Are Defined Benefits Plans on Endangered List?

John Commins, April 12, 2010

For decades, not-for-profit hospitals and health systems have used defined benefits pension plans as a recruiting tool to attract quality staff, and as a means of fulfilling their stewardship role with their employees and the communities where they live.

A new report from Standard & Poor's Rating Services, Pension Funding Woes Escalate for U.S. Not-for-Profit Hospitals and Health Systems, shows that those defined-benefits plans may come under increased financial pressure in the coming years, as hospitals adjust to softer patient volumes and lower cash reserves.

"A lot of hospitals are very concerned about it because they are starting to see the volatility that you can experience with a defined benefit plan, compared with a defined contribution plan," says S&P analyst Liz Sweeney. "They are seeing that more clearly now because of what happened in the investment markets in the last 18 months."

Unlike most other sector of the economy, Sweeney says nearly all of the 615 not-for-profit hospitals and health systems that S&P speaks with offer their employees defined benefits plans. "We only identified 40 that have defined contribution only, so the vast majority are doing defined benefit plans still," she says. "Some of those plans were frozen years ago and are essentially in run off now. But they are still out there. I've been surprised through all this recessionary pressure and what happened in the investment market that more hospitals haven't abandoned their defined benefits pensions, but most of them are sticking with it."

Nevertheless, Sweeney says many hospitals also are reassessing pension plan designs and figuring out if they should make changes. "Whether that is a one-year freeze in benefit accruals or a total freeze, or do they stop allowing new employees in the defined benefits plans?" Sweeney says. "Most of them have stuck with their plans but they are all examining it and making their individual decisions."

The recession has hammered pension funds. Funding status for defined benefits plans of not-for-profit hospitals and health systems in S&P's sample fell to a median 68.6% in fiscal 2009, from 82.9% in fiscal 2008 and 90.4% in fiscal 2007. (To find that median, S&P divides the market value of a health system's assets by the projected benefit obligation, which includes actuarial calculations about length of employee service, salaries, raises, turnover, age at retirement, etc. S&P then calculates the plan sponsor's discount rate for the liability back to the present.)

Sweeney says those valuations--based on audited financial statements from June 2009–will likely improve with the economy. "The majority of the December year-ends have not completed their audits. So we expect to see a rebound as we start to see those late 2009 audits and the fiscal 2010 audits," she says. "We do think the valuations have already rebounded. You won't see them in our numbers yet, but we think they already have to some extent. We clearly aren't back to peak level, and everybody understands that."

S&P doesn't believe fluctuations in the value of pension plans significantly impact credit ratings. "It's a long-term obligation so in a lot of cases it's a drop in the bucket," Sweeney says. "The net periodic benefit cost for these plans, our median showed, was 1.1% of total expenses for a sample of 250 hospitals."

Using that 1.1% median, if a hospital's pension costs went up 20%, that would still represent only 1.3% of total expenses, Sweeney says. That's not a big number, and it probably explains why not-for-profit hospitals and health systems are sticking with defined benefits pensions.

But, it is one more cost to worry about, and Sweeney predicts a gradual move away from defined benefits. "You will see more freezes where hospitals will say: ‘No new entrants to the plan. Anyone hired after today goes into a defined contribution plan,'" she says. "We will see hospitals looking more at their asset allocations for the plans, trying to reduce volatility."

Readers, I've got a few questions for you. What adjustments, if any, have you made to your defined benefits plans to account for the recession? How important is the defined benefits plan for recruiting and retaining quality staff? Will your hospital move away from defined benefits plans and into defined contribution plans? Why are defined benefits plans so deeply entrenched with not-for-profit hospitals when they've been phased out in most other sectors of the economy?

Drop me a note. Let's talk.

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John Commins

John Commins is a senior editor at HealthLeaders Media.

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