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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.
HealthPartners matches an executive officer's contribution dollar-for-dollar up to 5% of base pay.
1
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.) 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. (Ex. 23.)
------------------------------------
Senior Executives are entitled to the following additional benefits:
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:
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.
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:
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.
-----------------------------------------------
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:
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:
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:
26 C.F.R. §
53.4958-6(c)(3)(i).
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:
(Exhibit
18.)
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.)
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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
(Exhibit 23.)
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:
(Exhibit 27.)
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
(Exhibit 28.)
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:
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. (
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.
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.
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.
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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.
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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."
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.
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2 New Senior Executives do not participate in the Execu-Flex Plan and participate only in KEYSOP.
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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.
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.
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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 %:
Total Cash | Total Benefits | Total-
Compensation | |
| 1998 | $514,713 | $473,406 | $ 988,119 |
| 1999 | 534,522 | 418,602 | 953,124 |
| 2000 | 766,466 | 532,742 | 1,299,208 |
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
Year | Base Salary | % of Goals Met | Actual
Withhold Payment | Bonus % |
| 1996 | $362,811 | 90 | $147,715 | 40.7% |
| 1997 | 394,013 | 80 | 135,090 | 34.3% |
| 1998 | 425,534 | 73 | 111,999 | 26.3% |
| 1999 | 451,066 | 98 | 238,024 | 52.8% |
| 2000 | 505194 | 70.25 | 215,581 | 42.7% |
| 2001 | 555,713 | 82.65 | 247,314 | 44.5 % |
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.
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.
AG
#785817-v1
EXECUTIVE
COMPENSATION
I. INTRODUCTION
I. INTRODUCTION
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
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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.
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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:
- Salaries and benefits must be approved by an independent board or committee whose members are not related to or likely to be unduly influenced by, the officer whose salary is being set;
- In reaching its decision, the board must rely on salary data and compensation studies that show how much money people in similar jobs earn; and
- The board must document its decision process, showing exactly how it set compensation.4
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.
(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:
- The terms of the transaction that was approved and the date it was approved;
- The members of the authorized body who were present during the debate on the transaction that was approved and those who voted on it;
- The comparability data obtained and relied upon by the authorized body and how the data was obtained; and
- Any actions taken with respect to consideration of the transaction by anyone who is otherwise a member of the authorized body but who had a conflict of interest with respect to the transaction.
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.
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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:
- The use of Warren reports was inconsistent. Kathy Cooney's 1999 salary was benchmarked to an "insurer" category, while Nancy McClure's salary was benchmarked to a "not-for-profit corporation" category. (Exhibit 18.)
- While salaries were often benchmarked to a median or 50th percentile figure, in many notable cases, salary midpoints were benchmarked to a 75th percentile or even 90th percentile figure, including:
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
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;
(Exhibit
18.)
- The midpoint salary for Ted Wise, Vice President of Marketing, was volatile for no clear reason. Wise received a promotion in 1999, but his surveyed midpoint actually declined from $179,500 in 1999 to $152,300 in 2000. In 2001, his surveyed midpoint jumped to $289,000. The 2001 midpoint was based on the use of a single Hay report. By increasing the midpoint in 2001 over $100,000, Wise's actual salary as a percentage of midpoint dropped from 150% in 2000 to 88% 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:
- Fully paid family medical and dental coverage
- Section 125 cafeteria plan
- $50,000 Group Term Life Insurance Policy
- Paid time off with an option to purchase more
- Tuition reimbursement
- Qualified pension plan (HealthPartners makes contributions annually into an interest-bearing5 retirement account, based on the participant's annual salary, and age and years of service at the end of the plan year)6 (Exhibit 19.)
- A 401 (k) plan (HealthPartners matches an executive officer's contribution dollar-for-dollar up to the lesser of 5% of base pay or the sum of pretax contributions.) (Exhibits 20 and 21.)
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.)
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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.)
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Table 1: Withhold Percentages for Participants by Job Title
| Executive Vice President | 35% |
| Senior Vice President | 30% |
| Medical Director | 30% |
| Vice President | 25% |
| Associate Medical Director | 25% |
| Chief of Staff | 25% |
| Assistant Medical Director | 15% |
| Senior Director | 15% |
| Director | 15% |
| Board Secretary | 5% |
| Manager | 5% |
(Exhibit 23.)
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.
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.
(Exhibit 27.)
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
Name | 1999 Base Salary | Maximum
Withhold Payment | Total Eligible Compensation | Maximum Withhold % | Maximum Bonus % |
| Amundson, Craig | $161,200 | $ 69,086 | $230,286 | 30% | 43% |
| Brainerd, Marv | 358,000 | 192,769 | 550,769 | 35% | 54% |
| Cooney, Kathy | 220,000 | 94,286 | 314,286 | 30% | 43% |
| Darnay, Anne | 206,000 | 88,286 | 294,286 | 30% | 43% |
| Erickson, Kirby | 300,500 | 161,808 | 462,308 | 35% | 54% |
| Isham, George | 238,800 | 102,343 | 341,143 | 30% | 43% |
| McClure, Nancy | 183,750 | 78,750 | 262,500 | 30% | 43% |
| Rank, Brian | 270,000 | 50,000 | 320,000 | 30% | 43% |
| Reed, Maureen | 191,360 | 82,011 | 273,371 | 30% | 43% |
| Wise, Ted | 200,000 | 94,286 | 294,286 | 30% | 43% |
Table 3 shows actual withhold payments in 1999 and 2000.
Table 3: 1999 and 2000 Actual Withhold Payments
Name | Actual 1999 Withhold Payment | Actual 2000 Withhold Payment |
| Amundson, Craig | $ 59,068 | 54,405 |
| Brainerd, Mary | 146,505 | 156,369 |
| Cooney, Kathy | 71,657 | 54,987 |
| Darnay, Anne | 75,484 | 69,429 |
| Erickson, Kirby | 122,974 | 115,500 |
| Isham, George | 79,316 | 73,543 |
| McClure, Nancy | 67,331 | 65,893 |
| Rank, Brian | 50,000 | 37,500 |
| Reed, Maureen | 63,559 | 56,834 |
| Wise, Ted | 80,614 | 65,623 |
(Exhibit 28.)
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.'
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. (