Top salaries key to approval of Blues merger

The question from the Pennsylvania deputy insurance commissioner could not have been more detailed.

The official, Stephen J. Johnson, demanded that the top executives of the state's two largest Blue Cross plans disclose every last nuance about their future pay as Independence Blue Cross and Highmark Inc. pursue a merger.

Base pay, severance pay, bonuses - everything.

The Blues have yet to answer. But how they do is sure to be key in whether the merger goes forward, given that controversies over pay have dashed other mega-mergers.

"It's not surprising that the public is sort of skeptical of these large salaries, because quite often they don't feel the products offered to them are affordable or offer adequate coverage," said Renee Marus Hodin, a lawyer with Community Catalyst, a health advocacy group.

Independence and Highmark say that nothing about executive pay has been made final.

However, "this deal is not driven by executive compensation," Independence Blue Cross spokeswoman Elizabeth Williams said.

She added that neither Independence chief executive officer Joseph A. Frick nor his Highmark counterpart, Kenneth R. Melani, had any financial incentives that would reward them for completing the merger.

In the new company, Melani will be chief executive and Frick will take on the job of chief operating officer.

While mum about future compensation plans, Independence Blue Cross recently disclosed Frick's total pay for the first time.

It revealed that he was paid $1.6 million last year, putting him in the middle for pay among Blue chiefs nationwide.

Melani was paid $3.2 million. That placed him in the top tier among his Blue peers.

The Blues say the pay for Melani and Frick is well-deserved, in line with industry standards, and reflects challenging jobs running big operations with many lines of business.

Critics are skeptical.

"I cannot understand why they are making so much," said Lance Haver, director of Philadelphia's Office of Consumer Affairs. "It would make sense to tie their compensation to how well they serve the public and how affordable the product and how widespread the coverage is."

Haver said the Blues should openly explain how much the merged entity would pay its new executives - and why.

"They are owned by their members, they have a social mission, and that would mean explaining how they arrive at compensation," Haver said.

The firms announced their merger proposal in March. Pennsylvania's insurance commissioner, who has the final say on mergers, says he will not make any decision until next summer, at the earliest.

In August, Johnson, an accountant by training, included the compensation question, among many others, in a formal letter to the companies.

"It's a standard question," said Johnson's boss, Joel Ario, Pennsylvania's acting insurance commissioner.

Ario declined to say anything more about the issue of pay. "I have to be extremely careful about comments that would indicate a bias," he said.

Along with information about proposed pay, the department also asked the companies to provide outside experts who could discuss the appropriateness of their compensation.

Whether the proposed future pay will become public remains to be seen. The Insurance Department says the information will be disclosed - unless the firms make a convincing case otherwise.

Asked whether Highmark would commit to revealing the proposed future compensation packages, spokesman Michael Weinstein replied, "I don't know. I can't answer that question."

Independence spokeswoman Williams also said the issue of disclosure was unresolved.

Along with pay, regulators must consider many other important issues, ranging from the merger's impact on customers' bills to the ongoing controversy over the plans' massive surpluses. Highmark had a reserve to pay potential future claims of $3.6 billion last year. Independence Blue Cross' surplus was $1.7 billion.

In past years, Blue Cross, unlike Highmark, has refused to make public the entire pay of its chief executive. In response to questions from The Inquirer, it has changed that policy and disclosed his $1.6 million in compensation.

The firm is not required to disclose the total; it did so voluntarily. Since they pay federal taxes, Highmark and Independence Blue Cross do not face federal disclosure rules that apply to most nonprofit organizations. Moreover, Frick draws portions of his pay from a dozen Blue Cross entities, many of which are profit-making firms not subject to disclosure under Pennsylvania law.

Melani was paid twice Frick's amount - even though the two Blues are similar in size. Of Melani's compensation, $2 million was a bonus.

The Highmark chief's compensation has doubled in the last two years. The company said the surge rewarded a big boom in net income in recent years.

While technically nonprofit, both Blues are really collections of for-profit subsidiaries under a nonprofit corporate umbrella.

For example, Independence Blue Cross, as a nonprofit parent company, owns two key for-profit subsidiaries, AmeriHealth HMO Inc. and QCC Insurance Co., which operates its Personal Choice plans.

Because of the hybrid nonprofit/for-profit nature of their organizations, Highmark's and Independence Blue Cross' executive compensation does not follow trends in either sector.

Both Frick and Melani earn more than their CEO colleagues at even the biggest charities, except for large nonprofit health organizations, according to an annual survey of executive compensation by the Chronicle of Philanthropy.

To provide perspective, consider that the two Blues have annual revenue of about $10.7 billion each.

The chief executive of the $9.5 billion Lutheran Services in America earns $158,000, one-tenth of what Frick earns and one-twentieth of Melani's pay.

On the other hand, the president of Catholic Healthcare West, a big nonprofit health system in San Francisco, earned $4 million last year. The hospital system had about half the revenue of each Pennsylvania Blue.

Frick and Melani also earn less than the chief executives of two of their major for-profit competitors.

Aetna Inc. and UnitedHealth Group Inc., two insurance companies that sell health policies in Pennsylvania, pay each of their top executives more than $15 million. However, their annual revenue is also much higher.

As the national Blue Cross picture has been transformed by big mergers and a switch of many Blues to for-profit status, the pay of executives has flared again and again as an issue.

When Maryland's Blue tried to merge with WellPoint Inc., of California, the deal called for a whopping $39 million in bonuses and severance for the Blue's chief executive. Maryland's insurance regulator, Steven B. Larsen, said the transaction was "inappropriately influenced by the prospect of large payouts for some individuals." He killed the deal.

In another case that has generated criticism, the chief executive of Anthem, which owned Blue plans in eight states, saw his pay climb from $2.2 million to $30 million in the years after Anthem switched to for-profit status.

To be sure, most of that was in the form of stock, a pay option that will not be available to Melani or Frick. The two Blues in Pennsylvania have pledged to stay nonprofit after they consolidate.

Among nonprofit Blues, the highest-paid chief executive last year was the head of Health Care Service Corp., which runs Blue Cross plans in Texas and three other states. According to the latest survey by the AIS Report, a health-care newsletter, its chief executive was paid $5.8 million.

Despite the nonprofit status of their parent companies, the Pennsylvania Blues still pay substantial taxes, the firms point out.

Congress wiped out the federal tax exemption for Blues 25 years ago, although both Highmark and Independence do still get some breaks in state taxes.

According to the firms, Highmark enjoyed a state tax reduction of $80 million last year, based on its nonprofit status. Independence got a break of $9 million.

Even so, after the tax breaks, Highmark still paid a total of $240 million in taxes last year. IBC paid $170 million.

"Yet our competitors refer to us as though we have some extraordinarily privileged situation," Williams said.

On top of the taxes, the insurers note, they also put up a combined total of $205 million last year to subsidize health care for the poor and to pay for other charitable initiatives.

Nonetheless, U.S. Sen. Arlen Specter (R., Pa.) pushed Melani on the pay issue at a public hearing in April, shortly after the proposed deal was announced.

Specter asked Melani how he squared his compensation "in excess of $3 million . . . if nonprofit really has to have some significance in terms of not being for-profit."

Melani reddened.

Then he pointed out that Highmark serves 28 million people nationally, including the 4.6 million insured in Pennsylvania.

"So," Melani said, "if you were to charge our customers for my compensation . . . it would be about 10 cents per customer per year."