit executive leaders with value-based purchasing expertise, and 44% say they have seen no increase. Organizations appear to be split as to whether it is necessary to pay more when looking outside the organization to acquire value-based talent.

"For an organization such as Enloe, the emphasis on trying to bring outside talent into the organization, we've really cranked that down," says Wiltermood. "We're thinking that, for the real top talent, the big systems can get them. But we're looking at this [situation] and saying, 'If they're experts, they're going to be making more than the CEO.' And so we're coming to the conclusion that we're going to have to grow our own skills in some of these new areas. Maybe that's shortsighted, but it could be an indication that some people are giving up on trying to fix their knowledge deficits by recruiting outside."

In a broader context, survey results reveal that total compensation is experiencing modest increases on a year-over-year basis. For example, 59% of respondents report that their total compensation is $200,000 or more; in last year's survey, 54% of respondents said this. Further, 42% of respondents report that their total compensation is less than $200,000; in last year's survey, this figure was 48%.

Executive compensation challenges
Approximately two-thirds of respondents say that balancing quality and financial goals (65%) is among their top three challenges in executive compensation, evidence of the difficulty organizations face when trying to integrate new care models with long-standing financial goals and practices. In addition, roughly half of respondents cite determining metrics for pay-for-value tasks (46%), ranking it second in survey responses for the top three challenges.

Responses are grouped in a tight range for third position, with accommodating long-term goals with compensation programs (36%), determining goals for pay-for-value tasks (34%), and attracting executives with the right skill sets (33%) rounding out the group. Interestingly, the response for attracting executives with the right skill set ranked fifth in this year's survey, but had ranked third in last year's survey (41%). This runs against conventional wisdom that says providers are being challenged to find executives with value-based skill sets.

"I think there's a perception that things are really shifting under our feet, and to retain and attract good leadership we may all have to get a reality check on the compensation structure."

Wiltermood says that his organization uses a system that helps manage the challenge of balancing quality and financial goals. "We have a balanced scorecard methodology and every year we decide what effort is going to be made where and what constitutes a successful year. Bonus compensation is tied to these balanced scorecards, but you don't [receive a] bonus if one element of the balance scorecard falls below the previous performance target of the year before. This forces us—on a tactical day-to-day basis—to consider the impact of everything that we do in the context of the entire organization, rather than just focus on the fire that's in front of us."

Respondents have been remarkably consistent in their views over the last three years regarding the outlook for executive compensation structures. This year, 33% of respondents indicate that their organization's executive compensation structure needs major enhancement in order to attract, retain, and engage leaders. This response is nearly identical to the survey results in 2015 (31%) and 2014 (33%). Likewise, the response for needs minor enhancement (53%) is also similar to the results in 2015 (55%) and 2014 (49%).

It is apparent that the industry is undergoing dramatic change, which necessitates that executive compensation be continuously refined in order to maintain alignment. Wiltermood sums up the prospects for providers this way: "I think there's a perception that things are really shifting under our feet, and to retain and attract good leadership we may all have to get a reality check on the compensation structure."

C-suite skills
According to respondents, the top three skills or experience sets that will help a CEO succeed in the next five years are physician alignment experience (63%), optimizing results along a continuum of care (56%), and cost containment ability (40%). The latter is followed closely by value-based purchasing expertise (38%). The top three skills are the same as in last year's survey and the percentages are relatively comparable, with the exception of cost containment ability (49%), which was nine points higher then.

Given the important role that physicians play in the transition to value-based care, it's not surprising to see a requirement for skills such as physician alignment experience and optimizing the continuum of care, both of which involve managing physicians and physician organizations.

The top three skills or experience sets that will help a non-CEO C-suite executive succeed in the next five years are cost containment ability (54%), optimizing results along a continuum of care (51%), with value-based purchasing expertise (41%) and physician alignment experience (41%) in a tie. The top three skills are the same as in last year's survey: cost containment ability (64%), optimizing results along a continuum of care (55%), and physician alignment experience (42%). Note that value-based purchasing expertise was not offered on the response list in last year's survey.

It's worth mentioning that while cost containment ability is reported as the top skill for non-CEOs, it only ranked third for CEO skills. It also receives a higher response (54% non-CEO versus 40% CEO). This is perhaps evidence that cost containment responsibility is delegated by the CEO to his or her team, and that this responsibility is central to the team's overall mission. Although skills such as risk-management experience and payer or insurance experience are also important, they are more specialized and, therefore, received lower responses from respondents.

Wiltermood says that the results reflect a traditional view of the CEO as physician leader. "For CEOs, the docs make or break us. It's been that way for years, and now we need their leadership so much more in achieving CMS goals. It's even more important that we have alignments and relationships built."