In all of the conversation around the new tax law and its impact on executive compensation and the 162(m) rule, one interesting aspect may fall under the radar: the new law imposes a 21% excise tax on all compensation above $1 million paid to non-profit “covered employees.” This may prove to be a challenge in the healthcare industry, where according to Becker’s Hospital Review, almost 60% of registered hospitals in the U.S. are designated as non-profit.[1]
The excise tax will further diminish the ability of non-profits to compete for top executive talent. But while inconvenient and budget-constraining, we believe this new law should have little or no impact on the continued movement of healthcare boards towards variable, performance-based compensation. There are two high-level reasons the industry should maintain its growing reliance on leveraged pay-for-performance incentive compensation programs.
First, regardless of tax laws, there is an increasing need for provider organizations—both for-profit and not-for-profit—to meet or exceed critical CMS-related quality and efficiency criteria to avoid reductions to already diminished reimbursement rates. Boards can translate these expectations directly into variable compensation plans, thus aligning executive compensation opportunities with the delivery of performance that is critical to the enterprise’s survival.
Second, the demand for highly effective leaders who can succeed in an environment of diminishing reimbursements and other challenges far outstrips the supply of qualified candidates. However, a carefully designed and potentially lucrative variable compensation program can indicate to desirable, high-performance candidates that a provider organization—regardless of its tax status—is positioning itself for success, and that strong contributors can earn competitive incentive award opportunities. Further, long-term incentive programs, when designed correctly, empower the board with an executive retention vehicle.
Pearl Meyer will continue to advise our healthcare clients to establish pay-at-risk executive compensation programs, and to continually refine them as their strategy evolves, so long as these programs support their efforts at improving clinical quality, patient experience, and operational efficiency. In an environment of narrow or negative operating margins, boards can much better justify compensation costs driven by positive enterprise performance than fixed costs associated with high base salaries.
