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Funding Conundrum

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With most hospital pension plans underfunded these days, savvy finance leaders are applying new strategies to stay ahead of their growing liability.

Three pivotal events took place between 2006 and 2008 that upended hospital pension plans, leading to massive underfunding across the industry. It started with the Pension Protection Act of 2006, which mandated that defined benefit plans reach full funding over a seven-year phased-in period. This was followed the same year by accounting rule change FAS 158, which required a pension plan's unfunded or overfunded status to be reflected on the balance sheet as either a liability or an asset. The crowning blow was the dismal market returns of 2008.

As a result, most nonprofit hospital pension plans today are underfunded, say industry leaders. Prior to 2008, most hospital pension plans were funded at approximately 90%, says Chris Carabell, managing director, institutional retirement, philanthropy and investments with Bank of America Merrill Lynch in Charlotte, NC. Today, most are funded at between 70% and 80%.

CFOs react
"The triple impact of those three events caused not-for-profit providers to become much more concerned about the impact the plan has on the organization," says Carabell, noting that he has seen an uptick in hospitals looking for help with their pension plans. Carabell met recently with leaders at a hospital that had been nearly fully funded. "After 2008 and due to the accounting changes, the CFO is looking at the impact to his balance sheet, which will not only impact his credit rating but also could impact his debt covenant ratios, because now when you put a liability on the balance sheet, coverage ratios from the bond offering and the debt offering could become in peril," says Carabell.

Hospitals are exercising a variety of options, including pulling cash out of operations to fund pensions. Sacramento, CA-based Sutter Health, a nonprofit hospital system with 24 hospitals, for example, made the tough decision to move a big chunk of cash from operations into its defined benefit plan last November after a poor performance in the plan's investment portfolio.

While leaders maintained this was the right thing to do for employees, it led to a spanking from Moody's Investors Service, which downgraded the nonprofit system from AA- to A+ in May of this year. Moody analysts said that the move left Sutter Health's liquidity metrics too weak to maintain its AA- rating. Sutter Health officials were not available for an interview, but in a recorded statement, CFO Robert Reed said the organization's board "saw fit to invest an additional $505 million into the pension plan last year and that substantially was able to replace the losses that had occurred on the investment portfolio for the pension plan." While the organization's credit rating may have been downgraded, Sutter Health officials said funding the pension was the right thing to do in that it secured their employees' financial future. One could argue that such a move also increases morale and retention, which could translate into better bottom-line results.

Sutter Health's experience is not an anomaly in this new era of heightened risk and liability. Credit rating agencies are looking more closely at the funded status of the pension plan when evaluating the overall credit worthiness of the organization, says Carabell. "If the plan is significantly underfunded, it could potentially result in a lower credit rating. Also, if a hospital is putting significant money into the plan, the rating agencies look at that versus where else the money might be going," he says.

In Baton Rouge, LA, Our Lady of the Lake Regional Medical Center took a different path and chose to close its defined benefit pension plan to new entrants in June 2006, offering a 401a plan in its place. Even so, Robert Ramsey, chief financial officer, says the Catholic medical center, with 630 staffed beds, is still dealing with underfunding issues. "Our pension expense is projected to increase next year, partly because of the investment performance of the last couple of years."

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