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and Vol II Exhibits 44-78
"Based on the information provided by HealthPartners, there is a question as to whether the compensation paid to certain executives is consistent with state and federal law. "
Investigation of Kaiser Permanente's CEO George Halvorson and the HealthPartners Executive Board by the Minnesota Attorney General
SUMMARY OF EXECUTIVE COMPENSATION EXPENSES
A. Executive Officers
HealthPartners' Executive Officers are provided the following forms of compensation.
1. Base Salary.
2. Fully paid family medical and dental coverage.
3. Section 125 cafeteria plan.
4. $50,000 Group Term Life Insurance Policy.
5. Paid time off with an option to purchase more.
6. Tuition reimbursement.
7. Qualified pension plan.
8. 401(k) plan.
HealthPartners matches an executive officer's contribution dollar-for-dollar up to 5% of base pay.
9. Incentive Pay - Withhold Program (Bonus Program). Withhold percentages
range from 5% to as high as 35%. (Ex. 23.) HealthPartners boasts that its Withhold Program is extremely useful in dealing with legislators, news media, etc., who believe that part of the executive's pay is withheld. This is not true. Rather, HealthPartners pays its executives the market salary it sets and then determines an incentive payment. The amount supposedly "withheld" is really a potential bonus that can be paid. (Exs. 22 & 23.) Just as misleading is the fact that the percentage of incentive pay is not calculated according to normal expectation. A thirty percent (30%) withhold actually amounts to a bonus of over forty-three percent (43%).1 HealthPartners paid out over $4,000,000 in withhold payments in 1999 and again in 2000.
10. Severance Pay. Six months of base salary is paid even if the officer secures other
employment. If the officer has not commenced comparable employment at the end of six months, they are also entitled to be paid two months at 50% of their base salary for every full year of service up to a maximum of 12 additional months. In other words, an employee of six years will receive 100% salary for six months and can receive an additional one year of salary at the 50% level.
Senior Executives are entitled to the following additional benefits:
11. Executive Survivor Policy. A split-dollar life insurance policy that provides death proceeds equal to two times the executive participant's base salary in effect on the date of death, less $50;000. HealthPartners owns the policy and pays 100% of the premiums on the policy.
12. Execu-Flex Benefits (Split-Dollar Insurance and Capital Accumulations).
Senior Executive Officers are given between 7% - 9% of their base salary to purchase even more benefits. Senior Executives can put this money into a cash account. Otherwise, the executive can purchase Supplemental Survivor and Spouse Survivor Life Insurance Policies (Split-Dollar Life Insurance). The supplemental survivor life insurance policy provides a death benefit of up to 4 times base salary. Less commonly, executives purchase a spouse survivor policy that pays either $100,000 or $200,000 in death benefits in the event of the death of a spouse.
Split-dollar policies, so called because on paper the company and executive split the benefits. Typically, the company pays close to 100 percent of the premiums, which grow tax-free within the insurance policy and over a decade or two become a mountain of cash. When the executive retires, the corporation is repaid - without interest - from the cash buildup for the millions it has contributed in premiums.
Graef Crystal, a compensation consultant who has written widely on split-dollar life insurance calls split-dollar policies a "waste of assets" and states that "[t]he shareholders are entrusting to the C.E.O. and the board a body of capital to be invested in an advantageous way. So it ends up as a no-interest loan, when the money could have been used to invest in a plant or new equipment."
13. 401(k) and Defined Benefit (Pension) Restoration Program. HealthPartners also provides its Senior Executives with a 401(k) and Defined Benefit (Pension) Restoration Plan. Under state and federal law, the amount an employee may put into a qualified 401(k) program and pension plan is capped. In order to bypass this law, HealthPartners implemented a 40 I (k) and Defined Benefit (Pension) Restoration Plan to restore benefits that are lost due to legislative limits on compensation.
14. KEYSOP - Key Employee Share Option Plan. Under KEYSOP, Senior Executives are granted options to purchase a stated amount of mutual fund shares.2 The Senior Executives are able to exercise the options in the future if the funds appreciate.
15. Retention Bonuses. HealthPartners contributes $250,000 over five years on behalf of McClure, Wise and Cooney; and $500,000 over five years on behalf of Brainerd and Rank. The total cost for these five executives is $750,000.
16. Social Club Memberships. HealthPartners paid for social club membership dues for select officers at the Minneapolis Club, Town & Country Club, Decathlon Club, Minnesota Horse & Hunt Club, Edina Country Club and the Minnesota Club.
2 New Senior Executives do not participate in the Execu-Flex Plan and participate only in KEYSOP.
17. Spousal Travel. HealthPartners also pays for spouses to travel on trips. Executives entitled to this benefit included Craig Amundson, Mary Brainerd, Kathy Cooney, Anne Darnay, Kirby Erickson, Terry Finzen, George Isham, Ted Wise and Andrea Walsh.
18. Company Cars. Sixteen executives were provided a car allowance and/or a leased car.
B. CEO - George Halvorson
Between 1998 and 2000, CEO Halvorson's total compensation increased by 31 %:
CEO Halvorson's compensation package is made up of the following benefits:
1. Base Salary. CEO Halvorson's base salary increased from $362,811 in 1996 to $505,194 in 2000, a 53% increase.
2. Fully paid family medical and dental coverage.
3. Section 125 cafeteria plan.
4. $50,000 Group Term Life Insurance Policy.
5. Four weeks paid time off with an option to purchase more.
6. Tuition reimbursement.
7. Qualified pension plan.
8. 401(k) plan.
9. Incentive Pay - Withhold Program (Bonus Program).
CEO Halvorson's withhold percentage was generally set at between 30-35% entitling him to paid bonuses (withhold payments) as high as 52% of his salary. Unlike his officers, CEO Halvorson's withhold payout was not subject to a "baseline" requirement that had to be met before any withhold payout was made. Accordingly, CEO Halvorson received withhold payments in 1997 and 1998, even though no other executive in the organization received withhold payments in those years.
CEO Halvorson's Withhold Pay Outs and Percentage of Goals Met
In order to not fully disclose his withhold payments in 1998, CEO Halvorson told the Board that he wanted his withhold payments as deferred income as he was concerned that the other HealthPartners' officers would experience decreases in 1998 compensation over 1997.
10. Disability Coverage. Benefits provided at 100% of salary for 12 months plus HealthPartners paid the premiums for CEO Halvorson to carry an individual disability policy.
11. 401(k) and Pension Plan Restoration.
12. Severance Pay. If terminated without cause, CEO Halvorson was entitled to a lump sum payment equal to two times his annual base salary. HealthPartners could only terminate CEO Halvorson's employment contract for "Reasonable Cause" if CEO Halvorson:
1. Commits any material breach of the provisions of this Agreement;
2. Is convicted of a felony or a misdemeanor involving moral turpitude; or
3. Does or knowingly permits any act which is determined by a court of competent jurisdiction to constitute a breach of trust or a violation of the duties of office herein assumed by him.
It appears that if CEO Halvorson was fired for poor performance, this would not be considered "Reasonable Cause" under the contract and he would be entitled to two years of his annual base salary or over one million dollars.
13. Group Health Inc. CEO Designated Survivor Split-Dollar Insurance Agreement. A 1989 Equitable Life Insurance Company of Iowa Flexible Premium and Adjustable Life Insurance Policy with a one million dollar death benefit. HealthPartners paid all the necessary premiums ($171,400) to pay the policy in full until 2028. The cash surrender value as of July 23, 2002 was $224,183.72.
14. Group Health, Inc. CEO Supplemental Survivor Split-Dollar Insurance Agreement. This agreement is funded by two split-dollar life insurance policies. The agreement was put into place to provide CEO Halvorson with a death benefit equal to seven times his base salary at the time of his death (or termination of employment).
The first policy is a 1994 Equitable Assurance of New York Variable Life Insurance Policy with a $3,019,000 face amount and annual premiums of $95,651.00. The cash surrender value as of 2001 was $720,633.01. This policy is paid in full. The second policy is an Equitable Assurance of New York Flexible Premium Variable Life Insurance policy with a benefit amount of $1,308,000. This policy called for an initial premium of $6,769.54 and annual premium payments of $42,076.00. The cash surrender value was $114,659.25 as of 2001. Despite not being obligated to, HealthPartners agreed to make the remaining payments after CEO Halvorson resigned.
15. Section 83 Trust. In 1994, HealthPartners set up a Section 83 trust in CEO Halvorson's name and agreed to contribute $111,111 annually into the trust until January 2002. CEO Halvorson was the sole beneficiary and was entitled to the trust assets if he remained employed with HealthPartners until January 28; 2002, which he did. CEO Halvorson terminated the Section 83 trust in 2000 and transferred the assets to a KEYSOP account. After termination, HealthPartners continued to make the payments of$111,111 to CEO Halvorson's KEYSOP plan.
16. SERP Plan. HealthPartners established for CEO Halvorson a Supplemental Executive Retirement Plan ("SERP") provided through yet another split-dollar variable life insurance policy in 1998 so that HealthPartners could provide CEO Halvorson with retirement benefits equivalent to 70% of his average last three years of income upon retirement. HealthPartners agreed to pay annual premiums of $153,348 for 11 years, with the account vesting for CEO Halvorson at age 62, or January 28, 2009, if he remained employed at HealthPartners. When the plan was presented to the Executive Committee, it asked about regulatory reporting requirements because of concern over adverse public reaction to funding this policy at a time when HealthPartners was losing money. Upon hearing that the benefit would not be reported as income, the Executive Committee approved the SERP plan.
After less than three years, HealthPartners also terminated the SERP and transferred funds to Halvorson in the form of a KEYSOP award of $542,196.35. HealthPartners continued to make annual payment under the SERP in the form of $204,464 KEYSOP awards. By doing so, the company forfeited approximately $13,701.00 in the form of penalties and surrender charges relating to terminating the policy early.
17. Extended Medical Benefits. When Halvorson turns age 65 HealthPartners will provide him and his spouse a Medicare supplement in the form of medical benefits comparable to what HealthPartners provides its full-time employees.
18. Three Social Club Memberships.
19. Spousal travel at no cost for five trips per year.
20. Secretarial and Research assistance for any book authorship, article writing, etc.
21. One week paid time off for outside consulting.
22. Company provided car phone including payment for all local personal calls.
23. Automobile Allowance of a minimum of $600.00 per month.
Recent reports of corporate malfeasance, sharply declining stock values, employee layoffs and general economic decline have prompted a more intense scrutiny of corporate executive compensation. The dramatic increase in health premiums has resulted in a similar focus on executive salaries and bonuses in the healthcare industry, where one commentator points out that "when it comes to high CEO pay, the CEO's in the HMO/healthcare industry seem to be second to none." The Flap Over HMO/Healthcare CEO Pay Premiums, GRAEF CRYSTAL REP., December, 1998. (Exhibit 1.) The Midwestern health care industry is no exception. In the Central Northwest (Minnesota, Iowa, Kansas, Nebraska, North Dakota and South Dakota), chief medical officers have been the focus of commentators. How nice to be the chief medical officer--of a large commercial HMO in or near Minnesota, MANAGED CARE (Compensation Monitor), August, 2001. (Exhibit 4.) Not only has the health care industry paid its executives relatively well compared to other industries, it has been relatively slow to scale back compensation in response to the recent economic downturn. Executive bonuses: Health care takes care of its own, MANAGED CARE, February, 2002. (Exhibit 5.)
Nonprofit health care organizations in Minnesota also pay their executives well, but unlike the for-profit sector, non-profits cannot pay dividends to their executives in any form, including stock options, without running afoul of federal and state law. Generally, compensation is supposed to be reasonable but not excessive, and the corporation's board of directors must ensure that this standard is observed. Both HealthPartners and Group Health are non-profit, tax-exempt organizations established pursuant to the provisions of Minn. Stat. ch. 317 A (2002) & 26 U.S.C. § 501(c)(3) and (4) (1994 & Supp. V 2000). In addition, HealthPartners is registered as a charitable trust pursuant to Minn. Stat. § 501B.33-.45 (2002). The following examines the compensation and benefits paid to executives of HealthPartners. Based on the information provided by HealthPartners, there is a question as to whether the compensation paid to certain executives is consistent with state and federal law.
II. APPLICABLE LAW
A. Minnesota Non-Profit Corporation Act.
The Minnesota Non-Profit Corporation Act (the "Act"), Minn. Stat. ch. 317 A, is based in substantial part on the American Bar Association Revised Model Non-Profit Corporation Act adopted in 1987. The Act provides that the board of directors of a non-profit corporation is responsible for the management of the business and affairs of the corporation.
Minn. Stat. § 317 A.201 (2002). In carrying out their responsibilities under the Act, officers and directors have three basic fiduciary duties: (1) the duty of care; (2) the duty of loyalty; and (3) the duty to follow the law. Minn. Stat. §§ 317 A.011, subd. 5, 317 A.251, subd. 1, and 317 A.255 (2002). These duties are owed to the corporation itself and apply to the setting of
compensation as part of the business and affairs of the corporation. Indeed, the Official Comments to the ABA Revised Model Non-profit Corporation Act state that in setting directors' and officers' compensation, the board must comply with the ABA Model Act standards of care, loyalty and obedience to the law. (Comments § 8.12.) Accordingly, the comments state that the payment of reasonable compensation for services rendered is permitted, but unreasonable levels of compensation are not permitted. (Comments §§1.40, 3.01, 8.12, 13.01.)
Minn. Stat. § 317 A.30 1 (2002) provides that a corporation must have persons exercising the functions of the offices of president and treasurer. Further, the board must also elect or appoint other officers that it considers necessary for the operation and management of the corporation, each of whom has the powers, rights, duties, responsibilities and terms provided for in the corporation's articles of incorporation or bylaws or as determined by the board.
Minn. Stat. § 317 A.311 (2002).3
B. "Private Inurement" Doctrine.
To qualify for and retain tax-exempt status under 26 U.S.C. §§ 501(c)(3) and (c)(4) of the lnternal Revenue Code, an organization must be organized and operated so that "no part of ... [its] net earnings ... inures to the benefit of any private shareholder or individual." 26 U.S.C. §§ 501(c)(3) & (c)(4). This statutory requirement is known as the "private inurement"
doctrine and has been summarized as follows:
[T]he private inurement doctrine forbids ways of causing the income or assets of a healthcare organization (or other tax-exempt organization that is subject to the doctrine) from flowing away from the organization and to or for the benefit of one or more persons (usually individuals) with some significant relationship to the organization, for noncharitable purposes.
THOMAS K. HYATT & BRUCE R. HOPKINS, THE LAW OF TAX-EXEMPT HEALTH ,CARE ORGANIZATIONS § 4.1 (2d ed: 2001).
The payment of reasonable compensation by a tax-exempt organization does not result in private inurement. See, e.g., B.H W. Anesthesia Found., Inc. v. Comm'r, 72 T.C. 681, 685-687 (1979). Conversely, compensation in excess of what is reasonable does result in private inurement. See, e.g., Founding Church of Scientology v. United States, 412 F.2d 1197, 1200 (CT. CL. 1969), cert. denied, 397 U.S. 1099 (1970). Whether the compensation paid is reasonable is a question of fact to be decided in the context of each case. See, e.g., Jones Bros. Bakery, Inc. v. United States, 411 F.2d 1282, 1285 (Ct. Cl. 1969). Accordingly, whether the compensation paid to an executive by a tax-exempt organization constitutes private inurement must be reviewed on a case-by-case basis by reviewing the specific facts and circumstances of each situation.
4958. 67 F.R. 3076
3 The corporation's articles or bylaws may provide that this responsibility is delegated to a member of the organization. Minn. Stat. §§ 317 A.201 & 317 A.311.
C. Limits on Compensation Paid by Tax-Exempt Organizations Under 26 U.S.C. § 4958:
"Excess Benefit Transactions."
In 1996, Congress enacted a law authorizing the Internal Revenue Service ("IRS") to impose intermediate sanctions in cases of private inurement that the statute defines as "excess benefit transactions." 26 USC. § 4958 (1994 & Supp. V 2000). Section 4958 defines an "excess benefit transaction" as follows:
The term "excess benefit transaction" means any transaction In which an economic benefit is provided by an applicable tax-exempt organization directly or indirectly to or for the use of any disqualified person if the value of the economic benefit provided exceeds the value of the consideration (including the performance of services) received for providing such benefit. For purposes of the preceding sentence, an economic benefit shall not be treated as consideration for the performance of services unless such organization clearly indicated its intent to so treat such benefit.
26 U.S.C. § 4958(c)(1)(A) (1994 & Supp. V 2000). The "excess benefit" on which the sanction is imposed is simply the amount by which the value of the benefit received by the insider exceeds the value of services for which the benefit was paid. 26 U.S.C. § 4958(c)(1)(B).
In a report accompanying the law, officials of charitable organizations were advised that they could avoid running afoul of the law if they adhere to the following steps in making compensation decisions:
4 John Murawski, Law Penalizing Lavish Non-Profit Salaries Causes Uncertainty, THE CHRON. OF PHILANTHOPY, Sept. 19, 1996.
Section 4958 applies to any excess benefit transaction occurring on or after September 14, 1995. It does not automatically apply, however, to revenue sharing or incentive arrangements except to the extent prescribed in regulations adopted by the IRS. 26 U.S.C. § 4958(c)(2).
Effective January 23, 2002 the IRS issued final regulations under § 4958. 67 F.R. 3076. The regulations apply to all organizations exempt from federal taxes under 26 U.S.C. § 501 (c)(3) or (c)(4). Accordingly, the regulations apply to HealthPartners.
The IRS regulations are based on the existing private inurement standards for determining when compensation is unreasonable and excessive. The IRS regulations set forth a "safe harbor" in which compensation is presumed to be reasonable if the following occurs:
(1) the compensation is approved in advance by an authorized body of the tax-exempt organization composed entirely of individuals without a conflict of interest;
(2) the board or committee obtained and relied upon appropriate comparability data in making its determination; and
(3) the board or committee adequately documented the basis for its determination, concurrently with making that determination.
26 C.F.R. § 53.4958-6(a).
Items included in determining the value of compensation for purposes of reasonableness include all economic benefits provided by an applicable tax-exempt organization including but not limited to all forms of cash and noncash compensation, including salary, fees, bonuses, severance payments and deferred and noncash compensation with certain limited exceptions, and payments to welfare benefit plans. 26 C.F.R. § 53.4958-4(b)(1)(ii)(B).
The regulations provide that relevant information to use for comparability in making compensation decisions includes compensation paid by similarly situated organizations, both taxable and tax-exempt, for functionally comparable positions; the availability of similar services in the geographic area of the applicable tax-exempt organization; current compensation services compiled by independent firms; and actual written offers from similar institutions competing for
the services of the employee. 26 C.F.R. § 53.4958-6(c)(2)(i).
To adequately document a decision under the safe harbor, the records of the authorized body must. note:
III. HEALTHPARTNERS' STRUCTURE WITH RESPECT TO THE APPOINTMENT AND COMPENSATION OF OFFICERS
A. Articles and Bylaws.
HealthPartners is apparently governed by two sets of articles and bylaws as HealthPartners and Group Health each have its own set of articles and bylaws. As noted above, Minn. Stat. ch. 317A generally provides that it is the responsibility of a corporation's board of directors to appoint and oversee officers of an organization. With the exception of the president, HealthPartners' Board does not appoint the officers of its organization.
Article IX of HealthPartners' Restated Bylaws and Article X of Group Health's Restated Bylaws provide that the "Board of Directors shall elect the President of the corporation, who shall serve as the Chief Executive Officer and shall elect a Chief Finance Officer from a nominee recommended by the President." (Exhibits 6 & 7.) While the Boards may elect Vice Presidents and Assistant Secretaries from nominees recommended by the President, the Boards are not obligated to do so. (Exhibits 6 & 7.) The Board minutes also did not reflect that the Board was actively involved in appointing any officers other than the President/Chief Executive Officer ("CEO").
As for oversight of executive compensation, HealthPartners' Restated Bylaws provide that "substantial changes regarding employment policies, benefits, and compensation programs ... shall require the affirmative vote of two-thirds (2/3) of the entire Board of Directors." (Exhibit 6 § 6.5.) Group Health's Restated Bylaws do not mention oversight of executive compensation. The Board minutes do not reflect approval of all substantial changes regarding employment policies, benefits, and compensation programs. In some cases, approval was granted, but only years after the change was implemented.
B. Executive Compensation Policy and Process.
Unlike other non-profit organizations, HealthPartners' Board does not have a separate compensation committee to oversee executive compensation. During the compliance review, HealthPartners indicated that its' Executive Committee is the board committee that is responsible for setting its' CEO's compensation and for overseeing the organizations' overall compensation program. Interestingly, HealthPartners' CEO is a member (ex-officio) of the Executive Committee, which is responsible for overseeing the CEO's compensation. (Exhibits 6 § 6.2. & 7 § 7.2.)
HealthPartners does not have a specific or separate corporate policy on executive compensation. (Exhibit 8.) Rather, executives are included in the overall HealthPartners' compensation philosophy that is used for non-union employees. (Exhibit 8.) HealthPartners indicated that prior to 1999, the Hay Group guide chart method was used to determine salaries and supplemented by market pricing of new executive positions. (Exhibit 8.) Since 1999, HealthPartners indicated that its compensation philosophy is to provide market based pay structures for base salary compensation. (Exhibits 8 & 9.) HealthPartners failed to obtain Board approval for its 1999 change in compensation philosophy. (Exhibit 10.) HealthPartners has since provided documentation demonstrating that the job valuing compensation philosophy' adopted in 1999 was presented to the Finance & Audit Committee in 2001, but has still failed to demonstrate any approval by a Committee or the Board. (Exhibit 10.)
At HealthPartners., neither the Executive Committee nor any other Board committee actually oversees the amount of salary paid annually to its executive officers, other than to its CEO. Rather, the base salaries of all officers, except the CEO, are reviewed by the senior officer to whom each officer reports. (Exhibits 8 & 11.) Essentially all power and responsibility for setting the senior executives' salaries lies exclusively within the control of the CEO with no oversight by the Board. (Exhibit 11.)
With respect to executives other than the. CEO, the process used by HealthPartners for determining total compensation is fractured. As stated above, HealthPartners uses a market pricing strategy to determine the value of its positions. (Exhibit 9.) Market pricing of salaries is accomplished through an evaluating process, coordinated by HealthPartners Human Resources Compensation Team ("Compensation Team"), whereby the senior officer provides the Human Resources Department with a job description, the Compensation Team advises the senior officer of market salary ranges for the position and the senior officer finally determines the salary. (Exhibit 9.) The Compensation Team really only consists of two employees: a Compensation Specialist and the Manager of Employee Compensation. (Exhibit 12.) Incentive pay is not overseen by the Board nor by the Compensation Team, but rather is set by a committee comprised of the Executive Vice-Presidents and the Vice-President of Human Resources. (Exhibit 13.) Management may adjust withhold payouts at its discretion to reflect the impact of any extraordinary event that distorts actual results. (Exhibit 13.) All withhold payments are paid at the discretion of management. (Exhibit 13.) Special retention pay is within the exclusive province of the CEO, although it is approved by the Executive Committee. (Exhibit 14.)
HealthPartners follows separate procedures for the compensation of its CEO. It places full responsibility for oversight of its CEO's compensation in the hands of its Board. (Exhibit 15.) The Board delegates this responsibility to its Executive Committee, which is comprised of Board members and HealthPartners' CEO as an ex-officio member. (Exhibits 7 & 8.) The CEO's cash compensation is set annually by the Executive Committee pursuant to a formal "evaluation program" consisting of three elements: (1) The CEO's self-evaluation, including an account of how well he/she achieved preset company goals and objectives; (2) a survey of the Directors' views on the CEO's performance over the past year; and (3) a report from a consultant, usually MCG HealthCare Compensation Strategies, n/k/a Clark-Bardes evaluating the competitiveness and reasonableness of the CEO's compensation. (Exhibits 15 & 16.)
IV. COMPENSATION ISSUES
A. Compensation of All Executive Officers
HealthPartners defines its Executive Officers as those executives serving at one of the following levels: 1) Vice-President and Associate Medical Director; 2) Senior Vice President and Medical Director; 3) Executive Vice President/Chief Operating Officer; and 4) CEO. (Exhibit 8.) In addition, senior executives are entitled to participate in a special executive benefits program. (Exhibit 8.)
1. Base Salary--------------------------------------------------------------------------
3 The corporation's articles or bylaws may provide that this responsibility is delegated to a member of the organization. Minn. Stat. §§ 317 A.201 & 317 A.311.
As discussed above, an Executive Officer's base salary is set by the senior officer to whom the officer reports. (Exhibits 8 & 11.) For the majority of the Executive Officers, the salary is determined by either the CEO or the Executive Vice President & Chief Operating Officer. (Exhibit 11.) For most years, it appears that HealthPartners' Board did not oversee, nor was it informed of, the base salaries paid to Executive Officers. On March 4, 1999, CEO Halvorson reported to the Executive Committee on the 1999 salary increases, market salary ranges and withhold payments for HealthPartners' senior officers. (Exhibit 17.) By this time however, the raises had already been given. CEO Halvorson told the Executive Committee that he would provide an independent review of senior officer compensation, but no copy of or reference to such a report ever appears in the minutes.
HealthPartners provided compensation data used to set Executive Officer base pay from 1998-2001, but the data was problematic in several respects. First, in many cases the data was simply missing. For example, there was no data supporting the grade level salaries set in 1998. These levels reportedly came from Hay Group, but there were no documents from Hay Group for 1998. (Exhibits 8 & 18.) Besides data from Hay Group, HealthPartners provided limited data from Mercer, Sibson, Warren, Hewitt, Sullivan and Ernst & Young. (Exhibit 18.) HealthPartners could not, or would not, produce substantial portions of these reports. None of the data provided accounted for regional variations in the country.
Second, without complete reports, a full understanding of the data relied upon by HealthPartners is impossible. For example, while some employee midpoint salaries were benchmarked to "not-for-profit" corporations, most were benchmarked to "all companies" or "overall" or "all organizations." The use of "all company" data may be inappropriate in many cases. The Sibson reports, which tend to be used for "all company data," generally have a higher midpoint average than other studies. (Exhibit 18.) In the case of Nancy McClure, for example, the Sibson data salary figures were $100,000 more than the Warren data, which used a "not- for-profit" comparable. (Exhibit 18.)
Third, not only was the data provided incomplete, the purpose for using varying data points was not clear. For example:
Mary Brainerd in 2001;
Ann Darnay in 1999,2000, and 2001;
Kirby Erickson in 2001;
George Isham in 2001;
Nancy McClure in 1999,2000, and 2001;
Andrea Walsh in 1999; and
Ted Wise in 2001;
2. Basic Employee Benefits.
HealthPartners' standard benefits to its employees are numerous and generous. All employees, including Executive Officers, receive the following benefits in their basic benefits package:
3. Incentive Pay.
Executive Officers and physician leaders are also eligible to receive incentive pay through HealthPartners' Withhold Program ("Withhold Program"). (Exhibit 8.) According to HealthPartners' documents, the Withhold Program works by withholding a portion of an Executive Officer's total cash compensation or "eligible salary" pending the successful
completion of corporate business and health improvement goals. (Exhibits 8 & 22.) The withhold percentages range from 5% to as high as 35% depending on the executive's position. (Exhibit 23.) Senior non-physician officers must achieve goals in net margin or health improvement, customer satisfaction, business growth and individual department specific goals.
(Exhibits 8 & 22.) Physician leaders have a health improvement goal instead of a net margin goal. (Exhibit 8.) Each goal area has a threshold level, which must be achieved or that area receives a "0%." (Exhibit 24.) If the goal is met, a full" 100%" is credited. (Exhibit 24.)
5 The retirement account is interest bearing at the average annual yield of 3-year Treasury Constant Maturities for September of the prior plan year plus 50 basis points. (Exhibit 19.)
6 More specifically, the contribution is an amount equal to the sum of the participant's salary multiplied by a percentage based on age and years of service, plus the participant's salary in excess of two-thirds of the Social Security Wage Base. for the Plan year multiplied by a percentage based again on age and years of service. Group Health calls its pension plan a defined benefit plan, but the plan, while providing for an accrued benefit, does not provide for definitely determinable benefits over a period of years following retirement. See HYATT AND HOPKINS, supra, at 584. Instead, GHI pays a defined contribution into an account. Some employees may have been grandfathered into the defined benefit plan. (Exhibit 19.)
Table 1: Withhold Percentages for Participants by Job Title
Withhold payments are determined by taking the average of the percentage achieved in each goal area and multiplying that average percentage by the amount that was withheld from the "Total Eligible Compensation Amount." (Exhibit 23.) In determining incentive pay, HealthPartners places a lot of importance on meeting the organization's net margin requirements. (Exhibit 23.) In 1997, each goal had a baseline level which had to be met before any withhold payout was considered. (Exhibit 24.) In 1998, HealthPartners changed this policy so that a baseline achievement of only the net margin goal was necessary before any withhold payout would be considered. (Exhibit 22.) In 1997 and 1998, the baseline net margin objective was not met and HealthPartners did not make any withhold payments either year. (Exhibit 25.) The executives did, however, receive their base salary ("market salary") as well as all other benefits these years.
HealthPartners calls the program a "Withhold Program" and promotes it as a program that withholds a portion of the executives' salary based upon the performance of the organization. In reality, however, there is really no compensation "withheld" from the executive. HealthPartners sets its executives' base salary based upon current market rates. (Exhibits 8 & 23.) It then provides the executive a certain level of incentive pay that is based on the executives "Total Eligible Compensation Amount." (Exhibit 23.) The "Total Eligible Compensation Amount" is higher than base or market salary. (Exhibit 23.) To determine the "Total Eligible Compensation Amount," HealthPartners takes the executive's base salary (market salary) and divides it by "100% minus the withhold level." (Exhibit 23.) For example, if the executive's base salary ("market salary") is $100,000 and the executive's withhold level is 25%, the executive's "Total Eligible Compensation Amount" is $133,333 and the executive is eligible to earn an additional $33,333 in compensation or a 33% bonus ($100,000 divided by 75% (100% minus 25%) equals $133,333.) (Exhibit 23.) If the salary was $300,000 and the withhold level at 30%, "Total Eligible Compensation Amount" becomes $428,571 ($300,000 ÷ .75) and the executive can earn a withhold payment of $128,571 or a 42% bonus. (Exhibit 23.)
The labeling of such a bonus program as a "withhold" program is deceptive. Indeed, the Board members have complained that it is confusing. (Exhibit 26.) In materials presented to the Board, HealthPartners executives actually misrepresented the manner in which the Withhold Program works by describing it as follows:
We determine an appropriate total compensation level for each executive, based on outside survey information. That total compensation level is the equivalent of what executives in similar companies actually get paid. (In some other companies, that payment sometimes includes "bonus." In others it doesn't. Those approaches are all factored into our target amounts.)
Then, when we have established a total compensation level, we withhold part of it, pending annual performance. For a medical director who has a $200,000 compensation level and a 20% withhold, we hold back $40,000 pay, pending success in annual performance. If the performance is achieved, the withhold is paid.
HealthPartners contends that its Withhold Program is preferable to a bonus program because bonuses reward exceptional rather than expected work and because bonuses, often awarded capriciously, are more difficult to defend to the public and employees who do not receive them. (Exhibit 27.) HealthPartners boasts that its Withhold Program is "extremely
useful in dealing with legislators, news media, etc., who like the fact that part of our pay is withheld if we don't perform." (Exhibits 26 & 27.)
While a Withhold Program may be useful in dealing with the public, the purported distinctions between HealthPartners' Withhold Program and a bonus program do not stand up to scrutiny. First, a bonus program need not be more capricious than a Withhold Program if the criteria for the bonuses are measurable and enforced. Second, the inference that a portion of an executive's salary is withheld is simply inaccurate. HealthPartners tries to convince the public and its Board that it sets an executive's salary, say at 100% of the median and then withholds a percentage, e.g. 30%, so that the executive only earns 70% if the performance requirements are not met. This is not true. Rather, HeaIthPartners pays its executives the market salary it sets and then determines the possible salary, including an incentive payment, in determining the withhold. (Exhibits 22 & 23.) The amount supposedly "withheld" is really the potential bonus that could be paid.
In practice, the Withhold Program operates like a bonus program and its primary value appears to be its usefulness in defending bonus pay to the public. Not only does the Withhold Program create the appearance that salary is withheld rather than paid as a bonus, the amount of incentive payout looks more modest to the public. A thirty percent (30%) withhold actually amounts to a bonus of over forty-three percent (43%). Table 2 shows the potential withhold
payments executives could have earned in 1999.
Table 2: 1999 Potential Withhold Payments to Executive Officers
Table 3 shows actual withhold payments in 1999 and 2000.
Table 3: 1999 and 2000 Actual Withhold Payments
HealthPartners paid out over $4,000,000 in withhold payments in 1999 and agaIn In 2000. (Exhibit 29.)
B. Senior Executive Benefits Program.
Senior Executives enjoy all of the above benefits including: 1) base salary; 2) incentive pay; and 3) basic benefits. Senior/Executive Vice Presidents and Medical Directors ("Senior Executives") receive even more generous benefits through HealthPartners' Executive Benefits Program. (Exhibit 8.) One such lucrative benefit HealthPartners provides to its Senior Executives is split-dollar life insurance.
In a recent article in the New York Times, the attractiveness of a split-dollar policy was explained:
Split-dollar policies, so called because on paper the company and executive split the benefits, have been a feature of executive compensation for nearly 40 years. Typically, the company pays close to 100 percent of the premiums, which grow tax-free within the insurance policy and over a decade or two become a mountain of cash. When the executive retires, the corporation is repaid - without interest - from the cash buildup for the millions it has contributed in premiums.
The policies are set up so that the remaining cash pays for premiums for the rest of the executive's life, leaving the death benefit for his estate. Alternatively, after the corporation has been repaid, the executive can make regular tax-free withdrawals from the policy and spend the money during retirement, although the executive must take care to leave enough cash in the policy to continue paying premiums. If the policy lapses, the loans become taxable ....
* * *
'It's a waste of assets,' said Graef Crystal, a compensation consultant who has written widely on this kind of insurance. 'The shareholders are entrusting to the C.E.O. and the board a body of capital to be invested in an advantageous way. So it ends up as a no-interest loan, when the money could have been used to invest in a plant or new equipment.'
Tracie Rozhon and Joseph B. Treaster, Insurance Plans of Top Executives May Violate Law, N.Y. TIMES, August 29,2002. (Exhibit 30.)
In early July 2002, the IRS proposed rules for the tax treatment of split-dollar life insurance policies. Split-Dollar Life Insurance Arrangements, 67 Fed. Reg. 45414-01 (July 9, 2002). The IRS proposed two mutually-exclusive regimes for taxing split-dollar insurance premium payments, depending on who owns the policy. Split-Dollar Life Insurance Arrangements, 67 Fed. Reg. at 45416-17. Policies owned by the employee fall under the "loan" regime. Split-Dollar Life Insurance Arrangements, 67 Fed. Reg. 45417. Premium payments made by an employer under the loan regime are characterized as a series of loans. ld. If the interest the employee actually pays is below the market-rate interest on the loans, the premium payment is characterized as a "below-market" loan and is subject to taxation as compensation
under IRS § 7872. Prop. R. § 1.7872-15(a), 67 Fed. Reg. 45414, 45428-29 (July 9, 2002). HealthPartners employees have not paid any interest on their split-dollar insurance premium "loans."
On July 30, 2002, the Corporate and Auditing Accountability, Responsibility and Transparency Act of 2002, otherwise known as the Sarbanes~Oxley Act, became law, making it a criminal offense for a public company to lend money to its executives or directors. Sara Hansard, "Stop, in the name of the law!" Split-dollar payments may be illegal, consultants warn, INVESTMENT NEWS at 1 (August 12, 2002). (Exhibit 30.) Billions of dollars in split-dollar life insurance policies used as compensation for hundreds of executives --. including Martha Stewart, Ralph Lauren and Ted Turner may now be in jeopardy. Rozhon and Treaster, Insurance Plans of Top Executives May Violate the Law May Violate the Law. (Exhibit 30:) As a consequence, compensation consultants are warning their clients to stop paying premiums on split-dollar policies. (Exhibit 30.) Despite experts advising companies to not pay any future premium payments on split-dollar life insurance policies, HealthPartners still plans on continuing to pay the premiums on existing split-dollar policies.7
1. Executive Survivor Benefit.
HealthPartners also provides all of its Senior Executives with additional life insurance beyond the $50,000 benefit provided to all employees. (Exhibits 21 & 31.) Under the Executive Survivor Benefit, HealthPartners purchases a policy on the Senior Executive that provides death proceeds in an amount equal to two times the executive participant's base salary in effect on the date of his or her death, less $50,000 (the standard benefit). (Exhibits 21 & 31.) HealthPartners owns the policy and pays 100% of the premiums on the poticy. (Exhibits 21 & 31.) This policy is at so a split-dollar life insurance policy. (Exhibit 21.) The executive names the beneficiary under his/her life insurance policy that will receive the death benefits in the event the executive dies. (Exhibit 31.) The executive's interest automatically lapses upon termination of
employment with HealthPartners for any reason. (Exhibits 21 & 31.) The policies generate cash values, but these values inure to HealthPartners. (Exhibit 31.) Only a small portion of the premium based on the I.R.S. PS58 Rate, is reported, as compensation and on the Form 990. (Exhibit 32.)
2. Execu-Flex Allowance.
In addition, HealthPartners offers its Senior Executives benefits through an Execu-Flex Benefit Plan, adopted in 1994. (Exhibit 21.) On top of the already lucrative benefits, Executive Officers participating in the Execu-Flex Benefit Plan are given an additional amount of money, between 7% - 9% of their base salary, to purchase additional benefits. (Exhibits 21 & 33.) The Senior Vice Presidents and Medical Directors are provided 7% while the Executive Vice-Presidents and Chief Operating Officer are provided 9%. (Exhibit 33.) For some Senior Executives, this means as much as $32,000 in additional compensation is given to them. (Exhibit 33.)8 The Senior Executives may use this additional money to purchase supplemental survivor or spouse survivor life insurance, both split-dollar life insurance policies, additional disability insurance or put the money into a cash accumulation account. (Exhibit 21.) The executives are all required to sign a 24-month non-compete agreement in order to allocate funds to the capital accumulation account. (Exhibits 21 & 34.) The non-compete agreement restricts the executive from working for a competitor in the seven-county metro area. (Exhibits 21 & 34.)
a. Supplemental Survivor and Spouse Survivor Life Insurance Policies (Split-Dollar Life Insurance).
Senior Executives are entitled to use the money allocated to them to purchase additional life insurance in the form of an executive supplemental survivor or spouse survivor life insurance policy. (Exhibit 34.) HealthPartners pays the premiums on these policies for a ten-year period. (Exhibit 21.) The supplemental survivor life insurance policy provides a death benefit of up to 4 times base salary. (Exhibit 21.) Less commonly, executives purchase a spouse survivor policy that pays either $100,000 or $200,000 in death benefits in the event of the death of a spouse. (Exhibit 21.)
7. Interview with Senior Vice President and Controller on November 14, 2002.
8 The original schedule provided by HealthPartners did not accurately calculate the flex-allowance dollars. (Exhibit 33.) When questioned about these discrepancies during our review, HealthPartners indicated that it felt that close approximations were sufficient. Upon request, HealthPartners provided an accurate calculation of flex-allowance benefits. (Exhibit 33.)
The Senior Executives do not pay anywhere near the full cost of the premium for these policies. (Exhibits 21 & 35.) In fact, despite being given an additional 7% - 9% to purchase these benefits, the employee only pays a very small fraction of the cost of these policies. (Exhibits 21,33 & 35.) The majority of the premium is paid by HealthPartners. (Exhibits 21 & 35.) The amount paid by HealthPartners is not reflected anywhere on the compensation paid to the Senior Executive. The additional benefit paid by HealthPartners is substantial as evidenced below.
Table 4: Execu-Flex Split-Dollar Plans
(Exhibits 35 &36.)9
9 During our review we discovered there were errors in the TVM charges. HealthPartners acknowledged these errors and corrected them in Exhibit 36. TVM Charge equals Plan ER Premium times TVM Rate.
As outlined in the table above, the total premiums for this coverage on just seven executives amounted to over $139,000 in 2000 alone with cumulative payouts as of 2000 at $870,884.24. Of the $139,000 paid in 1999, HealthPartners paid over $133,000.00 and the Senior Executives paid a mere $6,200.00 out of their pockets. (Exhibit 35.) The amount charged to the Senior Executives Execu-Flex allowance is calculated by multiplying the "Time Value of Money or TVM" by the cumulative premium payments. (Exhibits 21 & 35.) The amount charged to the Senior Executives Execu-Flex allowance was only between 3% and 5% of the total cost of the premium. HealthPartners determines the TVM Rate by using the adjustable applicable federal rate for mid-term maturities of tax-exempt organizations as the benchmark rate. (Exhibit 37.)
HealthPartners pays an outside consultant, MCG Healthcare Compensations Strategies, n/k/a Clark-Bardes, to administer the Execu-Flex program. Surprisingly, despite there being only a handful of employees in the Execu-Flex program, HealthPartners has no controls in place to check to make sure the amounts charged for the supplemental survivor and spouse survivor life insurance policies are correct. Neither HealthPartners nor MCG Healthcare n/k/a Clark-Bardes uncovered the following errors until we brought them to HealthPartners' attention during the review:
1) In 2000, Clark-Bardes charged the TVM to the Execu-Flex Life Elections using the calculation of the TVM for 1999. This resulted in each of the Execu-Flex participants who are charged a TVM for life insurance policies not being charged enough for the TVM and having more money put into the Execu-Flex capital accumulation program. HealthPartners now indicates that this overpayment will be recovered in 2003.
2) In 1998, the Execu-Flex benefit schedule provided to HealthPartners by ClarkBardes for Craig Amundson's Total Execu-Flex Life Elections was incorrect. The total of the Execu-Flex Life Elections did not tie to the individual amounts of each policy that make up the Execu-Flex Life Elections. This caused more money to go into Mr. Amundson's Execu-Flex capital accumulation program. HealthPartners indicates that this overpayment will be recovered in 2003.
3) Clark-Bardes was inconsistent in their calculation of the TVM to be charged to each participant. In some years they used the TVM rate times the Corporate Recovery while in other years they used the TVM rate times the Plan ER Premium and in earliel years they used a combination of Corporate Recovery and Plan ER Premiums. HealthPartners has not indicated what, if anything, will be done to rectify this problem. (Exhibit 38.)
Upon termination of participation in either policy, the employee may either pay HealthPartners the aggregate premium amounts paid by HealthPartners and receive all of HealthPartners' interests in the policy, or receive from HealthPartners an amount equal to the employee's aggregate premium payments and assign all of the employee's interests in the policy to HealthPartners. (Exhibits 21 & 34.)
b. Capital Accumulation Account.
The vast majority of the money received by the Senior Executives under the Execu-Flex plan is paid into a Capital Accumulation Account. (Exhibit 28.) This account provides the executive with a number of investment options. (Exhibit 21.) Under the Capital Accumulation Account, the executive participant selects a "Deferred Vesting Date" or the distribution date that the executive will actually take the money and thereby recognize the money as income. (Exhibit 34.) The dollar amounts accumulated by the executive can be quite large. (Exhibit 28.) For the years 1998-2000, HealthPartners provided Mary Brainerd $71,655 and Kirby Erickson $59,697 in monies put in the Capital Accumulation Account. (Exhibit 28.)
Monies allocated to the Capital Accumulation Account are not reported as income or as compensation on the Form 990. HealthPartners claims that such compensation need not be disclosed because the executive could forfeit the amount due to the Senior Executives' non-compete agreement. (Exhibits 28 & 34.) This reasoning appears spurious.
c. 401(k) and Defined Benefit (Pension) Restoration Program.
HealthPartners also provides its Senior Executives with a 401 (k) Restoration Plan. (Exhibits 21 & 39.) Under state and federal law, the amount an employee may put into a qualified 401(k) program is capped. In 1998 and 1999, an employer could not match funds in a qualified 401(k) plan on compensation greater than $160,000. (Exhibit 40.) This salary cap increased to $170,000 in 2000. (Exhibit 40.) Accordingly, HealthPartners could only match an employee's contribution up to 5% of $170,000, rather than 5% of the employee's full salary. Accordingly, HealthPartners implemented the 401 (k) Restoration Plan as a means to "restore" the amounts the executive would have received in their 401 (k), but for the statutory limit. (Exhibit 39.) Under the Restated 401(k) Restoration Plan, the executive can defer additional compensation. HealthPartners matches the additional deferral to the same extent it matches the statutorily-allowed 401(k) deferral. (Exhibits 20, 28 & 39.) For example, a senior executive earning $300,000 would be entitled to a 5% match on his/her full salary. HealthPartners would match 5% of the salary up to $170,000 and place it in the qualified 401 (k) plan. HealthPartners would match 5% of the remaining $130,000 and place these funds in the Restated 401 (k) Restoration Plan. (Exhibit 39.)
Similar to 40 I (k) limitations, federal and state law limits the amount that an employer may place into a qualified pension plan. In order to bypass this law, HealthPartners implemented a Defined Benefit (Pension) Restoration Plan to "restore Qualified Defined Benefit Retirement Plan benefits that are lost due to legislative limits on compensation considered under such plans." (Exhibits 21 & 41.)
d. KEYSOP - Key Employee Share Option Plan.
All of the Senior Executives are also eligible to participate in KEYSOP, the Key Employee Share Option Plan, adopted in 2000. (Exhibits 8 & 42.) New Senior Executives are no longer participating in the Execu-Flex Plan and instead participate only in KEYSOP. (Exhibit 33.) For those Senior Executives who joined HealthPartners prior to 2000, half of their allocation (3.5%) is put into Execu-Flex and the other half (3.5%) is put into KEYSOP. (Exhibit 42.) The KEYSOP essentially provides a mechanism whereby a nonprofit can grant Senior Executives options similar to stock options. Under KEYSOP, Senior Executives are granted options to purchase a stated amount of mutual fund shares. (Exhibit 8.) The Senior
Executives are able to exercise the options in the future if the funds appreciate. The tax advantages of investing pre-tax dollars and the potential appreciation of the investment make this option a potentially attractive one for HealthPartners' Senior Executives. Options may be granted in three ways:
(1) in the form of outright awards in lieu of any additional special compensation;
(2) in exchange for a specified amount of future base compensation (up to 30%) or compensation withhold payout; or
(3) in return for the participants' agreement to relinquish rights to unfunded, non-qualified deferred compensation that has been accrued but has not vested.
Each option has an exercise price, which is the price of a mutual fund share. (Exhibit 42.) The initial exercise price is 25% of the shares' net asset value and thereafter the exercise price is determined by a formula. (Exhibit 42.) The value of the option to the participant at any time is the difference between the shares' net asset value and the option's exercise price. (Exhibit 42.) Terms establishing a schedule for vesting portions of the grant--for example, encouraging retention--may be imposed in Option Agreements, which are signed after the underlying shares are determined. (Exhibit 42.)
The amounts awarded annually under the KEYSOP Program, like the other benefits, are quite generous. For the year 2000, HealthPartners made the following awards under the KEYSOP Program:
Table 5: 2000 KEYSOP Awards
e. Retention Bonuses
In 2000, the year KEYSOP was originated, CEO Halvorson granted five executives retention bonuses in the form of a KEYSOP option. (Exhibits 14 & 43.) Pursuant to CEO Halvorson's plan, HealthPartners makes an annual contribution of $50,000 per year for five years to McClure, Wise and Cooney; and $100,000 per year for five years to Brainerd and Rank.
(Exhibits 13 & 43.) At the end of five years, McClure, Wise and Cooney will have received an additional $250,000 each in compensation and Brainerd and Rank will have received an additional $500,000 each in compensation. (Exhibits 13 & 43.) The total cost of this program for these five executives will total three quarter of a million dollars. When explaining the program to the Board, CEO Halvorson stated that each annual amount vests in the fifth year and the full amount set aside "cliff vests" in year ten. (Exhibit 14.) This is not the manner in which the plan works. In fact, the amounts paid are considered vested in full within 5 years or on January 2, 2006. (Exhibit 43.)
In presenting the program to the Executive Committee, CEO Halvorson also referred to a letter from outside counsel that concluded that the KEYSOP grants would not result in unreasonable compensation. 10 (Exhibit 14.) While the Executive Committee approved the retention bonuses, the full Board did not. (Exhibit 14 & 43.)
HealthPartners takes the position that compensation that is contingent on some future event need not be reported on the Form 990 until that contingency is satisfied. (Exhibit 28.) This position is also spurious. Accordingly, these payments were not reported on the Form 990 although in 2000, HealthPartners reported that it set aside $703,935 for payment on a contingency basis if the relevant future events occur. (Exhibit 44.)
10 Letter not produced due to HealthPartners' claim of attorney-client privilege.
f. Severance Pay Plan.
In addition to the above, HealthPartners has a generous severance plan adopted by Group Health on December 29, 2000 for employees terminated without cause. (Exhibit45.) Interestingly, while not adopted by the Board until 2000, the Severance Pay Plan was in effect January 1, 1998. (Exhibit 45.) The Severance Pay Plan offers officers/vice presidents six months of their base salary regardless of whether they secure other employment. (Exhibit45.) If the officer/vice president has not commenced comparable employment at the end of six months, they are also entitled to be paid two months at 50% of their base salary for every full year of service up to a maximum of 12 additional months of 50% base salary ("contingent benefit"). (Exhibit 45.) Comparable employment is set forth in the policy to mean employment that pays at least 90% of the former employee's Base Pay. Accordingly, it appears that if a former employee accepts a new position that pays less than 90% of the Base Pay the employee made at HealthPartners, he/she is entitled to full severance benefits. The plan documents do not provide for any offset for the monies the employee is earning at the new position. Contingent benefits end if the officer/vice president begins other employment which pays 90% or more of the individual's base salary. (Exhibit 45.)
Eligible employees who are directors or in senior positions receive three months of base salary regardless of whether they secure other employment. (Exhibit 45.) If the director/senior officer has not commenced other comparable employment at the end of three months they receive one month of 50% of their base salary for every full year of service up to a maximum of six additional months of base salary ("contingent benefit"). (Exhibit 45.) Contingent benefits end if the director/senior officer begins other employment which pays 90% or more of the individual's base salary. (Exhibit 45.)
It appears that on most occasions HealthPartners' employment agreements complied with the Severance Plan. On a few occasions, they did not. Maureen Reed was hired in 2001 and under her employment agreement she is entitled to 12 months of severance benefits regardless of how many full years of service to HealthPartners. (Exhibit 46.) Preston Simons, SVP for IT and Chief lnformation Officer, signed an employment contract in 2000 that entitles him to 12 months of base salary regardless of whether he found comparable employment. (Exhibit 46.) Mary Wood, Manager, Lawson-Materials Management Implementation, signed an employment contract in 2000 and is entitled to a contingent benefit with no outside limit. (Exhibit 46.) David Abrams, Vice President for Human Resources, employment contract providing severance benefits of six months at his base salary as well as a contingent benefit of two months at 100% of his base salary for every full year of service up to a maximum of six months. (Exhibit 46.)
g. Social Club Memberships.
HealthPartners pays for social club membership dues for select officers. The company paid for 16 memberships in 1997, 17 memberships in 1998, 12 memberships in 1999, 9 memberships in 2000 and 2 memberships in 2001. (Exhibit 47.) These memberships include the Minneapolis Club, Town & Country Club, Decathlon Club, Minnesota Horse & Hunt Club, Edina Country Club and the Minnesota Club. (Exhibit 47.)
h. Spousal Travel.
In addition to the above benefits, HealthPartners also pays for spouses to travel on trips. (Exhibit 48.) Executives entitled to this benefit included Craig Amundson, Mary Brainerd, Kathy Cooney, Anne Darnay, Kirby Erickson, Terry Finzen, George Isham, Ted Wise and Andrea Walsh. (Exhibit 48.)
i. Company Cars.
HealthPartners provided many executives with a company car allowance or leased 2 vehicle for the executive. The following ten executives were provided a car allowance:
1) Alan Abramson; 2) Scott Aebischer; 3) Anne Darnay: 4) Jim Dixon; 5) Terry Finzen; 6) Ann Gjelten; 7) Arnold Hebert;) Nancy McClure; 9) Doug Smith; and 10) Ted Wise. (Exhibit 49.) For the period from 1998-2001, HealthPartners paid car allowances totalling $135,892.00 for these ten executives. (Exhibit 49.) In addition, HealthPartners provided the following executives with cars leased by the HMO: 1) Mary Brainerd; 2) George Halvorson; 3) Craig Amundson; 4) Judy Meath; 5) Kirby Erickson; and 6) Andrea Walsh. (Exhibit 49.)
HealthPartners paid an additional $222,491 in car lease payments and related expenses such as licenses, tax, repairs, gas and insurance during the period from 1998 to 2001 on these leased cars. (Exhibit 49.) The only amount reported as income on the Form 990 or W-2 was the personal use of the vehicle. (Exhibit 28.)
The records demonstrating personal use of the cars were inadequate. First, CEO Halvorson kept no records, and simply estimated his business and personal use for each year. (Exhibit 50.) Similarly, Ms. Brainerd kept no records, and estimated her business use by subtracting her daily commute from her total annual mileage. 11 (Exhibit 50.) Ms. Walsh also failed to provide documentation of mileage, stating that it was kept in her calendars and expense submissions for each year. Ms. Walsh states, however, that she did not keep the information. (Exhibit 50.) Mr. Erickson provided a total for business miles by month for years 1997-2001. These miles, however, were not documented by log books or diaries for miles driven on a day-to-day basis. (Exhibit 50.) Mr. Amundson provided a calendar showing miles driven in 1997 and a log sheet showing business miles driven on specific days in 2001. Amundson could not, however, produce his logs for 1998-2000. (Exhibit 50.)
When one compares the amount of miles driven versus the cost to lease the cars,· it is evident that HealthPartners could save substantial money by simply paying the employee the I.R.S.-authorized mileage rate. (Exhibit 49.) In just the time period from 1998 to 2001, HealthPartners would have only had to pay $70,704.40 in mileage costs for these executives versus the $222,491.00 in lease payments on the six leased vehicles, a savings of $180,113.00 on the six leased vehicles alone.12 (Exhibit 49.)
V. CEO - GEORGE HALVORSON
HealthPartners compensates its CEO even more generously than it compensates its Senior Executives. Up until May 1, 2002 George Halvorson held the position of CEO at HealthPartners. HealthPartners entered into written employment contracts with CEO Halvorson. (Exhibit 52.) CEO Halvorson resigned his position effective May 1, 2002 and accepted a
position with Kaiser Permanente out of Oakland, California. At the time of his termination, HealthPartners entered into a Post Employment Memorandum of Understanding ("MOU") effective May 1, 2002 that set forth what benefits CEO Halvorson retained upon termination. (Exhibit 53.) After May1, 2002, the CEO position was filled by the former Executive Vice President and Chief Operating Officer, Mary Brainerd.
Like his Senior Executives, CEO Halvorson received a base salary, incentive pay in the form of the Withhold Program, basic employee benefits, restoration pay and severance pay. (Exhibit 54.) In addition, CEO Halvorson received a myriad of other benefits and perquisites. By HeaIthPartners own account, between 1998 and 2000, CEO Halvorson's total compensation increased by 31 %:
Table 6: Total Compensation
11 This method of calculation is questionable given the fact that Ms. Brainerd had a tow bar for hauling a boat or trailer attached to one of her cars. (Exhibit 51.)
12 This savings does not even take into account the nine vehicle allowances as there was-no information available on miles driven for these cars. This also does not take into account any vehicles provided to non-executives.
As will be demonstrated below, these figures do not take into account all of the compensation paid to CEO Halvorson.
A. Base Salary.
CEO Halvorson's base salary increased from $362,811 in 1996 to $505,194 in 2000, a 53% increase. (Exhibits 28 & 55.) In 2000, the Executive Committee awarded CEO Halvorson a 12% base salary increase despite the recommendation from an unnamed outside consultant that exceptional performers should only receive an increase of 8-9%. (Exhibit 55.) The Executive Committee concluded that the 12% increase appropriately brought CEO Halvorson .up to the 50th percentile of the CEO salary range, although the minutes do not show to which "range" the Executive Committee was referring nor what documents, if any, the committee was relying upon in making the salary determinations. (Exhibit 55.)
B. Standard Employee Benefits.
CEO Halvorson received a basic benefits package offered to all employees as part of his total compensation. (Exhibit 54.) As part of this basic benefits package, CEO Halvorson received fully paid single and family medical and dental coverage, a Section 125 cafeteria plan, $50,000 group term life insurance policy, four weeks paid time off with an option to purchase more and tuition reimbursement. (Exhibit 54.)
C. Withhold Program.
CEO Halvorson, like other top executives, participated in the Withhold Program, although his criteria was different than that of his officers. (Exhibits 54 & 55.) CEO Halvorson's total cash compensation was significantly enhanced by incentive pay provided through the Withhold Program. (Exhibits 28 & 55.) Like his officers, once CEO Halvorson's base salary ("market salary") was set, his "Total Eligible Compensation Amount" was calculated using his withhold percentage decided by the Board. (Exhibit 55.) CEO Halvorson's withhold percentage was generally set at between 30-35%; (Exhibit 55.)
CEO Halvorson received all of his withhold pay, or his entire "Total Eligible Compensation Amount," in a given year only if the target goals were achieved in corporate goal areas. (Exhibit 55.) Like his officers, if target goals were not met, CEO Halvorson received an amount proportionate to the average percentage. of goals achieved. in each goal area.
(Exhibit 55.) By participating in the Withhold Program, CEO Halvorson was paid bonuses as high as 52% of his salary on top of a generous compensation and benefits package. (Exhibit 55.) Unlike his officers, CEO Halvorson's withhold payout was not subject to a "baseline" requirement that had to be met before any withhold payout was made. (Exhibit 55.)
Accordingly, CEO Halvorson received withhold payments in 1997 and 1998, even though no other executive in the organization received withhold payments in those years. (Exhibit 55.) Table 7 shows CEO Halvorson's withhold payouts for the years 1997-2001.
Table 7: CEO Halvorson's Withhold Pay Outs And Percentage of Goals Met
(Exhibits 28 & 55.)
As discussed previously, the Board has been confused by the Withhold Program. (Exhibit 26.) In early 1997, a member of the board asserted a concern that the withhold approach used by CEO Halvorson was different than that used by other companies. (Exhibit 26.) HealthPartners' compensation consultant advised the board in 1997 that by using CEO
Halvorson's approach for withholds that HealthPartners' incentive plan was not only competitive with other health plans' target levels, but was at the maximum level paid by other health plans. (Exhibit 55.)
In some instances, the Board varied even from the generous Withhold Program it established for CEO Halvorson. In 1997, the Executive Committee agreed to pay CEO Halvorson 95% of his eligible withhold despite the fact that he only met 90% of his goals. (Exhibit 55.) The Executive Committee approved this overpayment even though it clearly recognized that by overpaying they were reducing the credibility of the CEO's goals and objectives. (Exhibit 55.) In 2000, the Executive Committee again arbitrarily increased the percentage of withhold goals met by CEO Halvorson from 96% to 98%, thereby increasing his withhold payment from $238,024 to $242,882. (Exhibit 55.)
In order to not fully disclose his withhold payments in 1998, CEO Halvorson requested that portions of his withhold payment be placed into a deferred income program.13 (Exhibit 55.) CEO Halvorson told the Board that he wanted the pay deferred as he was concerned that the other HealthPartners' officers would experience decreases in 1998 compensation over 1997. (Exhibit 55.)
D. Disability Coverage.
HealthPartners provided CEO Halvorson disability/salary continuation pay that provided benefits at 100% of salary for 12 months. (Exhibits 52, 54 & 56.) In addition, HealthPartners paid the premium for CEO Halvorson to carry an individual disability policy issued by the Paul Revere Life Insurance Company. (Exhibit 54.) Upon termination, the MOU provided that
HealthPartners' obligation to pay the premiums on the long term disability policy was terminated effective April 30, 2002. (Exhibit 53.) CEO Halvorson could continue the policy by paying the premiums. (Exhibit 53.)
E. 401(k) and Pension Plan Restoration.
Like the Senior Executives, CEO Halvorson was entitled to participate in the 401 (k) and Pension Restoration Plans. (Exhibit 54.) Under the 1996 HealthPartners 401 (k) Restated Restoration Plan, CEO Halvorson could defer the maximum percentage of base salary he could have deferred under the 401 (k) plan less his actual contributions to the qualified 401 (k) plan. (Exhibit 39.) HealthPartners matched his deferral to the same extent that it matched the 401(k) plan. (Exhibit 39.) Under his pension restoration plan, HealthPartners paid CEO Halvorson his base pay as it exceeded the statutory limit, multiplied by the qualified plan contribution percentage (for CEO Halvorson, 11 or 13%). (Exhibits 39, 41 & 57.) For the period from 1998-2000, HealthPartners provided CEO Halvorson the following in 401 (k) and pension benefits:
Table 8: 401(k) and Pension Benefits
(Exhibits 28 & 58.)
Both restoration plans are subject to forfeiture should CEO Halvorson violate his non-compete agreement, but his position with Kaiser does not violate his non-compete agreement. On April 26, 2002 HealthPartners transferred the proceeds from the restoration plans into a KEYSOP grant to CEO Halvorson of $1,013,333. (Exhibit 59.) HealthPartners indicated that this award represents the balance in CEO Halvorson's restoration accounts of $559,375.63 on March 31, 2002, plus an additional $195,000 that was not reflected in the balance. (Exhibit 59.)
F. Severance Pay.
If terminated without cause, CEO Halvorson's employment contract provided that he was entitled to a lump sum payment equal to two times his annual base salary. (Exhibits 54 & 60.)
13 In 1998, CEO Halvorson also requested that HealthPartners pay for refractive laser eye surgery for CEO Halvorson and his wife. (Exhibit 55.)
14 During our review, we noticed that the 401(k) matches on the compensation spreadsheets produced by HealthPartners, were incorrect. The 1999 and 2000 401 (k) matches were understated by $1600 each year. (Exhibit 58.)
Interestingly, CEO Halvorson's employment contract specifically states that HealthPartners could only terminate CEO Halvorson's employment contract for "Reasonable Cause" if CEO Halvorson:
4. Commits any material breach of the provisions of this Agreement;
5. Is convicted of a felony or a misdemeanor involving moral turpitude; or
6. Does or knowingly permits any act which is determined by a court of competent jurisdiction to constitute a breach of trust or a violation of the duties of office herein assumed by him. (Exhibits 54 & 60.)
What is glaringly void from this "Reasonable Clause" paragraph is any inability to perform his position. (Exhibits 54 & 60.) It appears that if the CEO was fired for poor performance, this would not be considered "Reasonable Cause" under the contract and he would be entitled to two years of his annual base salary or over one million dollars. (Exhibits 54 & 60.)
G. Split-Dollar Life Insurance Policies.
HealthPartners paid the premiums on the following three split-dollar life insurance policies for CEO Halvorson that contributed funds to tax-sheltered accounts. (Exhibits 52, 53 & 54.)
1. Group Health Inc. CEO Designated Survivor Split-Dollar Insurance Agreement.
surrender value as of July 23, 2002 was $224,183.72. (Exhibit 61.) Pursuant to the terms of the agreement, upon termination of employment, CEO Halvorson had to elect either to repay HealthPartners an amount equal to the policy's cash value as of the date of the 1994 agreement plus the sum of HealthPartners' premium payments, or assign all of his interests to HealthPartners. (Exhibit 61 .) If CEO Halvorson elects to cash out under the first option, he is entitled to the account value of the policy less the surrender charge ($2,350 in 2002) and other charges. (Exhibit 61.) This provision is in stark contrast to Article 3 of CEO Halvorson's Severance Agreement which provided that upon his termination, HealthPartners:
... shall deposit to the life insurance policy under the CEO Designated Survivor Plan an amount sufficient to increase the cash value of the policy to the level required to continue the policy in force for the CEO's life expectancy with a death benefit equal to its face account, after which the Company shall release all interests in the policy to the CEO. The Company shall also pay to the CEO an amount equal to the state and federal income taxes due on the cash value of the policy using the highest marginal income tax rates, including any tax surcharges applicable generally based on income level.
Under the MOU, HealthPartners agreed to "take such actions as may be required under the Plan or as may be otherwise agreed to by the parties to fully vest in CEO Halvorson his interest in this policy." (Exhibit 53.) HealthPartners further agreed to pay additional premiums if necessary to increase the cash value of the policy to the level required to continue it in force for CEO Halvorson's life expectancy with a death benefit equal to its face amount. (Exhibit 53.)
In determining CEO Halvorson's termination benefits, it appears HealthPartners adhered to the Severance plan rather than the 1994 Group Health, Inc. CEO Designated Survivor Split-Dollar Insurance Agreement. (Exhibit 53.)
2. Group Health, Inc. CEO Supplemental Survivor Split-Dollar Insurance Agreement
This agreement is funded by two split-dollar life insurance policies that designate CEO Halvorson as the owner and the insured. (Exhibit 62.) This agreement did not automatically terminate upon CEO Halvorson's resignation in May, 2002. (Exhibit 62.) Rather, the agreement provided that if CEO Halvorson worked at HealthPartners until age 55, which he did, the agreement did not terminate until the later of: (i) his termination of employment, or (ii) 15 years after the date of the agreement, i.e. February 2009. (Exhibit 62.) Upon termination, CEO Halvorson can elect to either pay HealthPartners an amount equal to the aggregate premiums HealthPartners paid or assign all of his interests in the policies to HealthPartners. (Exhibit 62.) The agreement was put into place to provide CEO Halvorson with a death benefit equal to seven times his base salary at the time of his death (or termination of employment), less $50,000. (Exhibit 62.) This would result in a death benefit of over $3.5 million.
The first policy under the agreement is a 1994 Equitable Assurance of New York Variable Life Insurance Policy. (Exhibit 62.) This policy has a $3,019,000 face amount of insurance and called for annual premium payments of $95,651.00. (Exhibit 58.) The cash surrender value as of 2001 was $720,633.01. (Exhibit 62.) This policy is paid in full. (Exhibit 62.) The second policy is an Equitable Assurance of New York Flexible Premium Variable Life Insurance policy with a benefit amount of $1,308,000. (Exhibit 62.) This policy called for an initial premium of $6,769.54 and annual premium payments of $42,076.00, thereafter. (Exhibit 62.) The cash surrender value of this policy was $114,659.25 as of 2001. HealthPartners made the four premium payments due as of May 1, 2002. (Exhibit 62.) Despite not being obligated to under the terms of the agreement, HealthPartners agreed to make the remaining payments pursuant to the MOU. (Exhibit 53.) The full premiums by HealthPartners paid by HealthPartners for these policies were not reported on the Form 990. (Exhibit 28.)
H. Retention Incentive Plans - Section 83 Trust and SERP Plan.
In addition to the lucrative split-dollar plans, HealthPartners provided CEO Halvorson with two additional programs. In 1994, HealthPartners set up a Section 83 trust in CEO Halvorson's name and agreed to contribute $111,111 annually into the trust until January 2002. (Exhibit 63.) CEO Halvorson was the sole beneficiary of the trust and was entitled to the trust assets if he remained employed with HealthPartners until January 28, 2002, which he did. (Exhibit 63.)
In 2000, the Executive Committee agreed to establish a KEYSOP plan for its CEO. (Exhibit 64.) For reasons undisclosed, CEO Halvorson decided to terminate the Section 83 trust in 2000 and transfer the assets to a KEYSOP account. (Exhibit 65.) On October 24, 2000 the trust was terminated and the balance of $777,777 plus earnings of $367,008 totaling $1,101,024 was surrendered to HealthPartners. (Exhibit 66.) HealthPartners made a special award of
$1,468,032.29 (($777,777 + $323,247 in earnings) ÷ .75) to CEO Halvorson.15 (Exhibit 67.) Despite terminating the trust, HealthPartners continued to make the payments of $111,111 to CEO Halvorson's KEYSOP plan. (Exhibit 67.) In January, 2001 and 2002, HealthPartners contributed the final trust-related grant of $148,148 ($111, 111 ÷ .75) into his KEYSOP account. (Exhibit 67.) The mutual funds purchased through these trust-related grants were exercisable on and after January 28, 2002. (Exhibit 66.) At the time of his termination, CEO Halvorson was fully vested in the $1,468,032.29 KEYSOP award and the January 2001 KEYSOP award of $148,148. (Exhibit 53.) CEO Halvorson was not vested in the January 2002 KEYSOP award of $148,148, as the KEYSOP plan required that the employee remain at HealthPartners for at least
six months after the date of the award. (Exhibits 53 & 67.) Nonetheless, HealthPartners decided CEO Halvorson met the terms to receive the $1,000,000 retention bonus the trust established by staying until January 2002 and paid him a cash award of $111, 111 to compensate him for the loss of the 2002 KEYSOP award. (Exhibit 53.)
The second retention plan HealthPartners gave to CEO Halvorson was in the form of a Supplemental Executive Retirement Plan ("SERP") provided through yet another split-dollar variable life insurance policy. (Exhibit 68.)HealthPartners established the SERP in 1998 so that HealthPartners could provide CEO Halvorson with retirement benefits equivalent to 70% of his average last three years of income upon retirement provided that he remained employed at HealthPartners until age 62, which he did not. (Exhibit 68.) HealthPartners agreed to pay annual premiums of $153,348 for 11 years, with the account vesting for CEO Halvorson at age 62, or January 28, 2009, if he remained employed at HealthPartners. (Exhibit 69.) After voluntary terminating his employment or after age 62, CEO Halvorson retained all interests in the policy including its cash value as long as he did not compete with the company for 24 months. (Exhibit 68.) The plan provided that upon CEO Halvorson's termination of employment, HealthPartners could withdraw from the policy's cash surrender value the unearned portion of the Accumulation Premium for such plan year. (Exhibit 68.) When the plan was presented to the Executive Committee, it asked about regulatory reporting requirements because of concern over adverse public reaction to funding this policy at a time when HealthPartners was losing money. (Exhibit 69.) Upon hearing that the benefit would not be reported as income, the Executive Committee approved the SERP plan. (Exhibit 69.)
15 Alternatively, the award is calculated by taking the trust balance and earnings and multiplying the total by 1.25.
After less than three years, HealthPartners also terminated the SERP. (Exhibit 70.) There is no documentation to disclose who made the determination to terminate the policy nor the business justification for terminating the policy. It is questionable that HealthPartners elected to terminate this policy when, by doing so, the company forfeited $13,701.00 in the form of penalties and surrender charges relating to terminating the policy early. (Exhibits 66 & 71.) Prudential wrote a check to HealthPartners for $253,299 on November 15, 2000. (Exhibit 71.) In November 2000, HealthPartners transferred the funds to CEO Halvorson in the form of a KEYSOP award of $542,196.35 (253,299 ÷.75) + $204,464 ($153,348 ÷ .75). (Exhibit 72.) HealthPartners also continued to make annual payments under the SERP in the form of KEYSOP awards of $204,464 ($153,348 ÷ .75) to CEO Halvorson. (Exhibit 72.) CEO Halvorson was not vested in any of the SERP funds transferred to him as KEYSOP awards and waived all rights to these payments when he terminated. (Exhibit 53.)
I. Extended Medical Benefits.
Because CEO Halvorson worked at HealthPartners to age 55, commencing at age 65 HealthPartners will provide him and his spouse a Medicare supplement in the form of medical benefits comparable to what HealthPartners provides its full-time employees. (Exhibits 52 & 53.)
J. Additional Perquisites.
HealthPartners employment contract provided that CEO Halvorson was entitled to additional perquisites in the form of membership in three social clubs, the right to take his spouse with him, at no cost, on five business trips a year, secretarial and research assistance for any book authorship, article writing, etc., up to one week paid time off for outside consulting, and a car phone including local personal calls. (Exhibit 52.)
K. Automobile Allowance.
HealthPartners provided CEO Halvorson with an automobile allowance of a minimum of $600 per month. (Exhibit 52.) In 1999, HealthPartners leased CEO Halvorson a 2000 Volvo S80 at a monthly lease cost of $1,030.76 paid by HealthPartners. (Exhibits 73 & 74.) HealthPartners does not report the full amount of the lease payments to CEO Halvorson. Rather, CEO Halvorson's personal use of the car is recorded as compensation. (Exhibit 28.) HealthPartners' obligations under this lease ended upon CEO Halvorson's resignation. (Exhibit 53.)
VI. CEO - MARY K. BRAINERD
Mary Brainerd and HealthPartners signed an agreement for her employment as President and Chief Executive Officer effective May 1, 2002. (Exhibit 75.) The agreement is fairly comparable to CEO Halvorson's, with some exceptions. Brainerd's base salary for 2002 is $600,000, which represents a $50,000 or 9% increase over CEO Halvorson's $550,000 2001 base salary. Brainerd is entitled to 7 weeks of paid time off, compared to CEO Halvorson's 4 weeks, but unlike CEO Halvorson, she is not entitled to up to one week's salary while consulting elsewhere. (Exhibit 75.) Brainerd receives fully-paid medical and dental benefits through age 65 even if she retires early, a company-owned or leased vehicle, a car or cell phone, a club membership, short and long-term disability policies, and annual paid attendance at an executive seminar--all benefits that CEO Halvorson received. (Exhibit 75.) Brainerd does not receive special supplemental insurance or additional retention income beyond that received by her executive officers, unlike CEO Halvorson, who received four split-dollar life insurance policies paid by HealthPartners as well as special retention payments. Brainerd is entitled to keep the honoraria paid for speaking engagements if she uses her paid time off for the
engagement. (Exhibit 75.)
VII. THE COMPENSATION DECISION-MAKING PROCESS IS FLAWED.
A. The Excess Benefit Transaction Safe Harbor is Not Met for Base Salaries.
As discussed above, the law authorizing tax sanctions on tax-exempt entities for excess benefit transactions provides a safe harbor in the form of a presumption of reasonableness in compensation. The duty of care imposes on the Board a responsibility to satisfy the requirements for this presumption and so shield HealthPartners from these excise taxes. In order
to rely on the safe harbor provision, the tax exempt organization must meet three requirements:
(l) the compensation must be approved by an authorized body of the organization composed of individuals without a conflict of interest;
(2) the authorized body must rely upon appropriately comparable data in making its determination; and
(3) the determination must be adequately documented. C.F.R. § 53.4958-6(a).
1. Independent authorized body.
It is questionable whether HealthPartners has met the requirement for an independent authorized body. According to federal rules:
An authorized body means--(A) The governing body (i.e., the board of directors, board of trustees, or equivalent controlling body) of the organization; (B) A committee of the governing body ... ; or (C) To the extent permitted under State law, other parties authorized by the governing body of the organization to act on its behalf by following procedures specified by the governing body in approving compensation arrangements or property transfers.
C.F.R. § 53.4958-6(c)(1).
Other than with respect to CEO Halvorson, it appears questionable whether either option A or option B is satisfied in connection with Executive Officer salaries, because neither the Board nor any committee of the Board determines or approves their compensation. While Option C might be satisfied, the members of the Compensation Team who "value" executive positions may be disqualified by conflicts of interest. According to the conflict of interest rule,
A member of the authorized body does not have a conflict of interest with respect to a compensation arrangement or property transfer only if the member. .. (C) Does not receive compensation or other payments subject to approval by any disqualified person participating in or economically benefitting from the compensation arrangement or property transfer; ... and (E) Does not approve a transaction providing economic benefits to any disqualified person participating in the compensation arrangement or property transfer, who in turn has approved or will approve a transaction providing economic benefits to the member.
C.F.R. § 53.4958-6(1)(iii). Human Resources employees on the Compensation Team may have conflicts under (C) or (E) or possibly both, because they would be valuing positions of Executive Officers who approve salary and benefits for them. Furthermore, it is questionable whether the board or any committee has actually ever approved the current compensation philosophy used by HealthPartners based on the minutes.
2. Adequately comparable data.
The Executive Committee relied on compensation reports from MCG Health Care Compensation n/k/a Clark-Bardes to set CEO Halvorson's base salary. MCG provided the Executive Committee with compensation data on CEO Halvorson's position relative to national and local peer groups and recommended a base salary range.16 MCG did not provide data, however, that breaks down CEO compensation by size of organization or by responsibilities of the CEO.
As previously discussed, the data relied upon to set Executive Officer's salaries was inadequate. It appeared that HealthPartners used data from different surveys for different positions with no apparent justification, other than to maximize the compensation paid to its personnel. The data relied upon by HealthPartners to set Executive Officers' salaries was
incomplete and HealthPartners was unable to produce the full reports.
Executive Compensation Decisions Do Not Follow the Bylaws and Board-Approved Policies
The Board of Directors and its Executive Committee have failed to follow HealthPartners
Bylaws and Board-approved compensation policies in several respects.
16. According to MCG, CEO Halvorson's relative position is better when total cash compensation is compared rather than base salary. In 1998, for example, CEO Halvorson's base salary was 4% higher than the lowest 25th percentile of CEO's in his "National Peer Group," but his total cash compensation was 9% lower than the 50th percentile of CEO's in the same group. In a comparison to his local peer group of CEOs from six health care organizations, CEO Halvorson had the fifth highest base salary but the second highest total cash compensation. (Exhibit 16.) In 1999 CEO Halvorson gained ground on his national and local peer groups with respect to base salary, but lost ground with respect to total cash compensation. (Exhibit 16.)
First, withhold awards are not consistent with policy. In 1997 the Executive Committee determined that CEO Halvorson met 90% of his 1996 goals and objectives, yet granted him 95% of his withhold payout because he had implemented several health care initiatives. (Exhibit 55.) The Executive Committee also altered the incentive pay plan without full Board approval in 1998 and 1999 as it paid CEO Halvorson part of the incentive pay as deferred rather than cash compensation. (Exhibit 55.) When questioned during our review as to who decided to pay the Withhold payments as deferred compensation and how this transaction was approved, HealthPartners did not know.
Second, the full Board has not properly approved material changes in compensation policies by a 2/3 margin as required by the HealthPartners Bylaws, in several instances. First, there is no evidence that the full Board approved the KEYSOP special awards for Senior Executives as approved by the Executive Committee in 2000. Second, HealthPartners Board minutes do not indicate that all insurance plans were established with Board approval. Minutes of the full Board or the Executive Committee do not contain any discussion of the addition of the 1998 split-dollar policy to CEO Halvorson's deferred compensation package. Third, in September, 2000, the Executive Committee terminated the Supplemental Executive Retirement Plan ("SERP") and the Section 83 Trust, but these plan changes were not ratified by the full Board. As discussed above, the funds that had accrued in CEO Halvorson's Section 83 Trust and SERP Plan were transferred to KEY SOP accounts in his name. Finally, while the SERP was ratified by the full Board of Directors, ratification came three months later and in a 15-minute session. (Exhibit 55.)
C. The Board Provides Insufficient Oversight Over the Compensation of Executive Officers.
Regardless of excess benefit transaction rules, Board oversight over the compensation of Executive Officers is insufficient. HealthPartners' documents from 1997-2000 revealed no evidence that the Board reviewed the determination of Executive Officers' cash compensation.
On February 17, 1997, CEO Halvorson reported to the Executive Committee on the executive compensation plan and said that he would provide a detailed report on executive compensation at the next meeting on March 11, 1997. (Exhibit 55.) He also said that he had asked MCG Healthcare Consultants to contact each member of the Board for their opinions on executive compensation. (Exhibit 55.) The March 11, 1997 meeting was extended 30 minutes in anticipation of CEO Halvorson's report, but the report did not come. (Exhibit 55.) CEO Halvorson said that he was behind schedule in completing an executive compensation and retention plan, which he had promised to present to the Executive Committee in 1996, but assured the Executive Committee that he would present it "in the near future." (Exhibit 55.) There is no evidence of any discussion of an executive compensation and retention plan in the 1998 and 1999 Executive Committee minutes.
On March 4, 1999 CEO Halvorson reported to the Executive Committee of the Board of Directors on 1999 salary increases respectively, including market salary ranges, and withhold payments for senior officers. (Exhibit 55.) He said that he would provide an independent review of senior officer compensation, but a copy of or reference to such a report does not appear in the Executive Committee or Finance and Audit Committee minutes. The Board did not ratify the 1994 executive compensation benefit program (Execu-Flex) until November 2001, after our review began. (Exhibit 55.) The Board has never ratified the 1999 compensation plan.
D. Disclosure of Compensation is Not Provided as Required by Federal Law.
HealthPartners must file an annual information return with the Internal Revenue Service disclosing its gross income, receipts and disbursements for the year. IRS § 6033 (2000). I.R.S. regulations generally require that HealthPartners furnish a schedule showing compensation and other payments included in gross income to each officer, director and key employee, see 26 C.F.R. § 1.6033-2(a)(2)(ii)(h), and such specific information as required by the I.R.S. in the annual return. See C.F.R. § 1.6033-1 (a)(4)(i). The annual return-Form 990-specifically asks for "compensation" in Column C of Part V and "contributions to employee benefit plans & . deferred compensation" in Column D of Part V paid to all officers, directors and key employees. (Exhibit 76.) HealthPartners must therefore disclose payments to its officers that go beyond those payments included in individual gross income.
The Form 990 is the principal document used by government and individual contributors to evaluate tax-exempt entities. Bruce R. Hopkins, The Law of Tax-Exempt Organizations 571 7th ed. 1998); Unofficial Transcript of Ways and Means Oversight Hearing on Activities of Public Charities, 1993 Tax Analysts, Tax Notes Today, August 6, 1993 at 14. It is a public document that must be filed with federal and state government and made available by the tax exempt entity to interested individuals. IRC § 6104 (2000). Since its introduction, the Form 990 has been continually altered to induce tax-exempt organizations to provide more useful information. See, generally, Unofficial Transcript of Ways and Means Oversight Hearing on Activities of Public Charities, 1993 Tax Analysts, TAX NOTES TODAY, August 6,1993. In 1993, for example, the Form 990 was changed to require explicitly that tax-exempt organizations disclose deferred compensation payments to its officers.
HealthPartners claims that it is not required to report all contributions to benefit plans and deferred compensation on the Form 990 on the grounds that some contributions are "subject to a substantial risk of forfeiture." (Exhibit 28.) In particular, HealthPartners does not report Capital Accumulation Account contributions, Restoration Plan contributions and KEYSOP contributions. HealthPartners does not report this compensation on the Form 990 until it vests with the employee, in which case it is reported in Column C of Part V. HealthPartners reasons that reporting unvested benefits in Column D one year and vested benefits in Column C in a subsequent year results in double counting and misrepresents the employee's compensation.17 As a result, HealtlhPartners consistently under reports compensation paid to its officers. Table 9 compares total compensation reported in the Form 990's to total compensation reported to the Attorney General as part of this audit for select officers.
Table 9: Comparison of Total Compensation Reported.
The major discrepancies between reported and unreported income, i.e. any amount over three thousand dollars, are among those executives who participated in the Execu-FLEX and/or KEYSOP programs. The discrepancies at least doubled in all cases between 1999 and 2000 because increases in incentive payouts augmented benefit program payouts. By far the most dramatic discrepancies are with CEO, Halvorson, whose compensation was under-reported on the Form 990 by a quarter of a million dollars in 1998 and 1999 and by over four hundred thousand dollars in 2000. (See Table 9) HealthPartners undereported CEO Halvorson's compensation in 2000 by 31 % of his total compensation for the year. In a footnote to its schedule listing officers and directors and their compensation for 2000, HealthPartners notes that
it set aside $703,935 to pay for contingent benefits that it did not report in the Form 990. (Exhibit 44.) This is the sum of the discrepancies noted above in the year 2000. Thus, HealthPartners reports the benefits subject to substantial risk of forfeiture as a lump sum set aside for payment on a contingency basis, rather than disclosing it by executive. 2000 I.R.S. Form 990, Statement 4, Part V, at 2.
17 Interview with HealthPartners; see also Glen Howatt, interview with HealthPartners spokeswoman Sara McFee in "Listed Pay of Health CEO's doesn't include deferred pay," STAR TRIBUNE, Nov. 30, 2001 ("Our policy is to fully report those deferred amounts of money when they are actually paid.")
HealthPartners' position on reporting deferred compensation is spurious. The 2000 IRS "Instructions for Form 990" directs HealthPartners to include "all forms of deferred compensation and future severance payments (whether or not funded; whether or not vested ... )." (Exhibit 76.) HealthPartners' assertion that it may apply a "substantial risk of forfeiture concept" to IRS Form 990 disclosures is also spurious. The rule may serve the purpose of determining whether personal income should be reported, but it does not serve the purposes of I.R.S. Form 990, which is to provide the public with information on how the tax-exempt entity spends its charitable dollars. Even if a '''substantial risk of forfeiture" concept is applied to I.R.S. Form 990 disclosures, it does not shield HealthPartners from disclosing the compensation at issue here. According to one commentator, the I.R.S. generally takes the position that substantial risk of forfeiture does not exist if the employee can receive the amounts in the future in the event of any occasion, with the exception of having to work until a specified date, death or disability. Michael S. Sirkin, "Navigating Among the Shoals of Deferred Compensation," PHILANTHROPY MONTHLY, December, 1997. If this is the case, a non-compete requirement would not constitute a substantial risk of forfeiture.
According to PPC's Deskbook, "[a]ll forms of deferred compensation are entered in [the] (D) column, whether the deferred compensation plan is funded or unfunded, vested or unvested, or qualified or unqualified. Reasonable estimates can be used if exact amounts are not readily available." C. DOUGLAS PUCKETT, ET AL., PPC'S DESKBOOK 7-3 - 7-4 (10th ed. 2002). The PPC authors recognize the double-reporting problem, but they believe that unvested deferred income
must be reported as a benefit in Column D. They recommend that the organization attach a schedule disclosing any compensation paid in the current year (Column C) that was reported as deferred compensation in a prior year (Column D). Id. at 7-4. The consequence for not reporting deferred or at-risk income may be under-reporting compensation, particularly if the employee receives the income after he or she has left the company and/or is no longer identified on the IRS Form 990 as a key employee. In 1997 the IRS warned HealthPartners' Central Minnesota Group Health Plan that it failed to disclose its Executive Director's deferred compensation and welfare benefit plans as required. (Exhibit 77.)
E. Incentive Pay Based On Financial Goals Interferes With The Charitable Function Of HealthPartners.
As discussed above, HealthPartners pays its officers incentive compensation based In part on the profit margin of the company. While profit margin is only one of four criteria for calculating incentive pay, its importance relative to the other criteria is heightened because it is the only criterion that serves as a baseline requirement for incentive pay. The Board has also signaled its particular interest in the company's profit margin. The Executive Committee approved CEO Halvorson's 12% salary increase in 2000 based on his overall performance and specifically the company's "positive financial margin." (Exhibit 55.)
Pressure to increase premiums is surely amplified by the importance of meeting the baseline margin requirement in the incentive program. In 2000, executives received large incentive payouts as a result of the company's performance in 1999. Coincidentally, commercial premiums also jumped dramatically in 1999. According to the Minnesota Department of Health, commercial premiums increased 11.9% in 1999 after posting an 11.6% increase in 1998. (Exhibit 78.) Commercial premiums increased 2.3% in 1997. (Exhibit 78.) An incentive program that rewards executives for increasing premiums runs counter to the charitable objectives of Health Partners.
HealthPartners' executive compensation program is problematic in several respects. First, HealthPartners' structure and process is flawed for determining and monitoring executive compensation. In particular, Board oversight is insufficient. The excess benefit transaction safe harbor is not met because no independent authorized body oversees compensation for Executive Officers other than the CEO, and the data as to comparability is inadequate. Second, data on executive compensation is not adequately reported on the Form 990. Finally, the criteria used in the HealthPartners' incentive program, which is based on increased profits, inappropriately encourages the executives to enhance the financial margin, which may be accomplished by increasing premiums or withholding treatment.