This article appears in the November issue of HealthLeaders magazine.
As hospitals and health systems try to protect their margins against declining reimbursements and soft patient volumes, many are looking at redesigning their traditional defined benefit pension plan as a way to cut costs. By offering a defined contribution plan instead—typically a 401(k) or 403(b)—hospitals can reduce their overall contribution to their retirement package and make their financial obligation predictable because it will no longer be vulnerable to market fluctuations.
Unlike a defined benefit plan where a predetermined benefit is payable to each retired employee, in a defined contribution plan the employer matches a set percentage of the amount each employee sets aside in an individual retirement account.
Corporate America and many state and local governments have already made the move to defined contribution retirement plans to a large extent. The healthcare industry has been slow to follow suit, but the tough economic conditions that most hospitals are facing appears to be changing that.
In April 2013, ratings firm Standard & Poor's released a report showing that many hospitals and health systems have underfunded defined benefit pension plans and blamed low discount rates (interest rates) as one of the major reasons. Although the S&P report is specific to nonprofits, all provider organizations are struggling with the same issue, and low discount rates have increased pension liabilities across the board.
Low discount rates are wreaking havoc because pension plans use the rate to determine the amount of an organization's liability, explains Liz Sweeney, S&P director and credit analyst and one of the report's lead authors.
"A defined benefit pension plan is essentially a promise to pay future benefits to people. It's a stream of future cash flow. … The lower the rate, the higher the liability," she says. "Discount rates have been dropping pretty dramatically in the past several years, so liabilities have been growing. Assets have been growing, too, but the liabilities have grown even faster than the assets. … When the liability exceeds the assets, we call that being underfunded. Over time, when a plan is underfunded, you are going to have to put more contributions into the plan."