"Making Their Numbers" - Examples of the Perverse Effect of Incentives Based on Short-Term Financial Targets in Health Care

Last week, we discussed how the large incentives for pharmaceutical executives to meet short term financial targets (that is, "making their numbers") may be an important cause of their firms' decreasing capacity to fulfill their most basic mission, manufacturing pure, unadulterated medicines. 

In the news recently were two examples of how other health care leaders are incentivized to meet short-term financial targets.

University of California

The first, and bigger example appeared in the San Francisco Chronicle. First, note that the University of California system is currently in dire shape:

Finances are so dire at the University of California that it might have to turn away qualified students,....

Also,

UC President Mark Yudof told the regents that UC will need to close a $1 billion budget gap next year. He said layoffs and course reductions are inevitable, and that he expects to have to turn away 20,000 to 30,000 qualified students over the next decade because the university won't have the money to educate them.

However, that did not stop the university from giving bonuses to a variety of employees, including larger bonuses for higher-ranking managers

UC has still found a way to reward hundreds of employees with more than $4 million in incentive pay and raises.

At the regents meeting Thursday in San Diego, UC officials reported giving rewards of $150 to $41,205 to nearly 1,500 UCSF employees who met performance targets, raising the pay of some campus executives to above market rate, and providing 10 percent raises of about $20,000 a year to three executives at their Oakland headquarters.


The executives, who have various financial responsibilities for the UC system, will earn between $216,370 and $247,500 in base pay.

'Whether a budget crisis or not, the university still has to be able to pay competitive salaries and incentives consistent with industry standards,' said Steve Montiel, a spokesman for the university. 'The university has no problem paying incentives to be competitive.'

Note that the bonuses were apparently mainly based on short-term financial goals,

[UCSF spokeswoman Amy] Pyle said the rewards were issued because those employees met targets for saving money and streamlining procedures - but that the incentive program for that group has now been suspended because of the budget crisis.

Note that despite the fact that the University has long-term financial woes, the biggest bonuses went to finance executives whose short-term performance obviously did not have much effect on these long-term problems:

One of them, Grace Crickette, UC's chief risk officer, 'has saved the university over $100 million by driving down the cost of workers' compensation, negotiating much more advantageous terms with our insurance company,' Taylor said. The raises 'are a small price to pay for people working at the highest level.'

That rationale failed to convince representatives of UC's lowest-paid workers.

'The lowest-paid workers do a lot to save money too, and we've actually told them how. But our workers are being hit' with higher costs for their own benefits, said Lakesha Harrison, president of the American Federation of State, County and Municipal Employees, which represents custodians, groundskeepers, patient-care workers and other employees earning less than $40,000.

Also,

At UC Berkeley, for example, the new vice chancellor for administration and finance will earn a base salary of $375,000 - 9 percent higher than the salary midpoint of $344,000 earned by colleagues at other universities, UC officials reported.

At UCLA, the chief financial officer of the hospital system will receive a 10.5 percent raise, bringing his salary to $420,000 from $380,000 as a hedge against the possibility that he would go somewhere else. The campus called it a 'pre-emptive retention salary adjustment.'

So while the University of California has long-term financial woes, so severe that they will likely require major curtailment of fulfillment of its major academic mission, its leadership had no problem handing out bonuses for meeting short-term financial goals whose achievement obviously did not forestall the current problems. The biggest bonuses went to financial managers, rationalized by their supposed performance "at the highest level," or their need to prevent them from going "somewhere else." However, obviously the long-term FINANCIAL performance of the University is its current biggest problem, suggesting that overall these financial managers are not doing so well. Thus, the way the University handed out bonuses for people "making their numbers" seemed completely at odds with the University's inability to make its numbers in the long-run. Of course, the bonuses also seemed entirely unrelated to the University's ability, or lack thereof to fulfill its mission.

Erlanger Health System

The Erlanger Health System is "an academic medical center associated with the UT College of Medicine Chattanooga." The Chattanooga (TN) Times Free Press reported:

Erlanger Health System executives took home bigger bonuses in December compared with the awards paid out the year before, despite recording lower profits.

In December, 123 management-level Erlanger employees split $1.9 million in bonus payments, $200,000 more than the total awarded in bonuses in fiscal year 2009.

President and CEO Jim Brexler received a $192,395 bonus in December on top of his base salary of $550,000.

The payments were based on the hospital's performance in fiscal year 2010, which ended in June of last year. The hospital's operating profit of $8.58 million, and other performance measurements that year, met pre-established criteria approved by the hospital's board of trustees.

The irony is that by the time the bonuses for fiscal year 2010 were awarded, it was already known that this year's finances are not so good:

Fiscal year to date, Erlanger has earned a $1.3 million profit, compared with a budgeted $6 million profit, according to financial statements released at the hospital's Budget and Finance Committee Monday.

Of course, one rationale for the bonuses is that Erlanger's executives are above average, just like, it seems, finance executives at the University of California (as noted above), and maybe all other health care organizational leaders:

'It takes a real expertise to deal in health care. ... Just to make any positive operating margin is great,' said Kim White, an Erlanger trustee and chairwoman of Erlanger's Management and Board Evaluation Committee, which sets the criteria that determines whether bonus pay will be awarded and how much.

'It's tough for people who don't have jobs to look at bonuses, but we look at this as a piece of their total compensation package.'

Of course managers and executives may have "real expertise," as noted above, or be in charge of some initiatives that saves money (as noted above in the case of a UC executive.)  However, there may be many other people who work for the organization with "real expertise," some of whose expertise may be more directly related to the organization's primary mission.  Also, as the union leader noted above, even low-paid workers may have ideas for saving money.  However, the big bonuses or raises given to reward only the managers' expertise, or prevent only the managers from finding other jobs, show the exceptional treatment given to health care managers and executives, perhaps because they tend to answer to governing bodies (boards of trustees or directors) run by other managers and executives.

Summary

There is increasing evidence that bonuses given to employees of health care organizations, particularly high-level managers and executives, are predominantly tied to short-term financial goals, e.g., "making their numbers." In my humble opinion, these are important perverse incentives, driving people to actions that disregard, or may even subvert the organizations' fundamental missions.

While it is desirable for all health care organizations to be run in a business-like manner, and for not-for-profit health care organizations to have competent financial management, these are means to an end. The mission of health care organizations is health care.

The main priority of non-profit organizations (or NGOs) should be to uphold their missions, not to make surpluses. Avoiding deficits, or making surpluses are means to uphold the mission, but ought to be subservient to the mission.

While for-profit health care corporations are meant to make a profit, in the long run their profitability should depend on whether the health care products they make or services they provide are fit for purpose, that is, further health care of individual patients or populations. Putting short-term financial goals ahead of making quality products (e.g., making pure and unadulterated medicines as noted in our previous post) will ultimately be bad for patients, for public health, and for the long-term financial health of the corporation.

Therefore, I submit that incentives for employees should be based on how their work upholds the primary mission. It may not be unreasonable to have some incentives based on long-term financial goals for financial executives of health care organizations. However, even those should be explicitly tied to mission fulfillment.

However, as health care leaders seemed to have learned from leaders of financial services firms, the emphasis on incentives based on short-term financial goals seems to only be increasing. Failure to address these increasingly perverse incentives will only lead to increasing health care dysfunction.