Cowden Associates, Inc.
Recent economic volatility has taught us several painful lessons regarding the management of costs. One very important component of this equation involves, if not the most vital of our assets, our people. As our economy rebounds, it becomes even more important to manage our people with a comprehensive approach to Total Compensation (base pay, incentive opportunities, health benefits and retirement programs). When faced with difficult decisions, all too often health care organizations focus on one particular facet versus a total analysis. Although this may result in some short-term benefits, it may ultimately impact Total Compensation in a negative manner.
Health care organizations must respond to many challenges while managing Total Compensation programs including:
- Escalating benefits and health care costs
- Financial management constraints
- Distinct benefit needs (executives, physicians, nurses)
- Attraction, retention and engagement of all employees
- Maintaining a competitive total compensation and benefits program
This article focuses on a strategic approach to address people costs by considering each facet of Total Compensation versus making decisions focused only on one area. Health care organizations are now obligated to consider changes in their compensation programs based on several recent trends including:
- Reduced staff
- Commitment to hire non-smokers
- Recent medical students are choosing primary care fields versus specialty fields
- Transition of physicians from private practice to full or part-time employment
As an initial step, decision makers should fully comprehend their existing employee and retiree census. Questions such as the following are to be considered:
- Which strategic areas that drive profitability are not staffed properly?
- What is the age and service of our employee population?
- Do we have the talent needed to meet our customers’ current and future expectations?
By only reviewing headcount in total, without considering the make-up of headcount, is a flaw in planning.
It is also worthwhile to examine the demographics of existing retirees. This is an area that is often overlooked in analyzing various cost elements. As we will be examining this issue later, the make-up of the current retiree population (if applicable) is key.
Armed with key demographic information, the next phase of this analysis is to review each aspect of Total Compensation.
All too often, the review of base compensation is focused on how pay compares to market practices. We are too often driving our pay decisions tied exclusively to market. Base compensation improvements should focus more towards performance and future opportunity. If I, as an employee, perform well, what is my ultimate career progression and what are my upside compensation opportunities?
Pay grades should be examined and altered as needed to better match business models and operations. Health care organizations are beginning to institute base pay levels for educational experience for various staff positions. For example, nurses have an opportunity to increase their base pay with an incentive to differentiate themselves from their colleagues to advance within the nursing industry. This is accomplished through additional education and passing board exams. This does not mean that every employee’s base compensation level must parallel this approach, but a focus on how to utilize limited resources should be reviewed carefully. Once adjusted, pay grades should be increased periodically, but this does not require an automatic adjustment to compensation. For example, for nurses, specific goals related to safety, leadership, communication, patient satisfaction and organizational skills should be part of the overall compensation review process. All too often during difficult times, a universal base compensation freeze is enacted. This unfairly penalizes top performers that a health care facility needs as it struggles to improve. Furthermore, eventually a company’s fortunes will turn around. Treating these key employees well during difficult periods may enhance loyalty. Also keeping the high performers and eliminating waste is a better solution than simply freezing compensation for all employees.
Annual cost-of-living adjustments (COLA) should be replaced with a focused merit program. COLA increases, once granted, can never be recovered. Consider the annual (and recurring) cost of a three percent across-the-board increase in compensation. Can these limited resources be better spent?
When a turnaround does occur, health care facilities should not simply return to prior practices regarding compensation. The compensation philosophy, when clearly developed and communicated, will survive and be practical in both good and bad times.
- A consistent and clear pay philosophy will work in good and bad times
- Do not focus only on market data
- Align your compensation with your business practices
- Eliminate annual COLA programs and focus on merit
- Review pay grades
- Avoid universal pay freezes during tough times
After reviewing the base compensation philosophy, it is now time to focus on incentive opportunities. Incentive plans (both short and long-term) are becoming more typical for health care organizations. If a decision is made to add or refine an incentive plan, the following information will be of interest. These relate to short-term performance (generally a year or less) or longer term performance (generally two to five years).
Short-term Incentive Programs (STIPs)
Short-term incentive opportunities should be maintained during good and bad times. If base compensation increases are limited, more compensation opportunities must be shifted to incentives. Programs of this nature must be mainly objective focusing on health care facility results and other factors that are within an individual’s control. Physicians’ STIPs for example, can include using effective management resources and delivery of patient care. Eligibility should be generally limited to a select group of employees who can both understand and drive performance. Within health care organizations, these employees are usually physicians or those with management responsibilities or a combination thereof.
True incentive plans provide meaningful compensation opportunities tied to achievement of pre-determined goals. These often require a threshold level of performance before any rewards are provided. Plans of this nature should have clear and easily understood performance measures and benchmarks that relate to key success areas.
During difficult times, annual incentive plans are often cancelled or deemed unachievable. It is practical to consider a structure of an incentive plan that provides limited rewards for key individuals for achieving at least a threshold level of performance. However, a clearly communicated compensation philosophy that provides for reasonable, competitive base compensation and meaningful annual incentive opportunities during better times is an approach worthy of consideration.
Long-term Incentive Programs (LTIPs)
These plans should be limited to a very select group of key employees who are in the position to drive longer term performance of the company. Similar to short-term programs, clear and understandable performance measures and benchmarks are vital to the success of a LTIP. Overlapping performance cycles provide for a cushion against one bad year ruining a long-term rewards program benefit.
LTIPs are a means for delivering meaningful rewards for sustained long-term performance. Creating plans with a combination of time-based and performance-based vesting is an approach to achieving a balance between performance and retention. In designing these programs, a focus on cost should be merged with creating a plan that provides meaningful incentives for a select group of performers.
- Pick clear, understandable, meaningful and measurable performance measures
- Create benchmarks that are achievable but contain enough stretch
- Limit eligibility in order to provide for more meaningful rewards
This subject should be split into two areas: active and retiree (if applicable). Active and retiree health benefits are vital to the attraction and retention of employees. The issue is not only access to high quality care, but being able to utilize the system at a reasonable cost for employees and retirees.
Much has been written about this never ending struggle to balance a reasonable and competitive program at affordable levels for both employees and employers. Health care organizations may not be able to pass along cost increases at the levels that were historically in practice. As such, when reviewing this issue, health care facilities should keep the following in mind:
- Establish a core program that reflects the organization’s commitment to health care that is reasonable and competitive
- Provide alternate plans that permit employees the choice of buying-up (or trading down)
- Understanding the true drivers of the cost of health care and attempt to address plan design strategies to contain these areas
Once employees retire, organizations often maintain a hands-off attitude to effectively managing these plans. Alternately, companies may take very drastic attempts to cut or eliminate benefits. There are reasonable ways to address these issues while still providing meaningful retiree benefits.
In evaluating these choices, focus should not be just on expense reductions, but reductions in cash. As noted above, a complete census of current retirees should be reviewed. What is the breakdown between Pre-Medicare eligible retirees and Medicare eligible retirees?
Once this is understood, there are a variety of meaningful changes that can be identified within each plan that can effectively reduce and contain costs. With the creation of Medicare Supplemental programs, including drug plans, Medicare eligible retirees should be enrolled in these plans as a valuable replacement for traditional programs. A valid comparison between these plan designs will illustrate that they are substantially equivalent to existing plans in almost all areas.
Pre-Medicare eligible retirees do not have to be enrolled in the identical plans that were in place when they retired or when they were active employees. Substantially, equivalent programs are available that provide better cost-containment provisions.
As part of the process, prior agreements and communications should be reviewed to determine what risk, if any, exists in making modifications to programs that are in-line with current practices. Retirees are more likely to accept reasonable modifications to retiree benefits versus an entire reduction or substantial modifications.
As is the case with active benefits, the following process should be followed:
- Establish a core program that reflects a facility’s commitment to retiree health care that is reasonable and competitive
- Provide alternate plans that permit retirees the choice of buying-up (or trading down)
Retirement programs are immediate and significant issues for employers that sponsor any retirement programs. Recent legislative changes (Pension Protection Act of 2006), accounting reform, significant costs and changes in retirement patterns and employee demographics have further complicated retirement programs.
Defined Benefit Plans:
Health care facilities that sponsor defined benefit plans should operate these programs like any separate line of business. Formalized cash-flow, expense and balance sheet impacts should be modeled over a three-to-five year rolling time period under a variety of scenarios. Facilities should be prepared to manage the potential volatility of these programs and actively manage these plans. The link between accounting functions, treasury and benefits must be more closely coordinated. All too often, these have been operating independently.
As a parallel course, companies should review these existing programs to determine if they continue to make sense given their own employee demographics. If a decision is made to cease providing this form of retirement benefit, a careful analysis of who is potentially harmed and by how much should be understood. There are various avenues for balancing out the impact, while still achieving the cash flow, cost and balance sheet considerations. Alterative investment strategies should be considered in light of current economic circumstances, which should include a review of “fixing” some or all of the current retiree obligations.
Most health care facilities that established 403(b) plans did so with basically a hands-off approach. With the recent legislative changes one must take an active approach in offering these plans. Health care organizations need to now provide:
- A written plan document
- Required contractual provisions
- The application of certain qualified plan nondiscrimination rules
- The application of the universal availability rule
- The interaction of various catch-up provisions
- Required timing for remitting contributions
- New distribution restrictions
- New rules for nontaxable exchanges and transfers
- The termination of 403(b) arrangements
Additionally, health care organizations need to evaluate how meaningful are these programs to employees? Should they offer matching contributions, contributions as a percentage of salary or tied to profits? The operation of these plans have become even more vital given the ability to provide participant level investment advice. A properly structured and integrated program must consider all of these factors.
Retirement Benefit Points:
- Manage the plans as if they are separate lines of business, including forecasting and budgeting of cash-flow, expense and balance sheet impact
- Understand the potential benefits to participants – how meaningful are the level of benefits
- Link liability and asset management and consider alternate structures to accomplish goals
In addition to traditional health benefits, ancillary benefits will give employees peace of mind and the necessary coverage and support to help them through unexpected, difficult times in their lives.
Ancillary benefit plans offer employees another way to experience job satisfaction, especially during times when incentive compensation or other benefits are not available or reduced. These benefits include: Group Life Insurance, Group Disability or Individual Specialized Disability benefits.
Organizations should access these programs to determine if they are within the “industry” norms.
Ancillary Benefit Points:
- Identify the importance and impact that offering or altering ancillary benefits will have on employees and determine if that is part of the overall objectives of the company
- Analyze the cost of the ancillary benefits and determine the cost impact if supplemented by the employer and/or the impact on employees if offered on a voluntary basis
Paid Time-off Benefits:
Whether a facility utilizes paid time-off or vacation/sick days for employee’s time out of work, there is an impact on the overall cost of a compensation package. Regardless of the type of offering, consider the following:
- Ensure that the approach utilized suits the company culture
- Complete an analysis to determine an appropriate “bank” of paid time-off
- Implement appropriate guidelines for notification of paid time-off
Health care facilities additionally offer perquisites as additional incentives including:
|Parking/reduced parking||Telephone||Gas allowances||Vehicle allowances|
|Education reimbursement||Legal services||Adoption benefits||Cafeteria discounts|
|Pharmacy discounts||Blood assistance||Time off to vote||U.S. Savings bonds|
These all have an influence on the overall compensation package and cost to employers.
One of the most significant and yet often most neglected steps of the development of a compensation program is implementation. Employers need to account for training at various management levels within the organization to assure the compensation package is being delivered accurately and the same message is being told.
Additionally, employers need to have the appropriate documentation of what benefits and/or compensation arrangements are being offered to employees.
Total Compensation Approach:
Armed with data and information for each area, health care facilities can become better equipped to manage their people costs based on a complete and careful analysis. Reduction in forces may be inevitably required given operational issues and demands. However, for the remaining employees, a focus on providing meaningful, competitive and reasonable cost contained programs can provide a better alternative for more efficient and effective operations.