Aligning Executive Compensation to Strategic Priorities
Finance leaders should understand their boards’ mindsets when proposing performance metrics for executive incentive plans.
A properly designed and administered executive compensation program is an effective tool for motivating and rewarding performance and driving change within organizations. Today, executive teams are undertaking transformative changes as hospitals and health systems centralize key functions, integrate and coordinate care across the continuum, accept value-based contracts and responsibility for managing the total cost of care, and become more consumer-focused. Yet incenting the right behaviors and rewarding leaders for succeeding at these strategies can be especially challenging in a dynamic environment.
Whatever an organization’s top goals are—improving quality and safety, cutting costs, or driving clinical integration—boards and executive teams need to ensure that the compensation structures they use will help spur this transformation and ensure stable leadership to sustain high performance. CFOs and other finance leaders can support these efforts by understanding how the board approaches executive compensation and helping the compensation committee set appropriate targets that reflect not just past performance but also industry-wide benchmarks.
Today, many large healthcare organizations are refocusing compensation plans on promoting and rewarding “systemness” and transformation, rather than continuing the siloed orientation of the past. One of these organizations is Hartford HealthCare, a $3 billion health system based in Hartford, Conn., with six acute care hospitals, one behavioral health hospital, and nearly 800 employed physicians. During the past decade, leaders at Hartford HealthCare have turned their holding company into a vibrant operating company, says Elliot Joseph, FACHE, CEO. Today, their management team and governance are no longer oriented around institutions and programs, but rather markets and regions.
“The compensation philosophy that we have put together is aligned with our vision and is driving transformation, disruption, and high performance,” Joseph says. “We toggle back and forth between goals that are process-based and goals that are outcomes-based… . But we have fewer process goals than we have had historically.”
In 2010, the organization introduced standard titling and a new annual incentive plan to align leaders of all affiliates to systemwide performance. Several years later, it introduced a new supplemental executive retirement plan (SERP) to help recruit and retain executives and a new long-term incentive plan to help drive transformation of the organization.
Today, all of Joseph’s direct reports are rewarded exclusively based on systemwide performance. For other senior vice presidents in the organization, 70 percent of their annual incentive is based on systemwide performance and 30 percent is based on program-specific goals, while all of their long-term variable pay is tied to systemwide transformational goals.
Compensation Philosophies at Not-for-Profit Health Systems
Tying Pay to Value-Based Care
Main Line Health, a $2 billion organization based in the western suburbs of Philadelphia, is another integrated health system similar to Hartford HealthCare in which leaders have become more focused on systemwide performance as the health system has transformed from a holding company to an operating company. Just eight years ago, base salaries accounted for the majority of executive compensation at Main Line Health.
Now leaders have much more pay at risk through annual and long-term variable pay plans that include challenging goals. “These are not layups,” says John J. (“Jack”) Lynch, III, FACHE, president and CEO. Executive base pay at Main Line Health is at the 50th percentile, although executives who achieve superior performance can receive total cash pay at the 75th percentile when performance is at the 75th percentile, similar to Hartford HealthCare’s approach.
They also developed a supplemental executive retirement plan (SERP) to help retain a high-performing executive team to support and drive future success.
Main Line Health, like Hartford HealthCare, employs a long-term incentive plan as well as annual incentives. Their long-term incentive plan includes a rolling, three-year grant cycle that focuses performance on two or three meaningful goals. Over the years, one plan cycle included three goals related to the rollout of an electronic health record (EHR): patient portal utilization, days in accounts receivable (A/R), and physician EHR use of the EHR. This encouraged senior leaders to focus on what they could do to make their EHR implementation successful.
Under their short-term incentive plan, 40 percent of at-risk compensation is based on financial performance, 40 percent on quality performance, 10 percent on human capital management, and 10 percent is tied to expanding their research outcomes. For the long-term plans, executives can only earn an award if the organization hits its margin targets, but the awards are based on reaching transformational goals.
As organizations move further into value-based contracts with both upside and downside risk, executive compensation should be impacted. “With more revenue at risk based on clinical performance, quality, safety, and equity, metrics will impact financial performance,” Lynch says. “These results should have a meaningful impact on executive compensation.”
Independent organizations also are revamping their compensation structures to better reflect long-term strategic objectives such as clinical integration and population health management. One example is Emerson Hospital, an independent community hospital based in Concord, Mass., and affiliated with Boston-based Partners HealthCare. Like Hartford HealthCare and Main Line Health, Emerson has established a SERP to help retain executives.
Recently, the organization’s compensation plans have offered more at-risk pay with goals that encourage leaders to take calculated risks that drive hospital performance. “As the environment has become more difficult to work in, the at-risk component of the pay also has gone up,” says Christine Schuster, president and CEO. “So it takes a lot of planning with your team to make sure you can hit those targets.”
Her organization’s long-term goals are linked to its five-year strategic plan and corresponding financial management plan. Some specific long-term goals are based on the rollout of a new EHR, the implementation of telemedicine in their physician practices, and the expansion of urgent care services.
Meanwhile, executives’ short-term goals reflect operational improvements, patient satisfaction, and financial stability. Currently, executives must reach their days cash on hand and operating margin targets to receive any at-risk compensation, although the board has discretion in determining final awards based on performance against the predetermined goals.
Finance leaders should consider the following advice when proposing financial performance metrics or preparing or presenting reports on performance to the board’s compensation committee.
Understand how board members think. When reviewing executive compensation, approving incentive goals, or determining variable pay awards, effective board members often consider the following questions:
- What is the best use of limited resources: higher salaries, more variable pay, or better retirement benefits?
- What is the right amount of variable pay? And what is the right balance between short- and long-term opportunity?
- What is the best way to promote and reward clinical integration and transformation?
- How do the proposed goals relate to benchmarks in our peer group or industry-wide benchmarks?
- Should retirement benefits vary with performance?
Just as transformation takes more than one year to achieve, the answers to these questions may shift year to year.
Help educate the board on healthcare finance. Finance leaders can take a proactive role in these educational efforts. Schuster recommends sending board members to industry conferences so they better understand the healthcare environment as well as the payment norms. Her hospital also has created a web portal for board members that includes educational webinars and articles. “My board now understands what it takes to recruit and retain people,” she says.
Revisit peer data and industry benchmarks often. Consolidation reduced the number of independent hospitals in Emerson Hospital’s peer group from 20 to just seven this year and required a major review. “Our compensation committee had to work with our outside consultants to determine who we should measure ourselves against,” Schuster says.
Offering Context Is Most Important
Although some CFOs may not interact with the board much on executive compensation, they should still understand how they can best help boards align goals for incentive compensation to their organization’s strategic and financial success.
As CFOs and other finance leaders help develop goals and metrics for incentive plans and year-end reports on performance for the board and compensation committee, the most important step they can take is to provide industry or peer group benchmarks and both comparative and historical statistics to set the goals and results in context. Too often, targets are presented to the board without enough context on past performance and competitors’ performance. By providing comparisons with past performance and industry-wide or peer group performance, finance leaders can help board members develop a clear picture of why goals are set at certain levels. This can help the board understand if the measures are too easy, too difficult, or provide just the right amount of stretch to achieve the organization’s strategic objectives.
In this way, CFOs and finance leaders play critical roles in helping boards and committees understand proposed goals and metrics and year-end performance results, and thereby better align executive compensation plans to strategic priorities and support their transformation.
This article is based in part on a presentation at ACHE’s 2018 Congress on Healthcare Leadership.
David Bjork, PhD, is managing director and senior advisor, Integrated Healthcare Strategies, a division of Gallagher Benefit Services, Inc., Minneapolis.
Dan Mayfield is managing director, Integrated Healthcare Strategies, Austin, Texas.
Interviewed for this article:
Elliot Joseph, FACHE, is CEO, Hartford HealthCare, Hartford, Conn.
John J. (“Jack”) Lynch, III, FACHE, is president and CEO of Main Line Health, Radnor, Pa.
Christine Schuster is president and CEO of Emerson Hospital, Concord, Mass.