A New Perspective: RESPONSIBLE RETENTION PLANNING

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1 A New Perspective: RESPONSIBLE RETENTION PLANNING For Healthcare Executives v KIRK SHERMAN TONI DOLBY DALE EDWARDS Sherman & Patterson, Ltd. Integrated Healthcare Strategies Triscend NP PREPARED FOR Partner Senior Vice President, Total Compensation and Rewards Practice Principal

2 Learning Objectives: EXECUTIVE COMPENSATION AND BENEFITS 01 KIRK SHERMAN Current regulatory environment and public perception issues related to executive compensation, including 990 reporting 02 TONI DOLBY Trends in executive compensation Recruitment and retention tools 03 DALE EDWARDS New perspectives on executive compensation and benefits Case studies demonstrating impacts of plan techniques

3 KIRK SHERMAN As a partner with Sherman & Patterson, Ltd. for more than 25 years, Kirk has focused his legal practice in the area of executive compensation in taxexempt organizations. With over 600 not-for-profit clients, primarily hospitals and credit unions, Kirk regularly addresses issues of benefit design, documentation, administration, regulatory compliance, taxation and Form 990 reporting. Mr. Sherman is a frequent lecturer on benefits issues, addressing the expanding Form 990 reporting requirements, the interaction of Sections 457(f) and 409A of the tax code, governance best practices related to compensation, and avoiding intermediate sanction penalties.

4 TONI DOLBY As Senior Vice President, Total Compensation and Rewards Practice, for INTEGRATED Healthcare Strategies, Toni designs compensation, benefit and retention plans for a wide variety of health system organizations ranging in size from the local community hospital to one of the largest integrated delivery systems in the nation. Serving over 20 years at INTEGRATED Healthcare Strategies has contributed to her breadth of experience, enabling her to manage a large number of client projects during every stage of their development as well as the ongoing, longterm administrative relationship.

5 DALE EDWARDS As a co-founder of Triscend NP, Dale s vision is to take the experience and discipline from his investment banking background and provide unique offerings to the nonprofit executive benefits sector. Dale has used his extensive investment banking and M&A experience to invent numerous proprietary financial strategies to provide equitable outcomes. The Triscend NP CAP-Ex Program is a retention plan guided by a socially responsible approach to serve the nonprofit organization, the executive, and the community. Since its launch in 2011, it is projected to return over $1 billion to the nonprofit community. Triscend NP is the preferred provider of executive benefits for leading hospital associations throughout the United States.

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WOW you would have thought money pouring from the sky. No wonder we have no money to pay for Healthcare in this nation. He makes more than the President of the United States does.

18 WOW you would have thought money pouring from the sky. No wonder we have no money to pay for Healthcare in this nation. He makes more than the President of the United States does. Just keep handing out money like this and don't be surprise when your pension comes there is nothing left. This gentleman gets to walk to the bank laughing all the way. HAHA. [Spelling original.] 18

19 2005 Form 990 (C) Compensation (D) Contributions to benefit and deferred compensation plans (E) Expense account and other allowances 19

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21 Core Form - Part VII (D) W-2 compensation (F) Estimate of other compensation 21

22 Schedule J - Line 3 Compensation committee Independent consultant Form 990 of other organizations Written employment contract Compensation survey or study Approval by the board or committee 22

23 Schedule J - Part II (B) W-2/1099-MISC compensation (i) Base (ii) Incentive compensation (iii) Other (C) Deferred compensation 23

24 Schedule L - Part II Name/Relationship Purpose of loan Original principal amount 24

25 Example Executive A $500k salary $150k bonus $250k SERP Accrual Executive B $500k salary $150k bonus Loan regime split dollar 25

26 Reasonable Compensation Executive A - SERP SERP evaluated as part of total compensation Executive B - LRSD LRSD evaluated as part of total compensation 26

27 Tax Compliance Executive A - SERP Cliff vesting on SERP required for tax deferral Executive B - LRSD Vesting schedule on LRSD if important to the board for retention or incentive 27

28 Form 990 Reporting Executive A - SERP Executive B - LRSD $650 cash $250 deferred comp $650 cash $900 total $650 total (LRSD reported on Schedule L) 28

29 Millions Form 990 W2 Reporting $6 $5 $4 $3 $2 $ Year $0

30 Millions Salary Form 990 W2 Reporting $6 $5 $4 $3 $2 $ Year $0

31 Millions Salary Age 65 Cliff Vest Form 990 W2 Reporting $6 $5 $4 $3 $2 $ Year $0

32 Millions Salary Age 65 Cliff Vest 3-Year Cliff Vest Form 990 W2 Reporting $6 $5 $4 $3 $2 $ Year $0

33 Millions Salary Age 65 Cliff Vest 3-Year Cliff Vest LRSD Form 990 W2 Reporting $6 $5 $4 $3 $2 $ Year $0

34 Thousands Form 990 Deferred Compensation Reporting $200 $180 $160 $140 $120 $100 $80 $60 $40 $ Year $0

35 Thousands Form 990 Deferred Compensation Reporting Age 65 Cliff Vest $200 $180 $160 $140 $120 $100 $80 $60 $40 $ Year $0

36 Thousands Form 990 Deferred Compensation Reporting Age 65 Cliff Vest 3-Year Cliff Vest $200 $180 $160 $140 $120 $100 $80 $60 $40 $ Year $0

37 Thousands Form 990 Deferred Compensation Reporting Age 65 Cliff Vest 3-Year Cliff Vest LRSD $200 $180 $160 $140 $120 $100 $80 $60 $40 $ Year $0

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39 Exclusive to Healthcare. Dedicated to People. SM A NEW PERSPECTIVE IN RESPONSIBLE RETENTION PLANNING FOR HEALTHCARE EXECUTIVES Ohio Hospital Association May 2014 Copyright 2013, INTEGRATED Healthcare Strategies. All rights reserved.

40 Introduction How do you recruit and retain high quality executives especially in this era of significant change in healthcare delivery arena today? Competitive compensation programs Salary Annual Incentive plans Long-Term Incentives Benefits o o Security benefits Retirement benefits Salaries and annual incentives need to be competitive in order to recruit Long-Term Incentives and supplemental retirements retain Exclusive to Healthcare. Dedicated to People. SM 40

41 Hot Topics Market forces continue to drive pay higher C-suite turnover at record high Inadequate internal pipelines for leadership positions Limited pools of candidates with the right experience to face new challenges Need to recruit from insurance and general industry CEO turnover rate is 16% to 17% per year Pace of change makes the job riskier than ever Many CEOs choosing to retire early Some jobs lost to consolidation, streamlining Average tenure only 3.8 years Who wants the challenge of reinventing their systems? Are those who succeeded in the past the right leaders for the future? Exclusive to Healthcare. Dedicated to People. SM 41

42 Regulatory Environment IRS examination of tax-exempt universities 20% failed to establish rebuttable presumption of reasonableness because of comparability data Comparing to institutions that were not similar Failing to document criteria for selecting comparable schools Deficient compensation surveys o o Did not report total compensation Did not identify survey participants All had to make wage adjustments, pay additional taxes and penalties because of Misclassifying employees as independent contractors Failing to include value of perquisites in taxable income Problems with deferred compensation o o No substantial risk of forfeiture for deferred compensation under Section 457(f) Excessive 403(b) plan deferrals or loans Exclusive to Healthcare. Dedicated to People. SM 42

43 Regulatory Environment Senate Finance Committee tax-reform options being considered Tax all commercial activities of tax-exempt organizations Disallow tax-exempt status for organizations engaged in business activities; e.g., hospitals Require charity care of 5% of operating expenses Require JV for-profit hospitals to adopt charity care requirements Modify Section 4958 to apply a reason to know standard (rather than knowing ) Apply intermediate sanctions to employers, too Require disclosure of compensation studies Develop enforcement methods other than revocation of exempt status Exclusive to Healthcare. Dedicated to People. SM 43

44 Regulatory Environment State, local regulatory activity New York regulations limiting executive pay to $199,000 Massachusetts attorney general s reviews El Camino, CA voters cap executive pay at 2 times the governor s pay Ballot initiatives in California, Oregon, Massachusetts (California s was settled without being on ballot) Would cap executive pay or impose tax penalties on pay above cap Would limit markup over cost of services New Jersey, Florida, New Hampshire, Illinois efforts to cap executive pay at charities receiving state funding Exclusive to Healthcare. Dedicated to People. SM 44

45 Regulatory Environment Pay packages >$1M making headlines Charlotte, NC Observer November 18, 2013 CEO pay at Charlotte nonprofit hospitals higher than average Fox News, Providence, RI November 6, 2013 Lifespan CEO paid $7.88 million in 2011 Baltimore, MD Sun August 17, 2013 Some health care executives get bigger pay packages The Grand Rapids, MI Press July 18, 2013 $4.6 million in Grand Rapids hospital CEO pay Exclusive to Healthcare. Dedicated to People. SM 45

46 Regulatory Environment HIGH NUMBERS CALL FOR EXPLANATION! Location Net Revs CEO Total Pay Reason Amount Midwest $3.3 billion $4.9 million SERP payout? $2.9 M Southwest $3.5 billion $4.2 million SERP payout? $3.0 M Manhattan $2.6 billion $4.0 million SERP payout? $2.2 M Manhattan $1.8 billion $3.5 million SERP payout? $925 Southwest $1.8 billion $3.3 million?? Midwest $2.1 billion $3.0 million? $1.3 M Southeast $1.6 billion $4.1 million? $2.8 M Northeast $385 million $3.3 million DB SERP? Exclusive to Healthcare. Dedicated to People. SM 46

47 Trends Boards are responding to heightened public and government scrutiny by Becoming more diligent and cautious Wrestling with compensation philosophy Slowing salary growth, questioning above-average salaries Putting more risk into variable pay Trimming benefits, eliminating perquisites Shortening severance periods Exclusive to Healthcare. Dedicated to People. SM 47

48 Trends Still, boards know that hospitals and health systems need great leaders to Manage complex organizations Adapt to healthcare reform Cope with unprecedented rate of change Make up for inadequate internal talent pools Today s challenge is to balance economic realities with the need to recruit, retain, motivate and reward Exclusive to Healthcare. Dedicated to People. SM 48

49 Trends Recruitment needs continue to drive pay especially at top of the organization Nearly all organizations try to pay at median or above A third try to provide total compensation at the 75th percentile Exclusive to Healthcare. Dedicated to People. SM 49

50 Trends Median salary increase in healthcare 3.0% for 2013 vs % for 2014 vs Same for workforce as for executives Same for general industry (for-profit sector) Increases will be higher for clinical specialists (e.g., RNs, pharmacists) Increases will be higher for executives accountable for transformations (IT, quality, integration, ACOs) Exclusive to Healthcare. Dedicated to People. SM 50

51 Trends SYSTEM CEO $800M Net Revenues $658.2 $ % per year +2.9% per year $847.8 $143.8 $546.5 $ Median Salary Median Incentive Exclusive to Healthcare. Dedicated to People. SM 51

52 Trends INDEPENDENT HOSPITAL CEO $200M Net Revenues $430.7 $ % per year +1.1% per year $476.0 $46.4 $368.5 $ Median Salary Median Incentive Exclusive to Healthcare. Dedicated to People. SM 52

53 Trends ACTUAL SYSTEM CEO System In Upper Midwest Growth Thru Merger $1,370.5 $ % per year $560.0 $ % per year $1,038.0 $ Salary STI Exclusive to Healthcare. Dedicated to People. SM 53

54 Trends CEO pay is not that many times higher than pay for the average employee Net Revenues Sample Size N = CEO Total Compensation as a Multiple of Average EE Pay Median $10M 25 4X $50M 60 4X $200M 38 8X $500M 21 10X $1B 8 11X Exclusive to Healthcare. Dedicated to People. SM 54

55 Total Cash Trends $4.0M $3.5M SIZE MATTERS CEO Total Cash All Non-profit Health Systems & Hospitals $3.0M $2.5M $2.0M $1.5M $1.0M $500K $0K $0M $1.0B $2.0B $3.0B $4.0B $5.0B $6.0B $7.0B $8.0B $9.0B $10.0B Net Revenue Exclusive to Healthcare. Dedicated to People. SM 55

56 Total Cash Trends $2.5M $2.0M INDEPENDENCE MATTERS CEO Total Cash Independent Hospitals vs. Subsidiary Hospitals $1.5M $1.0M $500K $0K $0M $500M $1.0B $1.5B $2.0B $2.5B $3.0B $3.5B Net Revenue Subsidiary Hospitals Independent Hospitals Exclusive to Healthcare. Dedicated to People. SM 56

57 Trends Annual incentive plans are almost universal Goals focused on annual financial and quality performance improvement ANNUAL INCENTIVE OPPORTUNITY (% OF SALARY) TYPICAL RANGE Position Target Award Maximum Award System CEO 30% - 40% 35% - 60% Other system executives 20% - 30% 30% - 45% Hospital CEO 20% - 30% 30% - 45% Other hospital executives 15% - 20% 20% - 30% Exclusive to Healthcare. Dedicated to People. SM 57

58 Trends Long-term incentive plans historically found only in large systems are gaining interest in smaller organizations as a way to focus on longer term strategic initiatives Typically 3-year cycles Can assist in retention of executives LONG-TERM INCENTIVE OPPORTUNITY (% OF SALARY, ANNUALIZED) TYPICAL RANGE Position Typical Award Maximum Award System CEO 15% - 30% 25% - 60% Other senior executives 10% - 20% 15% - 30% Exclusive to Healthcare. Dedicated to People. SM 58

59 Trends Benefits being trimmed and redesigned Looking for offsets to escalating costs Shifting costs of medical benefits to employees Reducing paid-time-off accrual limits Reducing costs of retirement plans Correcting unintended benefits o o o Eligibility audits Eliminating or minimizing severance at retirement Excluding unusual items from basis for pensions Exclusive to Healthcare. Dedicated to People. SM 59

60 Trends Supplemental executive retirement plans (SERPs) still the norm Defined-benefit plans becoming less common 36% of CEO s and 20% to 25% of other senior executives Median benefit 60% for career service; most based on salary rather than total cash Defined-contribution plans for others Median contribution between 8% and 15% of salary depending on executive level Special Retention Incentive Program Provided to specific executives often during a special project or organization transition Shorter term, typically 2 to 5 year vesting Exclusive to Healthcare. Dedicated to People. SM 60

61 Trends Organizations looking for creative ways to provide retirement / retention benefits as IRS has made providing deferred compensation in not-for-profit organizations more difficult Pre-tax 457(f) plans Pre-tax deferral earnings Requires a Substantial Risk of Forfeiture (SRF) o SRF generally cliff vest Lump sum taxation at ordinary income rates upon vesting Corporate insolvency risk 990 reporting on Schedule J when deferred and again when paid out After-tax 457 plans Taxed on contribution, earnings tax-deferred until payout Earnings taxed at ordinary income rates Corporate insolvency risk 990 reporting as income on Schedule J Exclusive to Healthcare. Dedicated to People. SM 61

62 Trends Organizations looking for creative ways to provide retirement / retention benefits as IRS has made providing deferred compensation in not-for-profit organizations more difficult (cont d) Life insurance options 162 Bonus Plan o After-tax premium into policy o Cash value in contract may provide retirement accumulation o Premiums reported as cash compensation annually on Schedule J Loan Regime Split Dollar o Loan from employer into policy(ies) o Income tax free loans taken from the policy during retirement o Employer recovers loan at death of executive o Original loans reported on Schedule L as loan Exclusive to Healthcare. Dedicated to People. SM 62

63 Trends Deferred Compensation Periodically vest; specific ages or time periods; incremental vesting Examples: EACH CONTRIBUTIONS VESTS 5 YEARS LATER YEARS: Cycle 1 Cycle 2 Cycle 3 Cycle 4 4 YEARS OF CONTRIBUTIONS VEST AFTER 4 YEARS YEARS: Cycle 1 Cycle 2 Exclusive to Healthcare. Dedicated to People. SM 63

Conclusions Organizations need to balance higher scrutiny and economic pressures with the realities that competitive compensation is needed to be able to recruit and retain

64 Conclusions Organizations need to balance higher scrutiny and economic pressures with the realities that competitive compensation is needed to be able to recruit and retain high quality executives Long-term incentive compensation and retirement compensation more effective in retaining executives Exclusive to Healthcare. Dedicated to People. SM 64

65 A New Perspective in Responsible Retention Planning for Healthcare Executives June 9, 2014 (2:00 3:00 PM) Juniper A PREPARED FOR

66 Ohio Comparable Survey As a consultative research service for the healthcare organizations in Ohio 2, Triscend NP began with a group of 124 non-profit OHA members, and compiled each organization's public information filed in their Form Fifty nine of the 124 non-profit members, or 48%, are identified as most likely to benefit from alternative executive benefit programs which may provide a more responsible approach while mitigating negative perception regarding their allocation of funds. The assessment is based on annual revenue and compensation figures collected from each organizations Form 990. It is determined that 66% of the 59 identified organizations have some type of Supplemental Executive Retirement Plan (SERP) plan. SERPs have potentially negative accounting implications and can attract criticisms from the public due the organization's funds being permanently expended for the purpose of executive benefits. The average annual total compensation of the top executives at the 59 identified organizations is $734,859. This includes retirement and other deferred compensation funding. The average of these organizations total retirement and deferred compensation funding is $510,267 annually. Association Proportion of Identified Members to Total Members Number of Identified Members Proportion of Identified Members with SERP Plans Identified Members Average Employee Compensation Identified Members Average Retirement & Other DC Ohio Hospital Association 48% 59 66% $734,859 $510,267 Tiers Based on Revenue Proportion of Tiers to Total Members Number of Members Proportion of Tiers with SERP Plans Average Executive Compensation Average Retirement & Other DC Total Members 100% 72 57% $642,257 $425,392 Tier 1 >$400M 18% % $1,138,673 $1,095,253 Tier 2 $100M to $400M 34% 24 58% $625,516 $395,848 Tier 3 $10M to $100M 47% 34 38% $478,684 $202,594 Tier 4 <$10M 1% 1 0% $152,153 $1,343 ² Triscend NP conducted this study independently by using publicly available information, without the participation of OHA 3 The information is collected from publicly available reporting of each organization's Form 990, from either 2010 or This resource of information used in this study is dependent on how the organization submitted the information in their Form 990. Compensation information was not available for 72 of the 124 OHA nonprofit members due to government ownership not requiring 990 filing. Some of the non-government owned nonprofits information was not able to be located. 66

67 New Perspectives in Planning Current plan reviews and observations Trend #1 Change the investment vehicle and make it about retirement again Trend #2 Make it non-compensatory with capital recovery 67

68 Current Plan Reviews Income Tax Rates Rate of Return (Pre-Distribution) Discount Rate (Post-Distribution) We have seen 30-50% OVERESTIMATES of retirement income Will the SERP generate expected retirement income? How to address deficiencies without substantial increase in funding? 68

69 Current Plan Reviews Shorter-term deferrals are more bonuses than retirement accounts Most executives are not saving these payments And, if they are Two levels of taxation Distributions Earnings through life 69

70 Case Study #1 Northeast hospital with defined contribution SERP for mid-level management All executives had elected 1-year deferrals Updating tax and post-distribution earnings assumptions concluded plan was underfunded 70

71 Case Study #1 Old Assumptions New Assumptions Age of Executive 50yo Female 50yo Female Annual Deferrals $50,000 $50,000 Tax Rate on Distribution 35% 45% Years of Distributions Tax Rate on Earnings 20% 30% Pre-Tax Earnings Rate Post Retirement 20-Year Annual Retirement Income 8.0% 5.02% (1) $70,222 $37,422 (1) 20-year DALBAR equity-investor results 71

After-Tax IUL Pre-elected 30-year Annuity of Death Benefit Tax-Free Income Plus Death

72 CASE STUDY #1 CHANGE THE INVESTMENT VEHICLE AND MAKE IT ABOUT RETIREMENT AGAIN AFTER-TAX IUL Hospital Annual Contribution is Taxed Withhold Taxes Net Contribution Individually Owned After-Tax IUL Pre-elected 30-year Annuity of Death Benefit Tax-Free Income Plus Death Benefit Executive TRISCEND NP All Rights Reserved The CAP-Ex Program is a service mark of TRISCEND NP 72

73 NEW RETIREMENT RETENTION STRATEGIES CHANGE THE INVESTMENT VEHICLE AND MAKE IT ABOUT RETIREMENT AGAIN AFTER-TAX IUL 40.00% $2, % $2, % $1, % $1, % % % % $1,500 $1,300 $1,100 $900 Actual S&P Actual Investment Collared Investment % $ % $500 TRISCEND NP All Rights Reserved The CAP-Ex Program is a service mark of TRISCEND NP 73

74 Case Study #1 Old Assumptions New Assumptions After-Tax IUL Age of Executive 50yo Female 50yo Female 50yo Female Annual Deferrals $50,000 $50,000 $50,000 Tax Rate on Distribution 35% 45% 45% Years of Distributions Tax Rate on Earnings 20% 30% 0% Pre-Tax Earnings Rate Post Retirement 20-Year Annual Retirement Income 8.0% 5.02% (1) 6.51% (2) $70,222 $37,422 $48,758 (1) 20-year DALBAR equity-investor results (2) 20-year lower limit of 99% confidence interval, 0%/13% S&P collar 74

75 Case Study #2 West Coast hospital CEO with defined benefit plan, lump sum, age 65 Updating tax and post-distribution earnings assumptions concluded plan was underfunded Significant concern over 990 reporting 75

76 Case Study #2 Old Assumptions New Assumptions Age of Executive 55yo Male 55yo Male Distribution at Age 65 $8,000,000 $8,000,000 Tax Rate on Distribution 40% 52% Tax Rate on Earnings 25% 35% Pre-Tax Earnings Rate Post Retirement 20-Year Annual Retirement Income 10.0% 5.02% (1) $437,993 $256,070 Recovery by Hospital $0 $0 IRR to Hospital (neg) (neg) (1) 20-year DALBAR equity-investor results 76

77 CASE STUDY #2 MAKE IT NON-COMPENSATORY CAP-EX PLAN LOAN REPAYMENT OF LOAN Plus Interest RETIREMENT INCOME Plus Death Benefit REPAYMENT POLICY ACCUMULATION POLICY TRISCEND NP All Rights Reserved The CAP-Ex Program is a service mark of TRISCEND NP 77

TRISCEND NP CAP-EX PROGRAM Transforms an expense into an asset. Endows the employer with future cash recovery plus interest. More favorable Form 990 presentation.

78 TRISCEND NP CAP-EX PROGRAM Transforms an expense into an asset. Endows the employer with future cash recovery plus interest. More favorable Form 990 presentation. Tax-free retirement income to the executive without artificial vesting requirements. TRISCEND NP All Rights Reserved The CAP-Ex Program is a service mark of TRISCEND NP 78

79 Case Study #2 Old Assumptions New Assumptions CAP-Ex Plan Age of Executive 55yo Male 55yo Male 55yo Male Distribution at Age 65 or Loan at Age 55 $8,000,000 $8,000,000 $8,000,000 Tax Rate on Distribution 40% 52% 0% Tax Rate on Earnings 25% 35% 0% Pre-Tax Earnings Rate Post Retirement 20-Year Annual Retirement Income 10.0% 5.02% (1) 6.51% (2) $437,993 $256,070 $606,668 Recovery by Hospital $0 $0 $32,782,670 IRR to Hospital (neg) (neg) 5.50% (1) (1) 20-year DALBAR equity-investor results (2) 20-year lower limit of 99% confidence interval, 0%/13% S&P collar 79

80 QUESTIONS/ANSWERS v KIRK SHERMAN Sherman & Patterson, Ltd. Partner TONI DOLBY Integrated Healthcare Strategies Senior Vice President, Total Compensation and Rewards Practice DALE EDWARDS Triscend NP Principal

81 THANK YOU v KIRK SHERMAN Sherman & Patterson, Ltd. Partner ksherman@splawfirm.net TONI DOLBY Integrated Healthcare Strategies Senior Vice President, Total Compensation and Rewards Practice toni.dolby@ihstrategies.com DALE EDWARDS Triscend NP Principal dkedwards@triscendnp.com

IMPLICATIONS OF THE TAX ACT FOR TAX- EXEMPT ORGANIZATIONS AND EXECUTIVES

IMPLICATIONS OF THE TAX ACT FOR TAX- EXEMPT ORGANIZATIONS AND EXECUTIVES Important Considerations TRISCEND NP, LLC 1100 Parker Square Suite 245 Flower Mound, TX 75028 PUBLISHED: March 2018 Table of Contents