William Quirk

Long-term incentive pay plans for key leaders can help advance important strategic goals at not-for-profit hospitals and health systems.

At a Glance

Long-term incentives allow organizations to reward certain executives for performance without increasing base salaries or annual incentives. When designing long-term incentive packages, organizations should:

  • Focus primarily on strategic goals spanning multiple years
  • Ensure that long-term goals are supportive, yet not duplicative of annual goals
  • Balance financial imperatives with longer-term quality and satisfaction initiatives

When designing executive pay plans for key leadership positions, not-for-profit hospitals today should consider much more than base salary and annual incentives. Top-performing hospitals create total compensation packages that build in long-term incentive measures, which often offer far greater value to key executives and the organizations when compared with other forms of compensation.

For any healthcare organization, such plans should at least withstand regulatory scrutiny while they motivate and retain leaders. In optimal circumstances, the plans can engender even greater benefits to the organization and the patients by focusing executives' energies on key projects that advance the hospital's mission. Such a focus is increasingly important as industry challenges grow more complex.

Long-Term Incentives

Incentive plans in 2011 reflect the healthcare industry's increased focus on long-term improvement, according to Hay Group's 2011 healthcare compensation study. For example, although the median base salary for CEOs of integrated delivery systems (IDSs) grew by 1.5 percent in 2011, the rate of change for median total cash dropped 2.3 percent. This rate of change appears to be due to a decline in annual incentive plans. In fact, the prevalence of annual incentive plans for not-for-profit IDSs has dropped 10 percent since 2007 when 89 percent of IDSs offered these plans. Today, only 79 percent of not-for-profit IDSs offer one-year plans-the lowest in at least six years.

During this period, government regulations, budgeting, and physician relations have all become more complex. These complexities circle back to the organization, creating greater demands to attract and retain skilled, experienced leadership. Long-term incentives have become an important way to address these challenges. The popularity of long-term incentives has increased dramatically since 2006, when only 14 percent of IDSs offered them to senior executives. In 2011, 25 percent of IDSs offered these plans.

Long-term incentives allow a board to reward executives who have the position and ability to become change agents for performance without increasing base salaries or annual incentives. Meeting long-term incentive goals allows the executives to demonstrate competencies in a more definitive way than they might with a raise to base salary or an annual incentive because long-term incentives give executives a reason to focus on addressing complex challenges over time. The executives gain the flexibility-over a period of three or more years, for example-to make sustained progress on issues that are important to their hospitals' missions.

Drivers for Performance Excellence

Long-term incentive programs can enable not-for-profit organizations to achieve greater equity gains overall, compared with organizations that rely on base salary annual incentives as executive compensation pillars. However, only a quarter of IDSs have such programs, as many providers have yet to realize the true benefits of these structures and the positive shifts that can occur in leadership focus, according to the 2011 survey.

For example, executives not in a long-term incentive plan who are charged with budget cuts might opt to keep a nursing unit closed during high-volume flu season even though the community would be better served by more inpatient beds. A CEO charged with focusing on annual operational budget goals might do so at the expense of making long-term investments to meet future market demands.

In contrast, the highest performing healthcare organizations reach for big-picture goals that improve quality and efficiency throughout the entire organization. Executing the goals can often take longer than 12 months. Building an effective long-term incentive structure to meet these goals is a form of risk management and ensures that each party remains focused on progress while financial reward obligations are budgeted over many years and not awarded prematurely.

Well-designed long-term incentives for key executives can become the drivers for performance excellence for the entire organization. In an industry where both stakeholder expectations and government regulations continue shifting to a value-based model of care, the financial viability of a healthcare organization might actually rest, in part, on well-structured long-term incentives.

In designing long-term incentives, organizations should:

  • Focus primarily on strategic goals spanning multiple years (or that could take multiple years to achieve)
  • Ensure that long-term goals are supportive, yet not duplicative of annual goals
  • Balance financial imperatives with longer-term quality and satisfaction initiatives

Components of Long-Term Incentives

Long-term incentives can directly influence improvements in patient, staff, and physician satisfaction. The incentives also can influence specific quality and safety measures and pre-defined initiatives related to electronic health record adoption.

Incentives for such goals, proffered over a timeline of three to five years, provide an executive with the guarantee of rewards when milestones are met while ensuring leadership that rewards are paid only for results, not simply for effort.

Organizations can either budget for or self-fund incentive plans. Concerning specific targets, not-for-profit incentives, unlike those in for-profit organizations, must be based on goals that are directly related to the reason a hospital is tax-exempt. Each incentive should therefore align with the organization's specific missions and strategies.

Incentives based on pure financial goals can put a hospital's not-for-profit status at risk, as can unclear payout terms. Since financial performance is important to the success of any organization, incentives and bonuses based on fiscal goals are appropriate, but they should equal no more than 50 percent of the goal weighting in the executive long-term incentive program.

Awards also should be tied to documented achievements of specific, stated goals. Otherwise, a payout might be considered an entitlement, or private inurement, which is illegal under not-for-profit statutes.

Exhibit 1


In addition to financial goals, the most common long-term incentives relate to employee satisfaction, patient satisfaction, clinical outcomes, and longer-term programmatic achievements (e.g., building a cancer center). Most long-term incentives cover a three- to five-year period and all incentives should be highly measurable and clear. For example, an average length of stay might be 4.4 days, with a goal to reduce it to 4.0 over a set period of time. When the length of stay decreases to 4.3 in year one, an executive might get a payout. Additional payouts come with 4.2 days in the second year, 4.1 days in the third year, and so on. An executive achieves or does not achieve a long-term incentive goal based on such predefined targets.

Exhibit 2


Linking Finance and Quality

The link between financial goals and quality goals is strong as the Centers for Medicare & Medicaid Services (CMS) will link quality measures, such as lowered patient readmission rates, to payment for services, which will further solidify the relationship between finance and clinical quality. For many healthcare organizations, this link is critical to the success of their strategic plans.

Most organizations look at two to three objectives when crafting a long-term incentive plan, but some use as many as eight. Each organization has great flexibility in structuring how much of an executive's pay is tied to long-term incentives versus to annual incentives or base salary, and whether to place a stronger weight on financial successes, quality, safety, overall system performance, or other goals. Plans can also link some incentives to hospital-specific improvements and some to systemwide improvements.

Meaningful Incentives

For long-term incentive programs to be successful, the incentives must be meaningful to executives and the organization. Most long-term incentive plans include a combination of profit goals, cost-saving goals, and quality-of-care goals. Further, an organization's plan should provide strategic definitions for which executives are eligible. Most experts agree that participating executives include only those who can truly affect long-term achievements and have the position and ability to make meaningful contributions to strategic goals over several years. Possible candidates include the CEO, COO, CIO, CFO, chief medical officer, and chief strategy officer.

Long-term incentive goals should:

  • Be related to each executive's role
  • Be highly measurable
  • Be weighted
  • Be approved by the board administering the incentives and the executives
  • Complement annual performance goals
  • Specify what will and will not be incentivized
  • Document when executives will receive any payouts and how much they can expect

Sample of Executive-Specific Plan

Exhibit 1 illustrates one executive's long-term incentive plan. The third column shows that long-term financial performance accounts for 40 percent of the executive's potential earnings and four other measures, weighted equally, account for the remaining 60 percent.

Variations in Payouts

Incentives that span performance over three to five years are most common. However, regardless of which option an organization chooses, it can be difficult to forecast targets at the fourth year and beyond. Compensation committees should build in frequent, deliberate reviews and adjustments-as often as every year.

Timing of long-term incentive payouts can vary, depending on an organization's objectives. Exhibits 3 and 4 illustrate two possible options, one with a payout cycle of every two years, and the other with overlapping, yearly cycles.

Exhibit 3


Exhibit 4


Designing Payout Triggers

An incentive plan "trigger" is a minimum performance measure that the executive must achieve or exceed before receiving any incentive payments. These triggers are usually financial performance measures. Although plans and organizations vary, financial and nonfinancial targets as a whole are each often weighted at 50 percent of total long-term incentives.

Two options in designing payout triggers are a "complete trigger" or a "partial trigger." With a complete trigger, an executive must meet a defined goal or no payout occurs. In fact, some plans specify that an executive's failure to meet a specific trigger within a certain time frame will cancel eligibility for the long-term incentive for the entire year. With this design, the organization sends the strong message that without a specified minimal level of organizational performance, the executive will not be rewarded for other achievements.

With a partial trigger, an executive must meet some minimal metric to "turn on" any portion of the plan. This design rewards minimal acceptable performance in some areas while significantly reducing total incentive compensation when other targets are not met.

Passing the "Reasonableness Test"

For long-term incentive plans, the balance of financial and nonfinancial goals is also a concern of both state and federal agencies. In 2011, a New York state task force began what it called a "top-to-bottom review" of not-for-profit executive compensation, asking 600 healthcare organizations to detail salaries, bonuses, and perks of executives and board members.

As with for-profits, the IRS is watching not-for-profits and using penalties to regulate executive compensation. For example, IRS fines for inappropriate executive compensation to 40 executives and board members averaged $500,000.

In addition to governmental oversight, media publications have focused their attention on executive compensation, including not-for-profits, in numerous articles over the past few years, highlighting what some have called excessive packages. A defensible plan is a necessity in today's environment. Proactive healthcare organizations are anticipating such scrutiny and explaining reasons for the established compensation structures before they become the focus of attacks.

In short, each not-for-profit compensation plan should be created so it can pass the "reasonableness test." Does the compensation mirror and support the organization's not-for-profit mission?

Providing Direction Through Incentives

A challenging economy, shifting stakeholder expectations, and ongoing regulatory scrutiny continue to strain healthcare organizations and their leaders. Failure to consider these pressing issues could lead to dire consequences for healthcare organizations, such as higher CEO turnover, loss of tax-exempt status, debt accumulation, or even the organization's eventual demise.

However, highlighting the organizational priorities through measurable and defensible long-term compensation incentives can become part of the solution. The right long-term goals will help executive leaders navigate the storm by providing them definitive direction-and incentives-for accomplishing the important healthcare goals of the not-for-profit hospital.

William Quirk is national director, U.S. healthcare practice, Hay Group, Atlanta (bill.quirk@haygroup.com).


Long-Term Incentives Achieve Diverse Objectives  

Long-term incentive programs for not-for-profit healthcare organizations typically have multiple objectives:

  • Encourage executives to facilitate meeting the organization's mission and strategic goals over a sustained period (i.e., beyond a 12-month horizon).
  • Balance the participants' focus on achieving short-term annual objectives while building a foundation to achieve and sustain long-term strategic goals.
  • Enable the organization to attract and retain qualified executives.
  • Provide executives the opportunity to earn capital based on successes in improving organizational performance.
  • Create a sense of teamwork within and across senior executive ranks by establishing strategic goals and rewards they can strive for together.

Publication Date: Monday, September 03, 2012

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