New tax rule targets salaries of health insurance executives

As part of health system reform, insurance companies are facing limits on how much they can deduct executive pay from their taxes -- limits similar to what the government put on troubled banks that took TARP money.

Until the March enactment of the Patient Protection and Affordable Care Act, health plans, like other companies, could deduct up to $1 million in salaries paid to top executives, with the Internal Revenue Service not touching stock options, deferred compensation and other noncash payments.

However, health plans now can deduct only the first $500,000 of what they pay executives -- including all of the compensation, not just the cash part. The new rule is expected to raise $651 million in the next 10 years for Medicare.

The rule is similar to one put in place under the Troubled Asset Relief Program in 2008. In one sense, however, the health plans were hit with a heavier hammer than banks.

The deduction limits under TARP applied only to the chief executive officer, chief financial officer and the three other highest-paid executives, according to a review by the law firm McDermott Will & Emery. For health plans, the coverage is broader: Any employee, board member, outside consultant or outside broker is subject to the deduction limit.

America's Health Insurance Plans, the trade group for health insurers, is unhappy with the new rules. "The rules regarding executive compensation should be consistent across all industries," said Robert Zirkelbach, spokesman for the group.

The top 10 publicly traded health plans paid out $228.1 million in 2009 compensation to their chief executives, up from $85.8 million in 2008, according to a report issued in August by Health Care for America Now, a health system reform advocacy group. That excluded stock option exercises, such as the $98.5 million earned in such a manner in 2009 by UnitedHealth Group CEO Stephen Hemsley.

The new rule not only changes the guidelines for shareholder-owned plans but also applies to private insurers.

For health insurance companies, "it's potentially very significant," said John Shannon, a partner at the Atlanta law firm Alston & Bird who concentrates his practice on executive compensation. "It's certainly going to be a consideration when they think about setting compensation levels."

U.S. Sen. Blanche Lincoln (D, Ark.) introduced the rules as part of the health system reform bill as a way to keep health insurance company executives from benefitting too much from the new business that the health insurance mandate is expected to create.

"Without this change, every Arkansas taxpayer and every U.S. taxpayer subsidizes these big insurance executives' unlimited salaries and compensation packages. At the same time, the companies are denying coverage to hardworking Americans who desperately need care," Lincoln said at a Dec. 4, 2009, news conference where she discussed the amendment.

The deduction limits apply to any company that collects health insurance premiums between 2010 and 2012. In 2013 and beyond, the limits apply to any company that collects 25% or more of its premiums for "minimum essential coverage."

Most insurers will fall under that threshold, with minimum essential coverage applying to premiums for any government-sponsored insurance, employer-based insurance, individual insurance and most other general health benefits coverage, according to McDermott Will & Emery's analysis.

Experts say the law not only will raise insurers' tax bills but also could push them to re-examine and restructure how their executives are paid.

Without any way to get around paying taxes on most of an executive's pay, companies may look solely at how best to motivate their top people, said Pamela Baker, partner and chair of the Employee Benefits and Executive Compensation practice for the Chicago law firm Sonnenschein Nath & Rosenthal.

"I think it will mean compensation structures will be re-evaluated in light of what they truly incentivize, without regard to whether they will be deductible," she said.