Intelligence Report: Changes in Executive Compensation

As the healthcare industry transforms, healthcare leaders are facing new value-based incentives, as well as requirements for new skill sets.

This article first appeared in the November 2015 issue of HealthLeaders magazine.

Recasting organizational objectives to address shifts to value-based care has two major effects on executive compensation. First, incentive programs have to shift to reflect new directions. Second, attention to fundamental changes in compensation through at-risk reimbursement and capitated payments requires new executive skills, which in many cases will mean additions to and departures from the team that leads the organization.

Such moves within the executive ranks often are accompanied by a degree of disruption. And, in cases where new executives are sought to fill new roles, organizations are finding that they must be able to clearly define a set of responsibilities for which they may have little firsthand knowledge. Further, they will be recruiting from a limited and in-demand set of candidates, which can place upward pressure on executive compensation across the board.

Incentives: Finance on top
The executive team is accustomed to focusing on the numbers. Because financial stability of the organization will always be a top concern, compensation programs tilt their variable components toward financial performance. But financial performance is now becoming linked to the shift to value-based performance, which increases the use of executive performance parameters based on various aspects of clinical performance.

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With operating margin/cash flow placing as the top-mentioned incentive for both individual (76%) and group incentives (71%), we can see the dominance of financial objectives in executive compensation. The percentage including operating margin or cash-flow targets among individual targets varies little by organization size. But this is not the case for patient engagement/satisfaction and clinical performance, which are the individual goals mentioned second and third most often. Higher percentages of medium- (76%) and high-revenue (74%) organizations than low-revenue organizations (58%) have patient engagement or satisfaction targets. Likewise, higher percentages of medium-revenue (64%) and high-revenue (60%) organizations than low-revenue organizations (49%) have clinical performance targets.

James F. Hargreaves, senior vice president and financial advisor for Morgan Stanley Wealth Management and former head of the compensation committee for the board of directors of Johnstown, Pennsylvania–based Conemaugh Health System, explains that attention to finances is especially acute in low-revenue organizations, which helps us understand why we see relatively low percentages in low-revenue organizations offering incentives based on patient engagement and clinical performance. He says, "Making money is number one. That keeps them going. So while they might want to look at these other things, they can't get by the financial targets."

Conemaugh serves more than a half million patients each year through the Conemaugh Physician Group and Medical Staff, a network of hospitals, specialty clinics, and patient-focused programs in west central Pennsylvania. Hargreaves was serving on the Conemaugh board as the organization gained strength financially, and explains how emphasis changes with financial success. "The more successful we became, the lower the finance-based percentage became, and the higher other incentives became. When you get your financial shop in order, when you get your purchasing in order, when you get your insurance negotiations in order, and so on, then you can move some of these other things up to a higher priority. If those basic financial things don't happen, you always ask, 'Are we going to make enough money to be able to continue operating?' "

In medium- and high-revenue organizations, patient engagement or satisfaction targets are included in individual incentives nearly as often as operating margin/cash flow targets. For instance, 74% of high-revenue organizations use patient engagement or satisfaction targets, nearly equal to the 79% of high-revenue organizations using operating margin or cash flow as individual targets.

Parameters that may be more closely associated with healthcare reform are included less frequently overall, but we still see more emphasis in high-revenue organizations. For instance, population health management is an individual incentive for 45% of high-revenue organizations, nearly twice the rate of medium-revenue (24%) and more than triple the rate of small-revenue organizations (13%). Growth in lives under risk contracts is an individual incentive at only 10% of organizations overall, but 16% of high-revenue organizations.

David C. Pate, MD, JD—president and CEO of St. Luke's Health System, a nonprofit organization operating seven hospitals and a network of clinics covering all of Idaho and eastern Oregon—explains how emphasis on finances may add to the challenge not only of shifting to reform-related goals as incentives but also actually adopting reform-related strategies.

"Every hospital and health system has a finance committee," Pate says. "They're looking at their numbers, and they know that those finances are still driven by volume of services. So it's pretty hard for them to tell their management team that they want them to go full speed ahead, getting ahead of the market in driving toward pay-for-value, when they know that's going to adversely affect their financials and maybe their bond ratings. You can see the spot that they're caught in."

Over time, overall compensation demonstrates modest increases. In 2013, nearly half (48%) of respondents reported compensation of $200,000 per year or more. This year, 54% earn $200,000 or more. Pate, lead advisor to this Intelligence Report, suggests that industrywide transformation efforts may be pushing compensation levels up. "Some executives choose to retire, or retire early because they realize that, while they knew how to drive the ship under fee-for-service, they're less prepared to do so going forward."

Sometimes, he observes, it is the board that recognizes how some current executives "are not well-situated to drive the future, so boards are changing out some teams." Often, new executive hires, especially those with skills that address healthcare's new directions, are brought in at higher compensation levels. Says Pate, "We've been creating new roles to help drive the new world of healthcare, and people to fill those roles are few and far between. So they may be commanding higher salaries."

In the upper ranges, respondents reporting salaries of $400,000 or more has increased to 21% this year, up seven points since 2013's 14%.

The challenge of moving in new directions
Slightly more than one-third (68%) say that their organization's executive compensation packages are pretty well aligned or perfectly aligned with their organization's strategies. Of course, that means that 32% say their compensation packages are slightly or seriously misaligned with strategies.

Included in this somewhat troubling percentage are 36% of the CEOs participating in the survey, individuals whose closeness to the board presumably gives them a substantial role in contributing to both the organization's strategy and the organization's compensation policy. St. Luke's Pate suggests that the pace of change causes compensation practices to be out of sync with strategy. "Not all organizations develop the sense of urgency that's needed to address change, so they're now experiencing an increasing level of tension, seeing that they are out of sync in terms of how they are compensating versus the direction they're saying they need to go."

Generally, at-risk compensation—the incentive program—helps align compensation with the organization's strategy. Nearly one-third (30%) say changes in incentives are needed to address financial aspects of healthcare, but they see no plan in place to change. The perspective on incentives addressing the clinical aspects of healthcare is only slightly better, with 23% saying that change is needed but no change is planned. Hargreaves says, "These organizations may be traveling down a road of being far more reactive than proactive. That can create all kinds of problems in lots of areas."

Resolution is more than a matter of recognizing the problem and fixing it, partly because modifying compensation programs is a long-term activity. Hargreaves notes, "It takes time to step away from doing it the way you've always done it in the past and realize that, if we're going to be successful in the future, we're going to have to do things differently."

As with the misalignment noted earlier, a high percentage (26%) of CEOs say change is needed in order to address financial objectives, but they see no change coming within their organization. Although the percentage of CEOs is slightly lower than the percentages from other executives (31%), one expects CEOs to see the direction of the organization and the industry, and to be actively driving plans to move the organization in the right direction. Says Pate, "This reflects a little bit poorly on those CEOs, because, together with their board, they are charged with driving the executive compensation strategy. This is especially the case regarding financial objectives, because those haven't changed as much as many of the other parameters affecting compensation have."

As important as incentives can be in providing a focus for groups and teams, 43% say their organization has not modified or is not expected to modify such incentives in light of the shift from fee-for-service to pay-for-value. Organizations that know change is pending but will not or cannot make steps to modify their systems may face serious challenges.

"This is an indication that we're going to have trouble getting organizations to really focus on new models if they don't change the incentives, especially if incentives in place now are just reinforcing the old fee-for-service objectives," says Pate. He acknowledges the requirement that incentives track revenue flow, and the difficulty inherent in modifying incentive programs without a great deal of information about new revenue streams. "You can't expect people to act against their own economic self-interest for prolonged periods of time. People are willing to make sacrifices here and there. It's a big issue—given that we have these traditional models of compensation, what should be the model of the future?"

Carol Burrell, president and CEO of Northeast Georgia Health System, a nonprofit community organization serving northeast Georgia through the 557-staffed-bed Northeast Georgia Medical Center in Gainesville and an 80-staffed-bed hospital in Braselton, is specific about what may happen if individual compensation elements are based on factors not well understood and, as a result, executives have goals that eventually prove to be unreachable. "I think you can get away with that for a year or two, but if you're a visible organization such as we are, an organization that's nationally recognized, you're ripe for the picking with recruiters," she says.

Finding the right balance
Two-thirds of respondents (67%) include the need to balance quality and financial goals among their top three challenges related to executive compensation, an aspect of compensation policy that affects organizations of all revenue levels fairly evenly. This weighing of clinical and financial objectives places at the top of the chart, providing an indication that although healthcare leaders understand the industry is moving toward improving outcomes while reducing cost, they struggle a bit when they attempt to modify compensation programs to reflect that.

Of the four goal-related challenges respondents evaluated, 49% include determining metrics for pay-for-value tasks among their top challenges. Presumably, organizations are well versed in establishing financial metrics, and executives may be more practiced at tracking financial objectives. That helps us understand why a smaller percentage of for-profit (41%) than nonprofit (51%) organizations find determining value-based metrics troubling.

"For-profits typically have been much more financial- and metric-driven. Executives in the for-profit environment are looking at numbers and details on a daily basis because they have to drive to those numbers," Burrell observes.

But it's not merely a matter of having comfort and experience tracking the financial aspects of running a business. Healthcare reform asks us to look at clinical performance in new ways. Says Pate, "You start with the things that you know, and what we know is the sick-care business. We look at readmission rates, which assumes that the patient was admitted to begin with. Length of stay implies they're already in the hospital. What should the measures of population health be for the future? Is it looking at things like the average body mass index or the range of BMIs for the population you're serving? Is it looking at smoking rates? What are future measures going to be? That's the tough thing, and I don't know anyone that's got those down yet."

Seeing that 49% of respondents are challenged by determining metrics for pay-for-value tasks, Pate says, "a lot of organizations are not sure what to prioritize, what to set up as the key metrics."

New assignments, new team members
One-fifth (21%) have added new C-level positions in response to the industry's shift to value-based care, including 33% of organizations with net patient revenue of $1 billion or more. As one might expect, higher percentages of executives hired for new positions will be in the population health and IT areas. We see that 15% expect to add a population health executive, and 10% expect to add a chief analytics officer. More than one-third (39%) of low-revenue organizations have implemented little or no change to their C-suite due to their attention to value-based care, compared to 27% of medium-revenue organizations and 21% of high-revenue organizations.

"The larger organizations have the cash flow to do it and are able to see how it can benefit in either cost savings or better patient care down the line," Hargreaves explains. "Sometimes it's a lot harder for the smaller organizations to do that."

About those who plan little or no change, Burrell says, "those may be organizations that are less progressive and maybe are not thinking as strategically as others." She notes that even small steps toward focusing the C-suite in a value-based direction are important now. "Value-based care is coming whether we like it or not, and it's a difficult thing to change overnight."

Pate questions the resolve of some of the 49% who are accommodating change by asking current executives to take on new responsibilities. "It's a bit discouraging," he says. "What may be happening is that some organizations are not making the investments that they need for the future. If what they're trying to do is just get their current people to do more, and to ask them to try to live in two worlds, I would question how successful that can be."

Although the nature of the skills needed is highly dependent on circumstances, two-thirds say that physician alignment experience is among the top three skills that will help a CEO succeed in the next five years. "The specter of bundled payments hangs out there. The physician alignment situation is going to become more and more critical the closer we get to the bundled payments," says Hargreaves.

Pate has witnessed an earlier trend of appointing CEOs with a great deal of hospital operations experience. A subsequent trend (which included him) placed physician leaders in the CEO spot. "Most recently," he says, "we see examples where boards are saying, 'You know what? It's neither of those. We need some fresh thinking. We need somebody to come in here who actually isn't steeped in healthcare knowledge that will take a fresh look with fresh eyes.' "

Reprint HLR1115-3