Go Ahead Cap My (Non Performance Based) Pay

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Expert Perspective by Grahall’s OmniMedia Editorial Board

expert perspective telescopeAccording to The Wall Street Journal’s Greg Hitt and Janet Adamy in their October 2, 2009 article “Insurance Executive Pay Curbed in Health Bill” in “… responding to charges that expanding health insurance coverage would enrich insurance companies. … Democrats on the Senate Finance Committee approved an amendment that would limit the tax deductibility of compensation for insurance executives to $500,000 a year. The limit would apply to executives at companies that get significant business generated by the bill’s mandate that nearly all Americans must have insurance. Under current law, businesses can deduct up to $1 million a year in non-performance based compensation for executives.”

Is this limit a big deal, or not?  It certainly sounds significant since it cuts the current limitation in half.  But, frankly, it doesn’t represent a “cap” on compensation. It is simply a cap on the deductibility of executive “non-performance based pay.” 

Do companies pay more in non-performance based pay than the limit?  The answer to that question is YES.  And in that case who wins and who loses? 

• the executive clearly wins because he or she gets more non-performance based pay,

• the government wins because any amount over the limit is taxed and therefore represents revenue to the IRS,

• the shareholders lose, because they essentially pay the taxes on any non-performance based pay over the limit (whether that limit by $1 million for most industries or $500,000 for the health insurance industry). 

You might also wonder why we are harping on the “non-performance based” component of this.  Well, these limits only cap (for deducibility purposes) compensation that is not part of a pay for performance formula.  The non-performance components are base pay and non-restricted stock. So what’s not included in these limits?  Everything else – including options, retirement payouts, performance based bonuses, and other performance based incentives – all of which can push executive compensation into pretty big numbers.

Grahall has recently completed an authoritative study of compensation for the top five named executive officers in publically traded companies across 23 industries.  The insurance industry is one of these 23, with 36 companies included in the study group.  Study results will soon be available on the web site (www.grahall.com). 

The study results disclose important and insightful information pertaining to the insurance industry, which we will preview for you here.   The study looked at Base Pay, Annual Incentives, Total Annual Compensation, Long-Term Incentives and Total Direct Compensation.  For the insurance industry (and here we confess that the sample extends beyond health insurers) Grahall found that:

• for the 50% percentile company (on average) the revenues were $1.2 billion

• CEO base pay was $732,000,

• CEO Total Direct Compensation was over $2.3 million.

Assuming these companies do not want added tax burdens, CEO base pay could fall to $500,000 and CEO total direct compensation to just over $2 million. 

Further, Grahall found that executive compensation in the insurance industry is highly correlated to size measured by revenue, with the largest of these insurance companies paying CEO’s nearly $10 million in Total Direct Compensation.  So as these health insurers grow so will their executive pay packages, and a 50% reduction in non performance based pay will have little impact on the Total Direct Compensation received by any of these folks.

So the value of a $500,000 deductible pay limit is largely symbolic – as well as politically motivated.  As we see, it probably won’t have any material impact on burgeoning real compensation for Health Insurance company executives. So we rank this one a “10” (where 10 is tops) on the Grahall Symbolic Politics Scale and a “0” on the Grahall Materiality Scale.  If this were golf, we’d be giving Congress a “mulligan”.

Contact Grahall’s OmniMedia Editorial Board at edie.kingston@grahall.com

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