News & Events

High CEO Salaries at Nonprofit Hospitals Under Scrutiny…Once Again

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Shock and outrage ensue every time the press gets wind of the million-dollar-plus salaries and other perks reaped by some CEOs at nonprofit hospitals. This year is no different—except that the ongoing recession that is forcing states to make painful budget cuts, especially by slashing Medicaid programs, is making the compensation reports especially hard to stomach.

In New York, for example, a state Medicaid-redesign commission recently recommended cuts to health care spending that total $2 billion. But while the proposal includes limiting home health care, increasing co-pays for Medicaid recipients, reducing their dental and mental health services, and putting a $250,000 cap on malpractice claims, there was no mention of limiting what the New York Times calls “lofty” salaries for CEOs at nonprofit hospitals.

According to the Times, “At Bronx-Lebanon, a hospital that exists only by the grace and taxed fortunes of the people of New York State, the chief executive was paid $4.8 million in 2007 and $3.6 million in 2008, records show. At New York-Presbyterian, a hospital system that receives nearly half a billion dollars annually in public money, the chief executive was paid $9.8 million in 2007 and $2.8 million in 2008.” St. Vincent’s Medical Center, a 150-year-old institution in Manhattan’s Greenwich Village closed last year, but not before the top 10 executives took home about $6 million.

In fact, Joanne Doroshow, executive director of the Center for Justice and Democracy, writes in the Huffington Post, “the 21 top-earning New York hospital executives collectively earned $64.3 million in 2008. If New York simply capped annual hospital executive salaries to the level of the ‘cap’ to which they want to condemn the sick and injured for a lifetime ($250,000), we’d have $63 million for the Medicaid budget, right there.”

Non-profit hospitals and health care centers are exempted from paying income, property and sales tax in exchange for providing “community benefits” such as uncompensated care, education and outreach programs. But oddly, the Internal Revenue Service does not set a minimum level for what portion of a hospital’s revenues must go toward these charitable activities. In 2009, the IRS published a survey of nearly 500 nonprofit hospitals across the country and found that hospital CEO compensation averaged nearly $500,000 whereas uncompensated care expenditures as a percentage of revenues averaged about 7 percent.

But there is a wide range in CEO salaries (in California alone from $136,000 to $7.8 million, for example) and compensation is not always consistent with the size, revenues or charitable contribution of the institution.

As the authors of a 2009 working paper produced by the University of Connecticut School of Business write, ideally “not-for-profit status should mean hospital CEOs are compensated based upon their relative success at fulfilling the charitable mission of their organizations.”

In fact, the opposite often appears to be true. Hospitals that serve a larger percentage of private payers and provide less charity care pay their CEOs more. In Connecticut, for example, the working paper authors found that a “10 percent increase in the fraction of revenues devoted to uncompensated care lowers CEO pay by 1.5 percent.” Additionally, a 10 percent increase in the share of revenues coming from government payers lowered CEO pay by slightly over 19 percent.

Meanwhile in the real world where a different economic model is dictating compensation for nonprofit hospital CEOs, “the CEO may be more interested in expanding the size of the organization, maximizing revenues to finance discretionary expenditures, or increasing the structural quality of the institution. Pursuing individual goals may be relatively unconstrained because the CEO often plays a pivotal role in the selection of various board members,” according to the University of Connecticut report. In the typical nonprofit hospital, the “CEO faces an incentive to increase the occupancy rate of privately-insured patients and possesses little incentive to provide additional community benefits at the margin.”

Finally, the authors conclude, “the compensation of hospital CEOs may be unrelated to their on-the-job performance particularly with respect to satisfying the charitable mission of the organization.”

Health care executives defend the half-million-dollar-plus salaries (and added bonuses, deferred income, retirement plans, and other perks) as the only way they can attract the top people to their organizations. They argue that nonprofit hospitals compete with for-profit facilities, which also get a large share of their revenues from Medicaid and Medicare.

According to Roy Poses, writing on the blog Health Care Renewal, “The usual explanation by organizational spokespeople, and occasionally boards of trustees is that this is the sort of compensation needed to attract the best and the brightest, a variation of the ‘pay for performance’ meme that resounds throughout business schools and executive suites.”

In Washington State, reporter John Ryan from KUOW News (Puget Sound Public Radio) used public records to find out pay for nonprofit hospital executives in his state. In his report, which aired this past December, Ryan found that 15 hospital executives in Washington made $1 million or more in 2009. The biggest winner was John Koster, CEO of Providence Health and Services, a Catholic ministry that operates 27 hospitals in 5 states. Koster earned a cool $2.4 million in 2008, according to Ryan’s research. Executives (including Koster) would not talk with Ryan, but a human resources officer at the nonprofit said of the hospital chain, “So our mission is to reveal God’s love and care for the poor, especially for the poor and vulnerable, through our compassionate care. To be able to do that, we need to make sure that we can attract and retain the best talent. So, yes, we need to make sure that we’re paying at least market for any of our employees that serve.”

But what is this measure of “performance” when it comes to the CEOs of non-profit hospitals? Is it how well a CEO does in leading his or her hospital in providing community benefits like uncompensated care for the poor, or is it how successful the CEO is in building cardiac centers and laser-surgery programs that attract private-pay customers? The expansion of many nonprofit hospitals, the duplication of imaging and specialized surgery centers and investment in other features designed to draw in private-pay customers suggests the latter.

In another post, Poses looks at nonprofit hospital CEOs in Florida, Texas and North Carolina where salaries and bonuses often top $1.5 million (all the way up to the $3.4 million that Carolinas HealthCare paid CEO Michael Tarwater in 2009) and writes, “the sorts of compensation reported in [those states] are a product of the current management culture that has been infused into nearly every health care organization in the US. That culture holds that managers are different from you and me. They are entitled to a special share of other people’s money. Because of their innate and self-evident brilliance, they are entitled to become rich. This entitlement exists even when the economy, or the financial performance of the specific organization prevents other people from making any economic progress.”

Jay Hancock, a columnist at the Baltimore Sun recently wrote a piece titled, “For hospitals, non-profit stops with CEO’s salaries.” In it Hancock reports, “Eight top Baltimore hospital executives pulled in more than $1 million each in fiscal 2009, according to newly detailed disclosures from the Internal Revenue Service.”

“Close to a dozen had personal dues for ‘social clubs’ financed by your charitable donations, tax dollars and health insurance premiums. Many enjoy lavish and opaque executive retirement plans that also put upward pressure on the medical costs that threaten government budgets and the economy.”

The recent flap over hospital CEO pay is just the most tangible issue in the overall controversy over whether or not nonprofit hospitals and health care chains actually earn their tax exemptions. I wrote about how in May 2009, the Senate Finance Committee chairman Max Baucus, and ranking Republican Charles Grassley introduced a bipartisan proposal that would have required nonprofit hospitals to provide a minimum level of charity care, limit how much they charge the uninsured, and to scale back aggressive collection processes or face an excise tax or even an end to their tax-exempt status.

When the Affordable Care Act was enacted a year ago, a watered-down version of the Finance Committee proposal was adopted. Under the health bill, hospitals still do not have to provide a minimum amount of charity care, but they must make financial assistance information readily available to patients, they have to limit the fees they charge people receiving this assistance, and hospitals have to cut back on aggressive bill collection processes. The other big change is that every three years the Treasury Department will review the community benefit activities of each tax-exempt hospital. But there is nothing that specifically regulates executive salaries—other than the existing requirement that they be “reasonable.”

This “presumption of reasonableness” falls squarely on the shoulders of the IRS. But the agency has a fairly vague definition of what is reasonable. According to its 2009 “Exempt Organizations Hospital Study”:

“An organization may place the burden of proving excessive compensation on the IRS by using disinterested persons to review comparability data (including, in appropriate circumstances, that of for-profit organizations) to establish compensation, and by properly substantiating the process used to set compensation.”

To translate this from agency-speak, hospital boards and compensation committees use outside consultants (the so-called “disinterested persons”) to come up with the salaries, incentives and other perks offered to hospital CEOs. The consultants survey the field, looking at salaries of CEOs at nonprofit and for-profit institutions, see what the 50th percentile is and then in many cases offer 20% or 30% above to qualified candidates. Mathematically, this keeps the 50th percentile moving up and what the IRS considers “reasonable” also moves up. The consultant is not really “disinterested,” he or she would like to keep top hospital executives and the board (often allies of the CEO) happy in order to increase the chance the firm will be given future work.

“Right now, it’s not clear what power the IRS has in terms of nonprofit hospitals,” says Kester Freeman former CEO of Palmetto Health in Columbia, SC who blogs at the site Action for Better Healthcare. “The IRS now has all the information it needs and if I worked for the IRS and I saw the CEO of a hospital with four hundred beds making four million dollars I would investigate.” The agency has the power to remove a hospital’s not-for-profit status, but that almost never happens—when it does occur (as in the Supreme Court case of Provena Hospitals in Illinois) it’s almost always instigated by state or local officials who have an interest in recouping valuable property and sales taxes. In Provena’s case, the Supreme Court found that the hospital set aside just $831,000, or 0.7% of its revenue in 2002 for community benefit, less than the $1.1 million in tax breaks it stood to receive. Freeman believes that the IRS should have the authority to go to a hospital’s compensation board and say, “this salary is excessive,” it’s just not warranted.

For now, public opinion and state legislators are the de facto policemen when it comes to CEO compensation. As part of the tax reporting process, nonprofit hospitals must disclose yearly salary and other compensation information for their five top-paid executives. A new version of the forms (called 990’s) requires more details and stricter reporting of perks. Reporters and advocacy groups who hope to bring public attention to the issue of excessive compensation are increasingly mining these disclosure data. In California, for example, Payers and Providers, a publication covering the health care industry, conducted a survey of 118 nonprofit hospitals and found that the base salary for CEOs averaged $514,000 (similar to the national average). But with bonuses, retirement money, reimbursement for education costs, and expense accounts, the average total compensation for those CEOs rose to $732,000.

The survey also identified 17 hospitals in California where the total compensation to CEOs exceeded the cost of charity care.

“It would be outrageous if hospitals are paying more to their (entire) executive teams than in indigent care in their community,” Anthony Wright of Health Access California told the Ventura County Star: “For some hospitals to provide more to one individual just seems wrong.”

The Baltimore Sun’s Hancock agrees, “Hospitals aren’t Goldman Sachs. They’re not Stanley Black & Decker or Microsoft, either. They’re nonprofits, getting charitable donations and huge government subsidies beyond all the loot they rake in from Medicare and Medicaid. If the newly required disclosures on the IRS "Form 990" put pressure on hospital boards and CEOs to tone it down, it’s about time.”

In Massachusetts, home to seven major tax-exempt teaching hospitals that reap billions in federal health dollars, Attorney General Martha Coakely’s office is investigating executive compensation practices of nonprofit health care systems and insurers in the state. Likewise, in New Hampshire, Gov. John Lynch raised the issue of administrators’ compensation at the state’s nonprofit hospitals, noting the top 200 administrators earned $60 million last year. He has warned non-profit hospitals that high executive salaries will have to be cut as the state institutes major cuts in Medicaid and other state health programs.

Some state legislators are calling for caps on hospital executive salaries: Last month in Maine, State Rep. Brian Bolduc proposed capping a hospital administrator’s total compensation at $70,000, the same salary as the governor. The bill, which got a “cool reception with no co-sponsors” was easily defeated, according to a report in the Sun Journal. Meanwhile, two state senators in Washington are sponsoring a bill that would require nonprofit hospitals to publish their top executives’ incomes each year and provide proof that their paychecks are comparable to those for similar jobs in the public sector. Others have suggested that executives at nonprofit hospitals should be held to the same standard as their counterparts at firms bailed out by TARP—earning no more than $500,000.

Where do we go from here?

It’s clear that without any new limits on CEO compensation in the health bill, more transparency and stricter reporting requirements will be vital for raising the curtain on excessive salaries and perks. Faced with unsustainable budgets, states are putting pressure on nonprofit hospitals to cut these salaries and bring the outliers in line with the average. There will likely be more local challenges to hospitals tax-exempt status too as legislators look for new revenue streams.

According to a report on executive compensation at nonprofit health care centers by the Alliance for Advancing Nonprofit Health Care, “boards of many nonprofit health care organizations have begun to eliminate elements of their executive compensation programs that are most vulnerable to criticism.” These include previously standard perks like country club memberships, company cars, severance benefits and lucrative retirement plans, that might look bad to local communities and state regulators.

The Alliance report recommends that to avoid “avoid publicity” from regulators and stakeholders, “boards would be wise to take this opportunity to reform executive pay by (1) avoiding the types of practices that attract and deserve the most criticism and (2) rewarding executives for outcomes that represent prevailing public views of what nonprofit health care organizations’ goals should be.” That presumably is serving the poor and providing other community benefits—not building another open heart surgery center in an area already served by two others.

The outcry over high health care executive salaries will not go away any time soon. Insurers who continue to raise premiums are under scrutiny for the hefty compensation packages they use to reward their top executives. Hospitals that depend on Medicaid and Medicare—two programs that are facing drastic cuts over the next decade or so—will be under greater pressure to bring CEO salaries in line with other austerity measures. But all this depends on the power of public opinion and state action.

As health care reform kicks in and more Americans are covered by insurance, hospitals will be providing less charity care. Perhaps it’s time to rethink the non-profit exemptions of many hospitals—setting stricter limits on how much community benefit they must provide and ensuring that CEO salaries and tax exemptions don’t exceed the value of a hospital’s good works.

Posted by Naomi Freundlich on March 24, 2011