After the economic collapse of 2008, the word "pension" became a somewhat frightening term. Many individuals had lost significant portions of theirs, and many organizations that still had successful pension plans — including hospitals and health systems — realized it was becoming harder to deal with future liabilities.
Pension plan strategies have evolved even more rapidly within the past year. Sheldon Gamzon, principal at PricewaterhouseCoopers who has dealt with the pension plans of several hospitals and health systems, said last year, hospitals planned on remaining committed to their pension structure because traditional pensions were so important to their culture and, more importantly, their employees, nurses and unions. However, unfunded pension liabilities have been killing balance sheets.
For example, Mr. Gamzon worked with a hospital client on a monthly pension obligation report this past July. In one month, the large hospital lost $60 million on its balance sheet. That is not a final figure for the hospital and only a month-long snapshot, but it showed the magnitude of the problem.
"Picture yourself as a hospital CFO who is trying to manage everything else — the Affordable Care Act, other issues around healthcare reform — and here, out of the blue, an actuary says, 'By the way, you don't have to file this right now, but you just lost $60 million on something that you have no control over whatsoever,'" Mr. Gamzon says. "You have no control over interest rates. If that had been a fiscal year ending July 31, that would have been a $60 million loss."
When a hospital's pension liabilities and debt obligations become too high, its credit rating suffers, too. That's why hospital CFOs and executive management teams are looking at new strategies.
"Even though employers made those types of statements a year ago, the interest rates have fallen so much and unfunded liabilities are so high at this point that there is no sign in the future we're going to get a meaningful improvement," Mr. Gamzon says. "Now, hospitals are willing to do things now they weren't willing to consider a year ago."
"That's why CFOs basically have said, 'I understand the value of traditional [defined benefit] pension plans — it's good for retention, and it's an important part of our recruitment — but what does it matter if I don't have a hospital?'" Mr. Gamzon added. "What if I can't go into market and borrow money?"
In light of the volatile U.S. economy and growing concern over how to manage pensions, here are three dominant pension strategies that hospitals and health systems, in particular, are gravitating toward.
1. Freeze the defined benefit plan and move to a defined contribution plan. There are two main types of retirement programs: defined contribution and defined benefit plans. DC plans are those in which hospitals contribute money to the employees' accounts, but the employees assume the investment risk and reward (403(b) plans and 401(k) plans are common types of defined contribution plans). DB plans — which traditional pensions fall under — are those in which a benefit is promised at a future date, and the hospital is responsible for both contributing and investing the funds. However, bad investments do not impact the benefits provided to plan participants.
Lisa Goldstein, an associate managing director at Moody's Investors Service and an author of several reports on non-profit hospitals, says roughly 68 percent of the agency's rated non-profit hospitals still maintain DB plans. That number is on the decline, though. She says the top overall pension strategy that hospital and health systems are employing right now is to freeze the DB plan and move to a DC plan.
"Hospitals can say all new employees as of a certain date will go into DC plans, or they can freeze current DB plans and put everyone into DC," Ms. Goldstein says.
Tim Jodway, CFO of Garden City (Mich.) Hospital, can attest to that trend, as the 323-bed, 1,000-employee hospital froze its DB plans several years ago. '"Our [DB] plans have been frozen for at least five years, but it still requires funding every year, so that is a cash drain," Mr. Jodway says. "But going forward, we have a DC plan. That's our main vehicle."
A recent study from the American Hospital Association and retirement plan firm Diversified also showed that DC plans at hospitals are at a 10-year high. Roughly 73 percent of employees that work at hospitals or health systems participate in a 403(b) DC plan, the highest level in the past decade. The survey, which looked at 180 hospitals and health systems, also found that most hospitals that still offer DB plans have frozen the plans to either new employees or all employees.
The primary reason hospitals are freezing DB plans is because interest rates in the markets have been historically low, as Mr. Gamzon mentioned. Low interest rates coupled with overall investment losses are spelling panic since hospitals are obligated to pay DB employees their pensions regardless of the hospitals' own financial instability.
"I think what has really affected hospitals and health systems this past year is the decline in interest rates," says Jim Grigg, CPA, partner and national healthcare assurance practice leader at Crowe Horwath LLP. "Actuaries are determining the accumulated value of future benefits, and an important driver in this calculation is the discount rate assumption. This actuarially determined liability increases as the discount rate — interest rate — declines. That resulted in many hospitals taking a significant charge to earnings or net assets in the case of a non-profit hospital."
"That's the biggest issue with DB pension plans," Mr. Grigg adds. "They are so unpredictable as to the effect each year on financial performance because of the uncertainty related to interest rates and returns on investments. If you're a hospital with a DB plan, your credit rating is probably going to be adversely affected."
2. Fund more than what's required. Although DB plans are turning into a wardrobe few want to wear, several hospitals and health systems still have DB plans. "Nobody is really starting DB plans now," admits Martin Arrick, managing director at Standard & Poor's Ratings Services. "However, if you have DB plans, a lot of folks aren't giving up on them. They can keep them around, but it's tricky."
For example, in May, Moody's affirmed the Aa2 credit rating of Boston Children's Hospital, saying its DB plans are "relatively well-funded" with only $30.9 million in unfunded pension liabilities at the end of fiscal year 2011. Duke University Health System also has been cited as having a very stable and manageable DB plan, according to Moody's.
What's the secret to DB pension success? Ms. Goldstein says there is no silver bullet, but larger organizations with more capital and liquidity that can afford to increase their annual pension contributions usually are able to keep a strong DB plan around.
"There's no magic potion to fund a pension," Ms. Goldstein says. "We engage management to look at long-term strategies to begin finding a reasonable way to fund pension liabilities. Some hospitals are funding above their required level to get ahead and to help manage those long-term liabilities."
3. Consider alternative pension structures. DB and DC pension plans grab a lion's share of the attention, but hospitals do not have to box themselves into those corners.
Mr. Gamzon says there are two other lesser-known pension plans that hospitals could potentially consider: cash balance and Pension Preservation Plus. Cash balance plans are a hybrid between DB and DC plans. The hospital takes the responsibility and risk for managing investments and guarantees the employee a fixed interest credit like a DB plan, but many of the other risks remain with the employee like a DC plan. 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 DC 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 DB plan with all the investment risk on the hospital, but in PPP, the investment risks are shared.
Regardless of what route a hospital or health system takes with its pension plan structure, the executive team must do one thing above all else: communicate clearly to those who are affected most. Staff members, nurses and all other hospital employees depend on pension plans for their retirement. When changes to pensions are made, it can be a sensitive matter. However, receiving input from all stakeholders and being receptive to multiple perspectives will help hospital executives make the right pension decisions for their individual organizations.
"There's a lot of communication that goes on between management and employees regarding pensions," Ms. Goldstein says. "This is not an email blast. There should be face-to-face town hall meetings so management and [human resources] can explain what's going to happen, how it works and the rationale. A lot of communication is very effective."
Pension plan strategies have evolved even more rapidly within the past year. Sheldon Gamzon, principal at PricewaterhouseCoopers who has dealt with the pension plans of several hospitals and health systems, said last year, hospitals planned on remaining committed to their pension structure because traditional pensions were so important to their culture and, more importantly, their employees, nurses and unions. However, unfunded pension liabilities have been killing balance sheets.
For example, Mr. Gamzon worked with a hospital client on a monthly pension obligation report this past July. In one month, the large hospital lost $60 million on its balance sheet. That is not a final figure for the hospital and only a month-long snapshot, but it showed the magnitude of the problem.
"Picture yourself as a hospital CFO who is trying to manage everything else — the Affordable Care Act, other issues around healthcare reform — and here, out of the blue, an actuary says, 'By the way, you don't have to file this right now, but you just lost $60 million on something that you have no control over whatsoever,'" Mr. Gamzon says. "You have no control over interest rates. If that had been a fiscal year ending July 31, that would have been a $60 million loss."
When a hospital's pension liabilities and debt obligations become too high, its credit rating suffers, too. That's why hospital CFOs and executive management teams are looking at new strategies.
"Even though employers made those types of statements a year ago, the interest rates have fallen so much and unfunded liabilities are so high at this point that there is no sign in the future we're going to get a meaningful improvement," Mr. Gamzon says. "Now, hospitals are willing to do things now they weren't willing to consider a year ago."
"That's why CFOs basically have said, 'I understand the value of traditional [defined benefit] pension plans — it's good for retention, and it's an important part of our recruitment — but what does it matter if I don't have a hospital?'" Mr. Gamzon added. "What if I can't go into market and borrow money?"
In light of the volatile U.S. economy and growing concern over how to manage pensions, here are three dominant pension strategies that hospitals and health systems, in particular, are gravitating toward.
1. Freeze the defined benefit plan and move to a defined contribution plan. There are two main types of retirement programs: defined contribution and defined benefit plans. DC plans are those in which hospitals contribute money to the employees' accounts, but the employees assume the investment risk and reward (403(b) plans and 401(k) plans are common types of defined contribution plans). DB plans — which traditional pensions fall under — are those in which a benefit is promised at a future date, and the hospital is responsible for both contributing and investing the funds. However, bad investments do not impact the benefits provided to plan participants.
Lisa Goldstein, an associate managing director at Moody's Investors Service and an author of several reports on non-profit hospitals, says roughly 68 percent of the agency's rated non-profit hospitals still maintain DB plans. That number is on the decline, though. She says the top overall pension strategy that hospital and health systems are employing right now is to freeze the DB plan and move to a DC plan.
"Hospitals can say all new employees as of a certain date will go into DC plans, or they can freeze current DB plans and put everyone into DC," Ms. Goldstein says.
Tim Jodway, CFO of Garden City (Mich.) Hospital, can attest to that trend, as the 323-bed, 1,000-employee hospital froze its DB plans several years ago. '"Our [DB] plans have been frozen for at least five years, but it still requires funding every year, so that is a cash drain," Mr. Jodway says. "But going forward, we have a DC plan. That's our main vehicle."
A recent study from the American Hospital Association and retirement plan firm Diversified also showed that DC plans at hospitals are at a 10-year high. Roughly 73 percent of employees that work at hospitals or health systems participate in a 403(b) DC plan, the highest level in the past decade. The survey, which looked at 180 hospitals and health systems, also found that most hospitals that still offer DB plans have frozen the plans to either new employees or all employees.
The primary reason hospitals are freezing DB plans is because interest rates in the markets have been historically low, as Mr. Gamzon mentioned. Low interest rates coupled with overall investment losses are spelling panic since hospitals are obligated to pay DB employees their pensions regardless of the hospitals' own financial instability.
"I think what has really affected hospitals and health systems this past year is the decline in interest rates," says Jim Grigg, CPA, partner and national healthcare assurance practice leader at Crowe Horwath LLP. "Actuaries are determining the accumulated value of future benefits, and an important driver in this calculation is the discount rate assumption. This actuarially determined liability increases as the discount rate — interest rate — declines. That resulted in many hospitals taking a significant charge to earnings or net assets in the case of a non-profit hospital."
"That's the biggest issue with DB pension plans," Mr. Grigg adds. "They are so unpredictable as to the effect each year on financial performance because of the uncertainty related to interest rates and returns on investments. If you're a hospital with a DB plan, your credit rating is probably going to be adversely affected."
2. Fund more than what's required. Although DB plans are turning into a wardrobe few want to wear, several hospitals and health systems still have DB plans. "Nobody is really starting DB plans now," admits Martin Arrick, managing director at Standard & Poor's Ratings Services. "However, if you have DB plans, a lot of folks aren't giving up on them. They can keep them around, but it's tricky."
For example, in May, Moody's affirmed the Aa2 credit rating of Boston Children's Hospital, saying its DB plans are "relatively well-funded" with only $30.9 million in unfunded pension liabilities at the end of fiscal year 2011. Duke University Health System also has been cited as having a very stable and manageable DB plan, according to Moody's.
What's the secret to DB pension success? Ms. Goldstein says there is no silver bullet, but larger organizations with more capital and liquidity that can afford to increase their annual pension contributions usually are able to keep a strong DB plan around.
"There's no magic potion to fund a pension," Ms. Goldstein says. "We engage management to look at long-term strategies to begin finding a reasonable way to fund pension liabilities. Some hospitals are funding above their required level to get ahead and to help manage those long-term liabilities."
3. Consider alternative pension structures. DB and DC pension plans grab a lion's share of the attention, but hospitals do not have to box themselves into those corners.
Mr. Gamzon says there are two other lesser-known pension plans that hospitals could potentially consider: cash balance and Pension Preservation Plus. Cash balance plans are a hybrid between DB and DC plans. The hospital takes the responsibility and risk for managing investments and guarantees the employee a fixed interest credit like a DB plan, but many of the other risks remain with the employee like a DC plan. 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 DC 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 DB plan with all the investment risk on the hospital, but in PPP, the investment risks are shared.
Regardless of what route a hospital or health system takes with its pension plan structure, the executive team must do one thing above all else: communicate clearly to those who are affected most. Staff members, nurses and all other hospital employees depend on pension plans for their retirement. When changes to pensions are made, it can be a sensitive matter. However, receiving input from all stakeholders and being receptive to multiple perspectives will help hospital executives make the right pension decisions for their individual organizations.
"There's a lot of communication that goes on between management and employees regarding pensions," Ms. Goldstein says. "This is not an email blast. There should be face-to-face town hall meetings so management and [human resources] can explain what's going to happen, how it works and the rationale. A lot of communication is very effective."
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