Stock-Option Grants Boost MCO Execs’ Pay, But Experts Predict Fewer Options in Future

Stock-option grants still account for a sizable portion of executives’ compensation at health insurers, according to Managed Care Week’s annual survey of industry pay practices.  Despite a recent controversy over grants, they aren’t likely to go away, say executive compensation experts.  But in the future, board-level compensation communities likely will continue to de-emphasize options in favor of performance-based grants and other modes of compensation.

 

Stock option grants have come under scrutiny over the past month because of allegations that some companies, including, UnitedHealth Group, allegedly back-dated stock options to make grants more lucrative.

 

Although UnitedHealth has defended its granting practices, CEO William McGuire, M.D., told investors last week that he had recommended that the company stop granting options to senior executives altogether while the insurer conducts a review of the policy.

 

Some MCO executives still received very significant 2005 option grants.  For example, McGuire earned about $8 million in annual compensation, but received 1.3 million options that the company estimates could be worth $93.8 million by the time the grant expires in 2015.  Aetna, Inc’s. grant of 912,000 options to former CEO John Rowe, M.D., could be worth $9.8 million in 2010.  And WellPoint, Inc. CEO Larry Glasscock’s 2005 of 400,000 options could net him $7.8 million in 2010

 

McGuire again was the highest-paid executive among publicly traded MCOs, followed by Glasscock, who received $1.3 million in annual salary and a $3.4 million bonus, and CIGNA Corp. CEO H. Edward Hanway, who was paid $1.1 million in salary and a $3 million bonus.

 

Most CEOs received hefty bonuses, with the exception of some heads of Medicaid managed care companies that had disappointing financial results last year partly because of higher-than-expected medical costs.

 

For example, AMERIGROUP Corp. paid no annual bonus to senior or executive officers in 2005 in 2005 “because the company did not attain its financial goals,” the compensation committee said.  In 2004, AMERIGROUP CEO Jeffrey McWaters got a $1.4 million bonus.

 

The Controversy over UnitedHealth’s options granting practice was triggered by a March 18 Wall Street Journal article, which suggested that the company may have back-dated stock options to the day the company’s stock reached its lowest annual price, thereby allowing executives higher profits when they sold the stock at market value.

 

McGuire commented publicly on the issue last week, speaking during an April 18 conference call to discuss first-quarter 2006 financial results last year partly because of higher-than-expected medical costs

 

For example, AMERIGROUP Corp. paid no annual bonus to senior or executive officers in 2005 “because the company did not attain its financial goals,” the compensation committee said.  In 2004, AMERIGROUP CEO Jeffrey McWaters got a $1.4 million bonus.

 

The controversy over UnitedHealth’s options granting practice was triggered by a March 18 Wall Street Journal article, which suggested that the company may have back-dated stock options to the day the company’s stock reached its lowest annual price, thereby allowing executives higher profits when they sold the stock at market value.

 

McGuire commented publicly on the issue last week, speaking during an April 18 conference call to discuss first-quarter 2006 financial results.  He assured investors that company management “believes at the time we collectively followed appropriate practices” for granting stock options.

 

He added that he recommended to the board that UnitedHealth” forgo, for the foreseeable future, further equity-based grants or awards for our most senior and longest-tenured executives, for whom equity positions are well established from prior years of service.”

 

McGuire said the company and board would take appropriate action if the board-level review turns up any issues with options grants.  He did not detail potential actions, and UnitedHealth spokesperson Mark Lindsay did not respond to a request for comment.  But McGuire added that remedial action” requires more than writing a newspaper article.”  He declined to make further comments until the board committee’s review is completed, but said that “it is extraordinarily difficult and frustrating not toespond to media reports and related innuendo that impugn personal integrity and motive.”

 

The uproar over stock-option grants likely will further fuel boards’ interest in using other compensation methods, says Paul Dorf, managing director of Upper Saddle River, N.J.-based consultancy Compensation Resources, Inc. “I think boards are going to be much more wary” of options grants. He predicts.  “There will be a much more thoughtful process for assigning the targets and dates of grants and so forth,” he says.

 

What’s more, such changes to executive compensation practices made by public companies” certainly cascade down to private firms,” Dorf adds.  That’s because not-for-profit companies “by law are allowed to look at for-profit organizations when looking at compensation.”

 

Some firms are less willing to use stock options because of new accounting rules that require most public companies to start expensing stock options granted to executives, says Andy Goldstein, central division practice leader for executive compensation at Watson Wyatt Worldwide.  This means that stock-option grants affect the company’s bottom line.  For example, WellPoint reported in its 2005 Form 10-K filing that adopting the accounting change would reduce 2006 not earnings by 3% to 5%.

 
Some firms are moving to outright grants of restricted stock that vest over time, Goldstein says, or performance shares that vest only if certain goals are met.