Many defined-benefit pension plans in need of a workout
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Not many employees nationwide have the luxury of a defined-benefit pension plan anymore, but in healthcare, the opposite is true. Although many hospitals are rapidly making changes that limit access to pension plans for new hires, two years ago, almost all hospital retirement plans were of the defined-benefit variety, says James V. Morris, senior vice president of global institutional solutions with SEI Global Institutional Solutions in Oaks, PA. "In hospitals, more than two-thirds of the defined-benefit plans are still active and open to new hires, while about 22 percent are still open but closed to new hires."
Of course, while attitudes about the preference for defined-contribution plans over defined-benefit for healthcare is relatively new, hospitals must continue to fund and manage those plans for current employees and retirees.
Elizabeth Ward, chief financial officer at Moses Cone Health System in Greensboro, NC, figures her system's $168 million defined-benefit pension plan needs to survive and thrive for at least another 25 years, even though it was closed to new hires in 2002. An attempt to encourage employees to take a buyout and move to the new defined contribution plan in 2002 was largely unsuccessful. Only about 300 employees moved, "which was a little disappointing," she says. About 3,980 current and former employees are still in the plan, with 602 receiving benefits. That attempted solution still left the health system with huge costs to absorb.
Because of sub-par market returns, "in the past three to four years we've seen huge increases in pension costs and liabilities," she says, adding that Moses Cone's income statement funding liabilities for the plan rose steadily each year from 2002, when costs were $3 million, to $12.8 million in 2006. Because of the plan's previous dependence on safe fixed-income instruments, as interest rates moved down, her costs went up.
Those who must maintain pension plans face a two-pronged hit, says Morris. Because of the new accounting rules implemented in the Pension Protection Act of 2006, pension funds not only face increased volatility in the investment markets, but such funds are also less able to absorb subpar gains that they have traditionally expected to recoup with increased gains in subsequent years. So-called "smoothing" of returns is a less useful option under the new rules. "The smoothing period for how you value your assets and liabilities has been shortened," Morris says.
Ward, who worked with SEI to retool Moses Cone's pension plan, identified a two-pronged solution to the problem of increasing costs: matching the investment strategy with liability requirements, coupled with a one-time infusion of cash from the sale of a lab business. The cash infusion from the lab brought Moses Cone into compliance with strict new accounting rules Congress put in place with the Pension Protection Act. She was met with initial resistance from her board, so she spent about a year educating them, she says, about the need to manage the pension fund separately from the hospital system's investment fund, helping them understand that just getting a 10 percent return each year on the pension fund's money "was not going to work long-term," she says.
"I was putting a third of our margin in pension benefits," which was untenable, she says. "Now, we're trying to stabilize our costs at around $6 million to $7 million a year, which is one sixth of my margin."
In terms of investment mix, Moses Cone's asset allocation is fairly aggressively positioned, with stakes in equities and hedge funds along with some traditional fixed income to balance out the mix. The hospital is looking for a 15 percent to 16 percent return on its assets, Ward says.
While Ward says it was tough initially getting board buy-in for the new investment mix, the high funding costs needed to meet the act's provisions helped convince them. Putting it all in fixed income, she says, "would be safe but not prudent. We would pay for it down the road."
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