Top-paid healthcare CEOs see pay grow faster than profits

Total compensation for some of the highest-paid CEOs in the healthcare industry increased faster than their companies' profits last year, a Modern Healthcare analysis of the first firms to report executive pay found.

Corporations with the most richly rewarded CEOs by sector in 2014 included Community Health Systems, a Franklin, Tenn.-based hospital operator; Centene Corp., a St. Louis-based insurer; CVS Health Corp., a retail pharmacy and pharmacy benefit manager based in Woonsocket, R.I., and Regeneron Pharmaceuticals, a New York City-based biotechnology company.

Modern Healthcare's early look at executive compensation included more than 100 companies that disclosed CEO compensation as of April 10. The analysis, which looked across four healthcare sectors, found the five highest-paid CEOs in each sector enjoyed a median increase in total compensation last year of 8.5%. That's a more robust gain than the 4% median growth in net income for the 20 companies headed by these CEOs. Median total compensation in 2014 for the 117 CEOs for whom Modern Healthcare collected compensation data was $5.4 million, with a median increase of 9.6% over the prior year.

The lucrative healthcare pay packages in 2014 come as chief executives of the largest companies overall enjoyed the biggest compensation gains since 2010, according to a Towers Watson analysis of 500 companies in the Standard & Poor's 1,500 with publicly reported compensation through last month. The median compensation of CEOs at those 500 firms rose 12.1% last year, thanks in part to larger incentive awards, Towers Watson found.

Companies on Modern Healthcare's list of highest-paid CEOs deployed various strategies to incentivize their top executives, including equity awards tied to company performance, a strategy that is increasingly common but continuing to evolve. “To some extent, they're testing the water” with stock or option awards tied to performance, said Wayne Guay, an accounting professor at the University of Pennsylvania.

Regeneron CEO Leonard Schleifer led Modern Healthcare's list of highest-paid CEOs in the supply-chain sector, with total compensation of $42 million, up 15.7% from the prior year. That was despite Regeneron's relatively small $2.8 billion in revenue. Stock options accounted for roughly 90% of Schleifer's payout. In corporate filings, Regeneron cited 44% growth in its stock price last year as evidence of the achievement of its top executives. But the company's net income dropped 18%. No one was available for an interview.

Community Health Systems' Wayne Smith took the top spot among CEOs of provider companies, with total compensation of $26.4 million. CHS awarded its CEO by far the largest increase in total compensation—199.3%. CHS' revenue soared 45% with the $3.6 billion acquisition of Health Management Associates in January 2014. But the company saw net income slip 6% as it digested its new assets. CHS declined an interview request.

On the other hand, total compensation for Centene Corp. CEO Michael Neidorff, the highest-paid chief of an insurance company, grew at a lower rate than his company's profits. His 2014 pay was $19.3 million, up 33% from the prior year thanks to a boost to his stock options. The company's revenue totaled $16.6 billion, up 52% from the prior year, while net income reached $264 million, an increase of 59% from the prior year.

Thomas Kelly, an executive compensation consultant for Towers Watson, said performance-based equity awards have flourished among the Fortune 500 companies. But some companies have struggled to identify workable performance criteria and have revised targets to one-year from three-year time frames. Growth targets such as revenue or shareholder return can be skewed or stymied by unforeseen acquisitions, regulatory delays, congressional action or market swings. “It sounds easier to do than it is,” Kelly said.

That hasn't stopped companies from trying. Centene ties vesting of stock awards to company performance. So does CHS.

In the supply-chain sector, Actavis CEO Brenton Saunders ranked second to Schleifer, with compensation last year of $36.6 million. Last July, Saunders became chief executive of Actavis, which reported $13 billion in revenue.

The chief executives of Bristol-Myers Squibb Co., Johnson & Johnson and AbbVie also made the supply chain's highest-paid list.

In the healthcare services sector, CVS Health CEO Larry Merlo boasted the highest pay, with total compensation of $32.4 million, an increase of 3.3% over 2013. His company's revenue totaled $139.4 billion, up 10%, while net income edged up 1% to $4.6 billion.

Last year “was a very strong performance year for CVS Health with record net revenue and robust profitable growth in all of its businesses,” said Carolyn Castel, a company spokeswoman. “Mr. Merlo's compensation in 2014 reflected this significant level of achievement as well as his role in positioning the company for future growth.”

A one-time stock grant significantly boosted total compensation for CHS CEO Smith. That grant came as part of his company's acquisition of Health Management Associates. It increased his stock awards from the prior year by 258%.

Kelly said such one-time awards are not uncommon in extraordinary circumstances, such as major acquisitions, divestitures, new executive-level hires or when companies make significant changes to strategy. Stock awards typically can't be cashed out until executives meet performance goals or until a number of years have passed, or both. The strings attached to the stock—which is only as valuable as the stock price—are one way the board seeks to ensure CEOs work to deliver benefits from the deal, he said. “The end result is what happens after it closes,” he said.

Smith's stock award requires him to meet performance goals. He also must wait up to three years to collect. Community Health Systems must reap at least $150 million in gains from the merger through the end of 2016, but executives will see larger payouts if the gains exceed $200 million.

Overall, 2014 was a lucrative year for hospital CEOs on the best-paid list.

Alan Miller, CEO of Universal Health Services, King of Prussia, Pa., enjoyed one of the biggest increases in total compensation, receiving 40.1% higher pay than in 2013. Universal, the smallest of four hospital operators represented on Modern Healthcare's highest-paid CEO list, increased Miller's option awards by one-fourth and his cash incentive payout by roughly two-thirds. The company's financial performance and return on capital earned Miller the largest bonus he was eligible to receive—2.5 times his $1.5 million salary.

At Nashville-based HCA, CEO R. Milton Johnson saw his compensation increase roughly 90% with his promotion to chief executive in January 2014 from president and chief financial officer.

But not all hospital CEOs received a raise last year. Tenet Healthcare Corp. CEO Trevor Fetter saw his total compensation drop 21%. That followed a special stock award in 2013 for his tenure and performance that raised his stock compensation that year to $17.5 million. In 2014, the value of his stock compensation fell to $8 million.

McKesson Corp. CEO John Hammergren and Aetna CEO Mark Bertolini ended the year with compensation down 49.9% and 51%, respectively.

Hammergren's pension value saw a significantly smaller increase in 2014 compared with the prior year; that largely accounted for the sharp drop in his total 2014 pay. Bertolini's received a one-time retention award in 2013, explaining his much lower total 2014 compensation. Similar to CHS, Aetna tied the retention award to performance.

Increasingly, companies use performance—rather than simply length of time since the grant of stock or options—to determine whether executives can cash in on these awards. Performance measures are applied not only to one-time awards, but more commonly to vesting annual equity payouts as well, said Steven Sullivan, vice president at Pearl Meyer & Partners, a compensation consulting firm. “Performance shares are kind of everywhere.”

Regeneron Pharmaceuticals, however, dropped performance measures from its equity awards in 2013 after adopting them in 2008. The company said its industry peers don't use performance to restrict whether their CEOs can vest equity awards.

Midsized companies have moved more slowly to adopt performance shares, said Towers Watson's Kelly.

CVS Health does not tie restricted stock and options to performance criteria, but does offer its executives a long-term incentive plan that includes cash and stock awards. “Mr. Merlo's compensation, as well as the compensation of other executive officers, reflects a base salary as well as short- and long-term incentives, with an emphasis on long-term incentives,” CVS spokeswoman Castel said.

Merlo's payout for cash tied to long-term incentive accounted for 35% of his total compensation, the highest of any of his top-paid peers. “This approach aligns the interests of our executive officers and stockholders and fosters an equity ownership environment,” Castel added.