6 Best Practices for Nonprofit Hospitals Setting Executive Compensation

In October, a study in JAMA Internal Medicine delved into one of the most hotly contested and debated subjects within the nonprofit healthcare sector — executive compensation.

Harvard University researchers found that the average nonprofit hospital CEO earned $600,000, and executives of the largest teaching hospitals with advanced technology generally receive max packages that trickle into seven figures. Other statistics have shown that health system CEOs earn even more on average, usually around $750,000 for independent system chiefs.

However, the study found there was no significant association between CEO pay and how the hospital performed on quality metrics, like mortality and readmission rates. For a delivery system that is transitioning from fee-for-service to pay-for-performance, the study served as a lightening rod of discussion for top hospital officials to be held to the same standards as physicians and other stakeholders.

In addition to dealing with societal pressures, nonprofit hospitals and health systems face several other hurdles when setting executive compensation, says David Thornton, JD, chair of the employee benefits practice at Bass, Berry & Sims. For instance, hospitals have to ensure compensation does not put its tax-exempt status at risk, especially as the Internal Revenue Service ramps up its auditing of healthcare providers. At the same time, nonprofits are competing for talent with a for-profit healthcare industry. "They have to take such a balanced approach to creating a compensation system," he says.

Mr. Thornton recommends nonprofit healthcare providers adhere to the following six practices when setting executive pay to both avoid risk of tax law violations and portray a solid rationale for community members.

1. Review the current practices of the board's compensation committee. The past few years, Kenneth Ackerman, chairman of Integrated Healthcare Strategies and former president of Geisinger Medical Center in Danville, Pa., has told executives at the American College of Healthcare Executives Congress that compensation committees are crucial to balance, well-organized compensation structure for executives.

The committee must be comprised of dedicated board members, prepare a committee charter and adopt a compensation philosophy. Many hospitals may have let issues associated with the compensation committee collect dust over the years, but now is the time to review the infrastructure. "Make sure the committee is properly organized and delegated," Mr. Thornton says.

2. Provide a refresher lesson to all compensation committee members on their obligations. The board-approved compensation charters and philosophies are pertinent to the committee, but committee members also need reminders on why their analysis and decisions are so important. Most notably, compensation committee members are obligated to make sure all executive pay structures are compliant with U.S. tax laws. The IRS could hypothetically revoke a hospital's tax-exempt status, in a worst-case scenario, if compensation is deemed unreasonable or excessive, so education plays a key role.

"We want them to understand that these are the rules of the game, and once we understand them, we can take the steps to [follow] them," Mr. Thornton says.

3. Identify all executives, by position, who will have their compensation reviewed. Mr. Thornton says nonprofit hospitals and health systems must ensure compensation is reasonable under the Internal Revenue Code for all executives. In addition, a handful of executives in high-profile positions — such as CEO, CFO and COO — are under the microscope for their compensation not only by the IRS, but also by the public, as their pay is listed in the organization's annual Form 990 tax filing.

Boards must be aware that even if an executive's compensation is not listed in the Form 990, the compensation still must be reasonable under the tax code. Boards may want to review the compensation of executives who will be listed in the Form 990 from the viewpoint of how this reflects on the organization's reputation, but that is in addition to their primary duty of ensuring all executive compensation, listed or not, is reasonable, Mr. Thornton says.

4. Review policies and procedures for identifying conflicts of interest. When it comes to legal issues like compensation structure at nonprofit organizations, there is no such thing as taking too many precautions, Mr. Thornton says. This is especially true for conflicts of interest.

Hospitals ought to have strict conflict of interest policies in place. For every person that is involved in the compensation process — board members, officers, substantial contributors, department heads — the hospital should be able to prove he or she is able "to exercise independent thought," Mr. Thornton says. "Usually, disclosure is what we need."

5. Audit all outstanding compensation agreements with executives. Committee members and executives need to fully understand compensation arrangements. This goes beyond cash salaries, Mr. Thornton says. Incentives, fringe benefits, qualified/nonqualified retirement plans, perquisites — "everything should be spelled out," Mr. Thornton says. A hospital that takes these auditing steps will be in a much better position with the IRS if the agency ever decided to conduct an audit of its own.

6. Establish the rebuttable presumption of reasonableness. "Rebuttable presumption of reasonableness" screams legalese, but it's one of the most important components of the executive compensation process, Mr. Thornton says. Essentially, RPR is when a tax-exempt organization validates why an executive was paid a certain amount. For example, why did the hospital pay its CEO in the 75th percentile instead of the 50th? Hospitals must document every step of the journey, from meeting minutes to benchmarking sources used, to prove why the executive pay was deemed fair.

"You just want to be able to say, 'This is why this is appropriate,' " Mr. Thornton says. "We are building our case and presumption of reasonableness."

More Articles on Healthcare Compensation:
Massachusetts Nurses Propose Hospital Profit, CEO Pay Penalties
Salaries for Health System CEOs Increase 4% in 2013
16 Statistics: Salaries and Cash Compensation for Hospital and System CEOs

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