For hospitals that still offer pension plans, CFOs have a lot of pressure to manage them. They represent the culmination of an employee's dedicated work to the organization and a much sought-after retirement.
However, like most things in life needing management, it is not always easy. Sheldon Gamzon, principal at PricewaterhouseCoopers, says there are four inherent risks to any retirement program: investment risk, interest rate risk (as interest rates go down, liabilities and costs go up), inflation risk and longevity risk (as people live longer, pensions pay annuities longer). "But the two 600-pound gorillas to be managed are investment and interest rate risks," Mr. Gamzon says. "It's been very difficult for employers to manage and has resulted in many plans being frozen or closed."
Mr. Gamzon and Michael Rosenbaum, JD, partner at Drinker Biddle & Reath, explain five key components that should be a part of any hospital's pension management plan.
1. Intimately understand all fiduciary obligations. The two most popular types of retirement programs are defined contribution and defined benefit plans. Defined contribution plans are those in which employers contribute money to the employees' accounts, but the employees assume the investment risk and reward (a 403(b) plan is a common type of defined contribution plans). Defined benefit plans are those in which a benefit is promised at a future date, and the employer is responsible for both contributing and investing the funds, though bad investments do not impact the benefits provided to plan participants.
Hospital board members, CFOs and all other committees that decide to manage the pension programs must understand their fiduciary obligations to their specific plans, Mr. Rosenbaum says. Retirement plans are generally subject to the Employee Retirement Income Security Act, which has specific fiduciary duty rules that must be followed. Mr. Rosenbaum says an individual fiduciary could be personally liable for any losses in a retirement program resulting from a fiduciary breach of duty. These duties commonly include: establishing an investment policy; selecting, monitoring and/or replacing any service provider or investment option under the plan; interpreting and applying any provision of the plan; and determining when benefits are payable under the plan.
2. Delegate fiduciary liability risk away from the board of directors. After a hospital familiarizes itself with the financial duties and revisits its pension plan goals, a hospital has to make sure the actual handling of the plans is in the right hands. Some hospitals may decide that the board of directors should oversee the functionality of a pension plan, but Mr. Rosenbaum says that it may make sense for this responsibility to be delegated elsewhere. Instead, the task should be assigned to a more specific and actively involved financial committee within the hospital.
"A best practice with pension plans is to say, 'Let's get that personal fiduciary liability away from the people who don't have time to do the job right,'" Mr. Rosenbaum says. "Let's delegate that and get it away from the board committee. They should be focusing on strategy and the business plan, not necessarily spending a lot of time on retirement issues."
Typically, this financial or pension benefits committee will have less than eight people. People that should be on the committee include the hospital CFO, several people from human resources and legal and those who represent the employees, such as physicians, nurses and others.
3. Jumping to a defined contribution plan is not a panacea. Hospitals and other organizations may have a hard time dealing with a defined benefit plan due to the large amount of risk, but Mr. Gamzon says hospitals should not automatically assume the answer is a defined contribution plan. Defined contribution plans hold far less risk for hospitals, but they are much more inefficient. "Defined contribution plans are about 40 percent less efficient, which means it either costs the employer 40 percent more to have them or employees get 40 percent less in benefits," Mr. Gamzon says. "In addition, while reducing employer risk sounds good, the problem is that we have transferred the risk to the employee, who is far less capable of managing the risks."
Defined benefit plans are more efficient because employers can hire professional managers who are focused on the long term and are spreading the risk of a larger and continuing employee population. Employees typically are more conservative in their investments, attempt to time the market and usually "buy high and sell low," Mr. Gamzon says. "The cost is between 1 percent and 1.5 percent of lost return," he adds.
4. Consider alternative pension plans outside of defined benefit and defined contribution. Hospitals that want to offer a pension plan are not constricted to defined benefit and defined contribution plans. Mr. Gamzon says there are two other options that can be more effective: cash balance and Pension Preservation Plus.
Cash balance plans are a hybrid between defined benefit and defined contribution plans. The employer takes the responsibility and risk for managing investments and guarantees the employee a fixed interest credit like a defined benefit plan, but many of the other risks remain with the employee like a defined contribution plan. "It has the same level of efficiency as a traditional defined benefit plan, and this design has been popular in the private sector since the early 1990s," Mr. Gamzon says.
Pension Preservation Plus, a program developed by PwC, is similar to a cash balance plan in that there are annual pay credits and fixed interest credits. However, the interest credits go into a defined contribution plan as a discretionary employer contribution and are managed by the employee. Mr. Gamzon says cash balance plans have both the pay credits and interest credits of a defined benefit plan with all the investment risk with the employer, but in PPP, the investment risks are shared. "The thing that raises costs of defined benefit plans is you have to fund everything in advance," Mr. Gamzon says. "You have to anticipate in advance the aging process and the interest credits. In the PPP, you avoid that."
Typically, about 50 to 60 percent of the benefit is guaranteed to the employee. PPP plans provide a safety net for employees, but it is not quite as secure as a defined benefit plan, Mr. Gamzon says.
5. Look at pension plans as promises. Mr. Gamzon says employers, such as hospitals, have traditionally tried to see how quickly plan assets can grow with big-risk, big-return investments. If they were successful, they received the benefits of lower expense and improved profitability. However, if the financial collapse of 2008 has proven anything, it's that hospitals and other organizations need to be prudent with their pension plans. "If you want to manage pension plans, you can't look at them as a profit center anymore," Mr. Gamzon says. "Look at it as a promise you made to employees."
"How can I take care of this promise in the least volatile manner? If you approach investing plans in that way, you can significantly reduce investment risk and interest rate risk and lower costs at the same time," he adds.
However, like most things in life needing management, it is not always easy. Sheldon Gamzon, principal at PricewaterhouseCoopers, says there are four inherent risks to any retirement program: investment risk, interest rate risk (as interest rates go down, liabilities and costs go up), inflation risk and longevity risk (as people live longer, pensions pay annuities longer). "But the two 600-pound gorillas to be managed are investment and interest rate risks," Mr. Gamzon says. "It's been very difficult for employers to manage and has resulted in many plans being frozen or closed."
Mr. Gamzon and Michael Rosenbaum, JD, partner at Drinker Biddle & Reath, explain five key components that should be a part of any hospital's pension management plan.
1. Intimately understand all fiduciary obligations. The two most popular types of retirement programs are defined contribution and defined benefit plans. Defined contribution plans are those in which employers contribute money to the employees' accounts, but the employees assume the investment risk and reward (a 403(b) plan is a common type of defined contribution plans). Defined benefit plans are those in which a benefit is promised at a future date, and the employer is responsible for both contributing and investing the funds, though bad investments do not impact the benefits provided to plan participants.
Hospital board members, CFOs and all other committees that decide to manage the pension programs must understand their fiduciary obligations to their specific plans, Mr. Rosenbaum says. Retirement plans are generally subject to the Employee Retirement Income Security Act, which has specific fiduciary duty rules that must be followed. Mr. Rosenbaum says an individual fiduciary could be personally liable for any losses in a retirement program resulting from a fiduciary breach of duty. These duties commonly include: establishing an investment policy; selecting, monitoring and/or replacing any service provider or investment option under the plan; interpreting and applying any provision of the plan; and determining when benefits are payable under the plan.
2. Delegate fiduciary liability risk away from the board of directors. After a hospital familiarizes itself with the financial duties and revisits its pension plan goals, a hospital has to make sure the actual handling of the plans is in the right hands. Some hospitals may decide that the board of directors should oversee the functionality of a pension plan, but Mr. Rosenbaum says that it may make sense for this responsibility to be delegated elsewhere. Instead, the task should be assigned to a more specific and actively involved financial committee within the hospital.
"A best practice with pension plans is to say, 'Let's get that personal fiduciary liability away from the people who don't have time to do the job right,'" Mr. Rosenbaum says. "Let's delegate that and get it away from the board committee. They should be focusing on strategy and the business plan, not necessarily spending a lot of time on retirement issues."
Typically, this financial or pension benefits committee will have less than eight people. People that should be on the committee include the hospital CFO, several people from human resources and legal and those who represent the employees, such as physicians, nurses and others.
3. Jumping to a defined contribution plan is not a panacea. Hospitals and other organizations may have a hard time dealing with a defined benefit plan due to the large amount of risk, but Mr. Gamzon says hospitals should not automatically assume the answer is a defined contribution plan. Defined contribution plans hold far less risk for hospitals, but they are much more inefficient. "Defined contribution plans are about 40 percent less efficient, which means it either costs the employer 40 percent more to have them or employees get 40 percent less in benefits," Mr. Gamzon says. "In addition, while reducing employer risk sounds good, the problem is that we have transferred the risk to the employee, who is far less capable of managing the risks."
Defined benefit plans are more efficient because employers can hire professional managers who are focused on the long term and are spreading the risk of a larger and continuing employee population. Employees typically are more conservative in their investments, attempt to time the market and usually "buy high and sell low," Mr. Gamzon says. "The cost is between 1 percent and 1.5 percent of lost return," he adds.
4. Consider alternative pension plans outside of defined benefit and defined contribution. Hospitals that want to offer a pension plan are not constricted to defined benefit and defined contribution plans. Mr. Gamzon says there are two other options that can be more effective: cash balance and Pension Preservation Plus.
Cash balance plans are a hybrid between defined benefit and defined contribution plans. The employer takes the responsibility and risk for managing investments and guarantees the employee a fixed interest credit like a defined benefit plan, but many of the other risks remain with the employee like a defined contribution plan. "It has the same level of efficiency as a traditional defined benefit plan, and this design has been popular in the private sector since the early 1990s," Mr. Gamzon says.
Pension Preservation Plus, a program developed by PwC, is similar to a cash balance plan in that there are annual pay credits and fixed interest credits. However, the interest credits go into a defined contribution plan as a discretionary employer contribution and are managed by the employee. Mr. Gamzon says cash balance plans have both the pay credits and interest credits of a defined benefit plan with all the investment risk with the employer, but in PPP, the investment risks are shared. "The thing that raises costs of defined benefit plans is you have to fund everything in advance," Mr. Gamzon says. "You have to anticipate in advance the aging process and the interest credits. In the PPP, you avoid that."
Typically, about 50 to 60 percent of the benefit is guaranteed to the employee. PPP plans provide a safety net for employees, but it is not quite as secure as a defined benefit plan, Mr. Gamzon says.
5. Look at pension plans as promises. Mr. Gamzon says employers, such as hospitals, have traditionally tried to see how quickly plan assets can grow with big-risk, big-return investments. If they were successful, they received the benefits of lower expense and improved profitability. However, if the financial collapse of 2008 has proven anything, it's that hospitals and other organizations need to be prudent with their pension plans. "If you want to manage pension plans, you can't look at them as a profit center anymore," Mr. Gamzon says. "Look at it as a promise you made to employees."
"How can I take care of this promise in the least volatile manner? If you approach investing plans in that way, you can significantly reduce investment risk and interest rate risk and lower costs at the same time," he adds.
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