Extreme payoff: What CEOs get when they leave is a real eye-opener

Regulators and physicians are paying more attention to managed care executives who receive "golden parachutes" after mergers.

By Robert Kazel — Posted Aug. 23, 2004

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The high salaries of managed care executives have stirred controversy and caused consternation among doctors. But what's getting some regulators and physicians even more upset these days are the enormous sums insurance chieftains are being paid not to work.

As the consolidation of the health insurance industry has continued, top executives have benefited from golden parachutes, provisions in their compensation contracts that guarantee bonuses and benefits should their company ever be acquired by another. Or they've gotten golden handcuffs, which are essentially the same thing, except that the executive stays, often in a reduced role.

These frequently sizeable severance packages could include cash, stock grants and options, pension bonuses, insurance benefits and other perks that ostensibly help ease the pains of separation from the executive suite. These payouts occur in all industries, but those in the health insurance sector appear to be coming under fire in particular.

"Margins in the managed care world are extremely tight, and to know that their money is being tossed around in the millions just baffles me," says Brian Kelley, a partner in Ray and Berndtson, a New York consulting and executive search firm. "It's a terrible statement that we have these payouts to these senior leaders. We need to treat this as the crisis that it is."

Because of the magnitude of acquisition-related payouts, state regulators charged with reviewing mergers are, in some cases, scrutinizing deals like never before.

For example, California Insurance Commissioner John Garamendi cited a potential $600 million in golden parachutes to WellPoint Health Networks executives as a reason to refuse approving the California firm's $16 billion merger with Indianapolis-based Anthem Inc. On Aug. 3, Anthem sued Garamendi in an attempt to overturn his decision, which in effect overrode the approval of other federal and state regulators.

The Medical Society of New Jersey cited golden handcuffs for Oxford Health Plan executives -- such as a $37 million cash and stock option bonus to Oxford CEO and President Charles Berg -- as one of many reasons it sued in a Trenton, N.J., court to stop United Healthcare's $4.7 billion purchase of the Trumbull, Conn.-based health plan. The society's filing Aug. 2 stayed the United-Oxford merger, which the companies said got all necessary regulatory approvals by July 29. The insurers were expected to challenge the medical society's action.

Spokespeople for Anthem, WellPoint and Oxford didn't respond to requests for comment.

Can't jump without a parachute

Some argue that merger-related payouts are inevitable when insurers try to lure well-known and experienced executives, and that boards have little choice in the matter. In this view, any insurer that fails to offer a new CEO a handsome compensation agreement, with a parachute, is doing a poor job for its shareholders.

"There is a relatively limited group of people with the skill set to do certain jobs," says Nancy Shilepsky, a Boston compensation attorney. "Corporations compete for those people."

Furthermore, some say there's scant evidence that investors are interested in interfering with these types of bonuses as long as they gain financially from a merger. The Anthem-WellPoint merger was approved by 95% of shareholders. Says Bill Gerek, senior compensation consultant with the Hay Group in Chicago: "Most shareholders don't care."

But that could change, industry watchers say, as stockholders get more educated and as pressure on boards continues to emerge from other sources. Attention by state regulators will continue to mount. Institutional investors, activists, the media and consultants hired by boards are likely to exert more influence on corporate pay decisions, says Paul Dorf, a compensation consultant in Upper Saddle River, N.J.

"Shareholders can speak with a unified voice and may act, especially if large institutional buyers can vote millions of shares and can wield power," he says.

Golden parachutes also could be increasingly challenged by physician groups, which argue that such payments are grossly excessive and evidence of executives' greed.

And executives' merger pay could be more constrained, experts say, as boards come to realize that mergers might or might not prove successful in the long run.

"We expect a merger is going to be a wonderful affair and sometimes, because you have a different culture and style, it takes maybe five or more years for a merger to pay off," Dorf says. "An executive getting a large amount of money certainly doesn't facilitate the process."

It could become harder to get merger bonuses for another reason. Many of the planned payouts to many WellPoint executives are an example of "single-trigger" severance pay, which kicks in as a result of a company's changing hands but isn't predicated on executives actually becoming unemployed, said Paul Hodgson, senior research associate at The Corporate Library, an investment research firm in Portland, Maine. But these kinds of generous provisions are becoming rarer at large companies, Hodgson says, "and certainly are not in line with best practice."

Defenders of merger bonuses say they allow top management to pursue promising mergers that would be good for the company, even if it means being acquired and the loss of their jobs. Opponents of the payouts, though, argue that when merger bonuses become extremely big, it can be hard to know if CEOs are chasing the deals not on behalf of shareholders but just to retire richer. Big severance payments "provide a direct incentive for managers to arrange a change in control whether it's in the best interest of stockholders or not," Hodgson says.

Big packages

Golden parachutes can be over the top. When his firm was bought out by Aetna in 1996, U.S. HealthCare Chair Leonard Abramson, according to Securities and Exchange Commission filings, stayed on as business and public relations adviser for $2 million a year plus benefits, so long as he could work "during normal business hours."

Aetna supplemented that with an immediate $10 million merger bonus, an extra $1 million a year to sign a noncompete agreement, and an IOU for another $10 million when he left the company completely. In addition, he got a gift of a $25 million airplane and was paid up to $2 million a year to operate it.

But that didn't stop the deal from getting approved. Not so, as it turned out, with WellPoint and Anthem.

WellPoint Chair and CEO Leonard Schaeffer had a "change of control" clause in his contract in case of a merger. Although Schaeffer would stay on for two years with the newly merged company as chair, he would lose the CEO role to Anthem's Larry Glasscock, thus opening his golden parachute.

According to SEC filings, Schaeffer would receive $27.5 million in severance pay and a special executive pension with an added boost of $10.5 million. He could cash in stock shares and options estimated at about $250 million, with early vesting as soon as the merger closed.

His special executive retirement plan (SERP), valued at about $45 million, would be paid all at once soon after he left WellPoint. Schaeffer would also get country club memberships for 48 months and financial counseling, office space and secretarial support for five years.

But that didn't tell the whole story about the golden parachutes involved in the proposed Anthem-WellPoint merger. Details on merger payouts can be difficult to find and even harder to understand.

Although facts on payouts can be partly discerned by searching voluminous SEC filings, they've become couched in the kind of dense legalese that makes the fine print of doctors' HMO contracts seem transparent.

It took a Freedom of Information Act filing by the Foundation for Taxpayer & Consumer Rights, a corporate watchdog group, to obtain information clearly outlining that a large number of executives at WellPoint beyond Schaffer and other top executives stood to gain financially from the merger.

To some, the numbers were startling. According to data released by the California Dept. of Managed Healthcare on the consumer group's request, Anthem planned to pay 293 WellPoint executives between $147 million and $356 million in severance and retention bonuses, or between $502,000 and $1.2 million per executive, on average. The $600 million figure quoted by Garamendi includes other stock options and bonuses.

Among several others groups, the California Medical Assn. decried the bonuses, arguing that "it appears that the executive payout is the primary motivation behind [WellPoint's] decision to merge."

A few other state regulators feel the same way.

In 2003, CareFirst BlueCross BlueShield of Maryland asked the state for permission to convert to a for-profit company in preparation for a buyout by WellPoint. Insurance Commissioner Steve Larsen rejected the conversion, accusing CareFirst board members and management of manipulating the deal from the start to get huge signing bonuses and stock options from prospective buyers. Larsen's successor in the insurance department launched an investigation into the legality of what CareFirst managers had tried to do, saying there was proof of "flagrant attempts to profit from the proposed sale." The probe continues.

Recently, BlueCross BlueShield of North Carolina scrapped its plans to go for-profit after it appeared state insurance officials might impose a number of oversight measures, including limits on executive pay and golden parachute provisions.

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Merger money: A lexicon

Golden parachute: Cash, stock options and other benefits awarded to top executives when they lose their job -- or their jobs are altered -- because of an acquisition.

Golden handcuffs: Deferred compensation, including cash and restricted stock, awarded to key employees and management in a merger who stay with the new company a certain period of time. Often combined with a noncompetition agreement.

Change-of-control clause: Executive's contract provision that triggers severance because of a takeover.

Triggering event: Things that activate the change-of-control clause, such as changing an executive's duties or title, or requiring him to relocate.

Gross-up: Extra payment to parachuting executive to counteract the effect of federal excise tax on golden parachute.

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Anatomy of a parachute

Charles G. Berg, 46, president and CEO of Trumbull, Conn.-based Oxford Health Plans, will get a variety of rewards under a deal negotiated with UnitedHealth Group, which in April announced its plan to buy Oxford for about $5 billion. Berg gave up command but stayed on as head of United's Northeast region. According to Securities and Exchange Commission documents, Berg was to get:

  • $5.5 million cash payout.
  • $825,000 salary as regional manager and chief integration officer after Oxford is absorbed, as well as incentives and bonuses totaling about $1.6 million during the first two years.
  • A $32 million increase in the value of his stock options.

Four other top Oxford executives who stayed on Berg's team after the merger had a change in job status and got bonuses ranging from $1.4 million to $1.7 million.

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