Lawyers and consultants for CareFirst BlueCross BlueShield are attacking as unfair a report criticizing the insurer's $119.6 million bonus-and-severance package to be given to executives if the company is sold.
The package - including $39.4 million for Chief Executive Officer William L. Jews - has been a key focus for critics as CareFirst seeks approval to convert to for-profit operation and to sell itself for $1.3 billion to WellPoint Health Networks Inc., a California insurer.
In pre-filed testimony, released yesterday and prepared for hearings next week before Insurance Commissioner Steven B. Larsen, the CareFirst lawyers and consultants respond to a report by Jay Angoff, a consultant to Larsen. Angoff wrote last month that the bonuses were excessive and illegal.
Gene E. Bauer, a managing director of the Hay Group Inc., the compensation consultant to CareFirst's board, calls Angoff's report "unsound and biased."
Jay Smith, a partner at the Baltimore law firm Piper Rudnick LLP who advised the board, said in a telephone news conference that Angoff's report "was not intended to be a fair and balanced review. We believe it was intended to advocate a position, to point out whatever problems an attorney could find and to second-guess the board after the fact."
Both Bauer and Smith said they couldn't speculate as to why Angoff had written a report they viewed as unfair.
Angoff, a Missouri lawyer and former insurance commissioner there, said yesterday that he could not comment because he had not seen the filings.
Angoff and the CareFirst consultants and lawyers are all expected to testify next week when Larsen holds three days of hearings reviewing the bonus packages, CareFirst's business case for conversion and whether $1.3 billion is a fair price. Larsen is expected to rule in February on whether the deal is in the public interest.
In other pre-filed testimony released yesterday, Gregory Sorensen, a managing director of Banc of America Securities Inc., which advised WellPoint on the deal, says his company "continues to believe that $1.3 billion is an appropriate valuation for CareFirst."
Another consultant to Larsen, the Blackstone Group, had reported in September that the price was too low, probably by hundreds of millions of dollars.
Most of the material released yesterday, however, was a detailed response to Angoff on the compensation issue.
The Maryland legislature passed a law this year designed to block the bonuses. The pre-filed testimony does not address whether the bonuses are legal currently.
"That's an issue that will still have to be considered by all of the parties, including the individuals who have the [executive compensation] contracts and the CareFirst board," Smith said.
Despite the 2002 law, the issue is important because one of the things Larsen will look at is whether the board acted properly in 2001 when it approved the merger bonuses.
In the pre-filed testimony, Bauer said the compensation were reasonable, and Smith and a Piper colleague, Mark Muedeking, defended the process used by CareFirst's board in approving the executive pay packages.
Also, Sheldon S. Cohen, a former commissioner of the Internal Revenue Service, filed written testimony saying Angoff had not used the proper legal standards in deciding whether the compensation was reasonable and legal.
Among the points at issue:
Merger bonuses. Angoff wrote that a $9.1 million merger-related bonus to the chief executive (part of $33.2 million to be paid to executives if the deal is completed) "serves only to enrich Jews." On the contrary, Bauer stated, the bonus plan "was developed to incent Mr. Jews and the executive vice presidents to obtain the highest price for CareFirst."
According to the testimony by Sorensen, WellPoint's investment banker, WellPoint made its $1.3 billion bid on April 24, 2001. The board discussed the bonus plan two days later, and approved it in July, yet the price did not increase.
"The fact that [a higher offer] didn't happen doesn't alter the fundamental principle," Smith said.
Muedeking added that the bonus plan was approved at a time when the board "didn't know if $1.3 billion was the last price," and, in any case, wanted to provide executives an incentive to keep the price up at a time when bidders could be backing out.
Angoff wrote that the bonuses, which would be paid by the acquirer, would reduce the price to be paid for CareFirst. That price, in turn, will go to health-related foundations.
Bauer countered, in his testimony, that Angoff misunderstood; since the bonus "provides an incentive to management to negotiate a higher price."
Annual bonuses. Angoff was critical of the way in which the board administered annual performance bonuses for executives. (Jews, for example, had a base pay of $904,333 last year, but got $1.8 million in incentives.)
Angoff said the performance targets were so low "that it virtually guarantees a substantial payout" - in 2000, executives qualified for bonuses if enrollment increased 0.3 percent and earnings equaled 50.6 percent of the prior year's.
Bauer said there could be "sound business reasons" for a lower target, such as a "major and costly investment" that would suppress income in the short term but pay off over a longer period, meaning "a break-even target may be proper and achieving such a target may demonstrate superb performance."
Comparisons used. Angoff criticized the board and compensation consultants for using large, for-profit companies, including ExxonMobil, Chase Manhattan and CBS, in comparison groups to judge levels of CareFirst compensation.
Bauer said the large companies were used in only limited ways, and that for-profit comparisons were reasonable, since CareFirst competes against for-profit insurers for business and for talent.
The board's process. Angoff said the board should have sought a written legal opinion on whether the bonuses were permitted.
Smith and Muedeking said in their testimony that they had attended meetings as the board considered alternatives and listened to advice from consultants, meeting its legal responsibility. "While no written opinion was provided, the board was so advised," they stated.
The legal standard. Angoff said the executive packages were illegal, in part, because they were not reasonable. As a guideline, he referred to an IRS standard that taxes as "excess parachutes" any severance pay above three times annual earnings.
Cohen, the former IRS chief, said in his testimony that the tax code "requires an inquiry into all of the relevant facts and circumstances surrounding the payment of such compensation. ... No single factor, such as characterizing a portion of an employee's compensation as an 'excess parachute payment,' would characterize the payment as unreasonable per se."
As long as the board has full discussion, consults experts and has no self-interest, Cohen said, compensation should be presumed to be reasonable.