Senior Living Business: Target: Fair-Market Executive Compensation


A “Dust-Up” At Diakon Highlights The Sensitivity of Executive Pay

Last month, a local Lutheran group questioned the compensation that Diakon Lutheran Social Ministries paid its CEO in 2006. That year, The Reverend Dr. Daun E. McKee, CEO and president of the not-for-profit organization, collected a total of $1.03 million — $385,947 in salary, $582,925 in benefits, and $63,591 in expenses — reportedly the highest compensation of any not-for-profit executive in Central Pennsylvania.

Diakon is a fairly sizable organization. It has an annual budget of nearly $200 million and, with all its facilities in the region, it has assets of $500 million. Based in Allentown, Pennsylvania, Diakon serves more than 70,000 people a year in 50 centers in three states – Pennsylvania, Delaware, and Maryland.

"In addition to CCRCs, assisted living services, nursing homes, and memory-care facilities, we offer hospice care, rehabilitation services, a huge program for at-risk youth, other in-home services, adult day care, adoption services, community-based runs the gamut from birth to death," said Susan T. Schellenberg, chair of the board of directors. Diakon is affiliated with the Evangelical Lutheran Church in America.

Nevertheless, the whopping compensation of its CEO raised quite a few eyebrows at The Lower Susquehanna Synod, a nine-county church assembly, when it met in mid-June. The group passed a resolution officially questioning "excessive" compensation packages awarded by Diakon. An official response from the organization is pending...but here is some background.

Dr. McKee has been with Diakon since 1995. During the intervening years, the organization experienced two significant mergers. "It became more important than ever for us to keep senior management skills in place," said Peter L. Kern, member of the board of directors and chair of its Compensation Committee. "So we put together a Supplemental Executive Retirement Program (SERP) to attract talent and retain valuable senior management."

When Dr. McKee reached age 65 in 2006, the law required a distribution — and it was inordinately large, because Diakon had deferred payments to the pension plan due to the multiple mergers and other reasons and had to make up years of benefits in the last couple of years. In fact, 98% of the $582,925 that Dr. McKee received in benefits in 2006 reflected the pension distribution; the balance of that amount was for medical and other insurance. And the $65,591 in expenses was for housing and vehicle allowances, which the church sponsor recommends for ordained clergy.

"So it’s really a perception problem," says Kern. "People were shocked when they thought a not-for-profit organization was paying its CEO, a Lutheran pastor, a million dollars a year. But that is just not the case. In reality, his benefits appeared high simply because the funding had to take place over a short period of time."

So while the explanation for Dr. McKee’s unusually high compensation in 2006 may be reasonable, the Diakon "dust-up" illustrates the sensitivity generally surrounding executive compensation at not-for-profit organizations.

The value of "heart"
"A deep human motivation usually attracts people to the not-for-profit sector," observed Larry Minnix, executive director of AAHSA. "They’re people with heart, who are highly motivated to want to change some major human condition or at least improve care and services for an aging and disabled population."

That said, it is the responsibility of not-for-profit organizations to compensate people fairly. "You don’t want to take advantage of that ‘heart’ by compensating people inadequately," Minnix said. "Whether nursing assistants or CEOs, people need to be able to provide for their families. They need to be paid fairly and competitively."

So what is competitive pay? AAHSA conducts an annual survey through Hospital & Healthcare Compensation Services (HCS). The resulting Salary & Benefits Reports compare compensation for selected positions in various categories, as shown in the following chart.

CCRCs (2008-2009 average annual salaries)
CEO - up to 299 units $115,783
CEO - 300 units or more $142,282
Assisted Living (2007-2008 average annual salaries)
Administrator - not-for-profit $76,767
Administrator - for-profit $87,000
Nursing Home (2008-2009 average annual salaries)
Administrator - not-for-profit $73,559
Administrator - for-profit $63,769
AAHSA’s 2008-2009 report will be available at the end of July.

"It’s also incumbent upon boards to do independent, objective compensation studies of like or similar organizations," Minnix added. "Typically, the closest comparisons for not-for-profit senior-care providers are the benchmarks within the not-for-profit sector and some government sectors."

For example, Diakon’s Compensation Committee, which is totally independent of management, engages an outside firm to help set fair and competitive compensation levels. Watson Wyatt Worldwide, an international consultancy with considerable experience in executive compensation packages, provides market data for both not-for-profit and for-profit organizations in the senior care sector, as well as in the broader health care sector.

"We’ve been working with Watson Wyatt for a number of years now," explained Kern. "Using their analysis tools, they provide us with compensation information for comparable organizations, both for-profit and not-for-profit, that they have vetted as being peers. We set our executive compensation at the midpoint of the range, with one or two minor exceptions (not at the CEO level)."

Susan T. Schellenberg, chair of Diakon’s board of directors, has no reservations about the process. "There will always be people who say ‘who’s worth that,’ especially when it’s a not-for-profit," she said. "But the process is fair and, as stewards of the organization’s mission, we are totally responsible and accountable."

Increasingly complex organizations
"We’ve seen an evolution in senior-care organizations," said John Durso, partner at Ungaretti & Harris law firm. "Whether for-profit or not-for-profit, many have become very complex as they try to meet the most complex human needs in America. Many operate multiple facilities and/or communities. Some own captive insurance companies and other joint ventures. Others own pharmacies or rehabilitation companies. That’s quite different from the situation a generation ago."

Also, a fair number of CEOs in the not-for-profit sector were clergy 30 or 40 years ago and were paid the same salary whether they were in the pulpit or running an organization. Today, the executive team is likely to be professionally trained experts with advanced degrees in business or public administration or health care — or even long-term care — and broad-based business development, strategic planning, and/or human-resources experience.

Having an ordained Lutheran pastor as CEO actually exacerbated Diakon’s current compensation issue. "The perception is that a pastor should be paid less," said Schellenberg. "And as much as we have tried to explain the scope and complexity of Diakon, it’s sometimes hard for local community pastors earning a fraction of our CEO’s salary to understand."

"We’re not in any way disparaging the worth of a local pastor," added Kern. "But in addition to the CEO, we must compete for talent to fill the CFO, COO, and other senior management positions. And if we have to pay a CFO $250,000 to $300,000 a year to run the financial components of the organization, we can’t very well pay the CEO less simply because he happens to be ordained. So while the question raised by the Synod was legitimate, the fact that Dr. McKee is ordained is just not relevant in terms of his compensation."

Set fair compensation levels
Must the CEO of a not-for-profit nursing-home chain receive less compensation than the CEO of a comparable for-profit operation? "The answer is ‘no’ with respect to fair-market value of salary and similar benefits — bonuses, retirement incentives...all of the things companies provide to their CEOs," said Durso.

IRS rules allow a 501(c)(3) corporation to provide fair-market compensation to its top executives, according to Durso. When setting reasonable compensation, the IRS allows the organization to use both not-for-profit and for-profit data, as long as it’s for comparable positions in comparable organizations of comparable size.

"And frankly," Durso added, "it’s a matter of justice that not-for-profit organizations pay fair-market salaries to all of their employees, not just the top-level executives."

The issue then becomes...what is the fair-market value? By examining survey data, Heidi Toppel, senior consultant at Watson Wyatt, indicated that base salaries in health care (including hospitals, but not specifically elder care) are pretty much aligned between the for-profit and tax-exempt areas.

Incentive compensation, however, is not necessarily aligned. The CEO of a for-profit company can participate in the upside growth of the company through stock options and owning shares. In not-for-profit organizations, some other concept of increased value to the enterprise — e.g., retirement benefits, deferred compensation, or increased compensation based on longevity — must be involved.

Toppel is seeing a continued interest in, and believes there’s a place for, SERPs in the total pay packages of tax-exempt organization executives. In contrast, among public companies, where executives have the opportunity to accumulate wealth from stock-based compensation, there is a huge effort to eliminate SERPs.

Diakon’s Kern, however, doesn’t believe that the distinction between for-profit and not-for-profit benefits is significant except in the largest organizations. "In multi-billion-dollar for-profits, the benefits might skew the numbers," he said. "In organizations of our size [$200 million annual budget], it doesn’t seem to be a particularly significant factor."

Consider a for-profit subsidiary
Another way for a large not-for-profit system to approach executive pay is to set up a for-profit subsidiary — a management or development company owned by the not-for-profit organization that oversees operations and hires and pays top executives. That, Durso suggested, provides more options for achieving fair-market compensation and recognizing the value of executives.

The subsidiaries are set up so that they can operate within the not-for-profit system, as well as provide management services for outside clients to bring in outside revenue. By spreading costs over a broader base, the organization can bring more talented people into the system — which also helps the not-for-profit side.

"This is a new idea for some," said Durso, "but it’s becoming more common. It just provides more flexibility for the system to compete in the future with respect to compensation. It doesn’t compromise the organization’s tax-exempt status or its tax-exempt activities."

From CNA to CEO, people must be paid fairly and competitively, Minnix concluded. "The important thing," he stressed, "is for boards to set compensation levels objectively and independently and not just informally. You don’t want to pay too little or too much."

July 1, 2008