Health Law Limiting Tax Deductions for Executive Pay at Insurance Firms

Congress is using the new health- care law to limit tax deductions for executive pay at medical insurance companies in a bid to prevent corporate officers from personally benefiting from expanded enrollments.

The rule applies to UnitedHealth Group Inc., WellPoint Inc. and other insurers that earn 25 percent or more of premium revenue from health plans, cutting the deduction to $500,000 from $1 million on income per employee.

This change, plus the elimination of a provision on performance-based payouts, will translate into higher payroll taxes for this sector, according to data compiled by Bloomberg.

Senator Blanche Lincoln, the Arkansas Democrat who pushed for inclusion of the measure in the new law, said it’s designed to discourage insurers from enriching executives with the additional premium dollars from millions of new customers generated by the health legislation. The measure won’t be enough to force pay policy changes at the companies, tax analysts said.

“It’s an interesting tax limit in that it’s imposed on only one industry,” said Elizabeth Drigotas, a principal at Deloitte Tax LLP in Washington. “They’ll just have to take the hit, unless they think they can staff positions in their firms for $500,000 or less.”

Drigotas said the inconsistent tax treatment may bolster insurers’ arguments to repeal the provision.

Corporate Liability

The measure is expected to raise $600 million over seven years, according to Congress’s Joint Committee on Taxation. The added liability faced by the companies is nominal given that U.S. corporations paid about $100 billion in total taxes last year, said Joseph Rosenberg, research associate at the nonpartisan Tax Policy Center in Washington.

Robert Zirkelbach, a spokesman for America’s Health Insurance Plans, declined to comment. The insurance trade group is based in Washington.

The provision also removes longstanding exemptions for most performance-based pay, such as stock options and annual cash bonuses, and tax-deferred compensation. The size of these payouts varies each year, depending on whether management achieved certain financial goals.

While the new tax-change rule takes effect fully in 2013, it applies to income employees earn in 2010 and choose to defer. The measure will affect public and private health-insurers.

The average annual pay for the chief executive officers of the largest U.S. health-insurance companies in 2009 was $11.5 million, based on a study of 271 public corporations by Graef Crystal, a pay expert and consultant to Bloomberg News.

CEO Pay

Ronald Williams at Aetna Inc. was paid the most, at $18.6 million, followed by WellPoint’s Angela Braly, who earned $13.1 million, Crystal said. UnitedHealth paid Stephen Hemsley $8.9 million and Humana Inc. gave $6.5 million to Michael McCallister.

Stock awards and performance-driven bonuses or longer-term cash payouts eclipse salaries for the CEO and four other executives named in their 2009 proxy statements. As a result, companies could pay much more in payroll taxes under the new rule, given stock and bonuses averaged 86 percent of their total pay at Aetna, WellPoint, UnitedHealth, Humana and Cigna Corp.

The tax write-off applied for 99 percent of pay awarded to these five executives in 2009. The new rule would reduce it to 67 percent, according to data compiled by Bloomberg. The firms could face a tax liability of $45.7 million, or 33 percent of total pay in 2010, versus $245,000 or less than 1 percent in 2009, using 2009 pay levels and a 35 percent tax rate.

Total Taxes

A company’s total tax liability generated by the rule change is unknown, because disclosure doesn’t extend to all employees paid more than $500,000. Also, the tax liability for a firm in a given year isn’t always identical to its actual tax payment. Tax payments totaled $4.72 billion in 2009 for the five insurers.

Graef said firms could try to offset the incremental expense by chipping away at other costs. It could also translate into nominally lower shareholder returns. Mitigating the added tax hit through higher premiums isn’t a likely option, he said.

Tax-code changes have repeatedly failed to stem the growth of compensation for CEOs and other top executives across all industries, said Robert McCormick, chief policy officer at San Francisco-based proxy-advisory firm Glass Lewis & Co.

“Any time there’ve been changes in the tax code to limit executive compensation, they haven’t been successful,” said McCormick. “Companies will pay what they want and forego the deduction.”

U.S. public companies, under section 162(m) of the Internal Revenue Service code, can deduct as much as $1 million in compensation for each executive. The rule exempts most performance-based and deferred pay. Critics of the provision say it hasn’t worked as intended, because companies modified executive compensation and awarded large stock-option grants.

TARP Money

A rule similar to the health-insurance pay provision was included in the government’s Troubled Assets Relief Program, or TARP, in 2008, though it was a more limited measure because it applied only to firms that took bailout money.

“That was a penalty for what they cost the taxpayers,” said Paul Hodgson, senior research associate at The Corporate Library, a corporate governance firm based in Portland, Maine.

To contact the writer of this story: Elizabeth Smith at esmith583@bloomberg.net

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CEO Pay

David Rogowski/Bloomberg

Photographer: David Rogowski/Bloomberg