After swallowing rising costs for labor, malpractice insurance and supplies, hospitals are facing another new expense: pension deficits.
After years of "funding holidays" in which hospitals and healthcare systems significantly reduced or eliminated annual payments to their defined-benefit retirement plans because of strong investment returns that inflated pension fund assets, the situation has been reversed.
On average, not-for-profit hospital pension funds lost more than 6% last year, according to Commonfund, which released its first report on hospital investment returns this year. In addition, a drop in the discount rate used to calculate future benefits has caused funding requirements to rise.
Sixty-eight percent of hospital systems and 51% of stand-alone hospitals offer defined-benefit pension plans, according to a survey published this year by the American Hospital Association and CCM Advisors.
"It's a double whammy," said Kim McCarthy, director of financial reporting at 45-hospital Trinity Health, Novi, Mich., which saw the funding level for its accumulated benefit obligation fall to 77% this year, down from 143% when the system was founded in 2000. The accumulated benefit obligation measures benefits that have already been earned by employees.
Unlike for-profit companies, which can soften the blow by deducting pension contributions from their taxable earnings, not-for-profit hospitals lack that financial cushion.
The AHA has joined a coalition of employers that hopes to pass federal pension-reform legislation by Dec. 31, when a temporary fix expires. The group endorses a bill passed by the House and pending in the Senate that would ease corporate pension funding requirements for two years by tying benefit calculations to higher long-term corporate bond rates.
The current benchmark, the 30-year U.S. Treasury bond rate, has dipped so low that many employers have threatened to freeze their pension plans if Congress does not act. The Senate is expected to take up the issue when it reconvenes this week.
The current pension funding requirement "is drawing needed cash resources out of hospitals and it's unnecessary because it's based on an artificial measure," said AHA lobbyist Michael Rock.
Trinity is paying $158 million, the equivalent of 12 days of the system's operating cash, to fund its pension plan in fiscal 2004 and is budgeting to pay a similar amount for fiscal 2005. By comparison, it paid $108 million in fiscal 2003, ended June 30, $32 million in 2002, nothing in 2001 and $35 million in 2000.
"It's 12 days of cash that we could be spending on something else, or that we would hold on our corporate balance sheet in investments," McCarthy said of this year's expenditure.
This year's payment exceeds requirements of the federal Employee Retirement Income Security Act, which sets standards for the funding of pension plans, McCarthy said. She said Trinity wants to bolster its pension assets in order to smooth out future annual contributions. As a religious organization, Trinity technically is exempt from ERISA but chooses to abide by its funding rules. About half of the expenditure is meant to bolster the fund in case of future down cycles.
Because of the little-known ERISA exemption, workers at religiously affiliated hospitals and systems have fewer federal legal protections for their pension benefits. While such cases are rare, employees of one church-sponsored system went to court to recover assets after the system closed.
Last week a judge in Pittsburgh approved a settlement agreement between the defunct St. Francis Health System and its creditors that included $13 million for the system's pension fund. A class-action lawsuit filed on behalf of approximately 3,000 vested pension plan participants claimed the plan was underfunded by as much as $34 million, because of investment losses. The fund's total assets stand at about $49 million.
As a church-sponsored plan, it was exempt from ERISA funding and insurance requirements, beneficiaries' attorney Joseph Kravec Jr. said. He said St. Francis ceased paying premiums to insure its pension fund in 1994. The system closed in September 2002.
Attorneys for St. Francis and its employees disagreed over whether St. Francis guaranteed to employees while it was operating that pension benefits would be paid. As unsecured creditors, pension beneficiaries generally fall on the bottom rung of claimants. But Allegheny County Judge Frank Lucchino, who ruled on the agreement, was sympathetic to the employees.
"He appreciated that there were many people who had worked 20 or 30 years and were counting on monthly benefits at the time of their retirement," Kravec said.
Kravec said even church-sponsored plans should be guaranteed under the law. Exceptions "cause surprise and shock when a company becomes insolvent," he said.
This year and next, most hospitals and systems are expected to make significant infusions to fill deficits in their pension funds. Often, these liabilities consume big chunks of operating cash. Although pension deficits are expected to be temporary, analysts are concerned that the pension liabilities are diverting cash from capital projects such as new clinics and technology purchases, which fuel growth.
For example, St. Louis-based Ascension Health used $607.3 million of cash from its hospitals' operations to fund its pension liability in the fiscal year ended June 30, compared with just $34.8 million the year before, according to its latest financial statement. That item exceeded Ascension's annual net income ($215 million), as well as growing expenses such as indigent care ($538 million) and bad debt ($496 million).
Ascension, the nation's largest not-for-profit system, had operating revenue of $9 billion. Ascension officials declined to comment.
For a minority of hospitals and healthcare systems, pension deficits are contributing to credit erosion. Pension shortfalls factored into four of the 13 not-for-profit hospital and system downgrades that Moody's Investors Service issued during the third quarter. They are Tallahassee (Fla.) Memorial HealthCare; St. Barnabas Health Care System, West Orange, N.J.; University Hospitals Health System, Cleveland; and University Medical Center at Princeton (N.J.).
Still, pension funding is usually a secondary financial issue. "We have yet to see pension funding in itself cause a disaster for any hospital. It's thrown in there with other issues," said Fred Martucci, a managing director at Fitch Ratings.
Analysts say they are asking more questions this year about pension fund status, a topic they barely broached in the past. Moody's, which rates about 550 hospitals and systems, has begun to collect data on pension funding status and annual hospital contributions to pension funds, and may include the data in its next annual report on industry ratios.
But even analysts do some guesswork because hospitals' financial statements don't always include complete pension fund data, said Kay Sifferman, a senior credit officer at Moody's. She said most hospitals and systems report their projected benefit obligation, which includes future benefits that employees are expected to accumulate, rather than the more accurate accumulated benefit obligation, which includes only benefits that have accrued.
Sifferman said hospitals are expected to continue to make sizable pension fund contributions in 2004, but those will taper off if investment portfolios continue their current rebound.
Hospitals aren't alone. According to human resources consulting firm Watson Wyatt Worldwide, record low interest rates, stock market declines and corporate operating losses have combined to create the "worst environment for pension plan funding" since the passage of ERISA in 1974.
According to a Watson Wyatt analysis released in October, the percentage of fully funded corporate pension plans dropped to 37% this year, compared with 84% in 1998. Of the nation's 1,000 largest companies, nearly two-thirds have an underfunded pension plan, the firm said.
Individually, some hospitals with financial problems have sought more direct relief in the form of federal waivers. Detroit Medical Center, which is attempting to turn around a severe operating deficit, applied to the Internal Revenue Service in August to defer part of its 2004 funding requirement over a five-year period. If granted, the waiver would lower DMC's pension expense next year from about $27 million to about $14 million, preserving much-needed cash, said Chief Financial Officer Chris Palazzolo. He said the public system expects an answer from the agency by January 2004.
To stabilize its funding requirements, the DMC also froze the plan during 2003 so that employees received credit for a year's service but accumulated no new benefits for the year, and lowered future benefits by more than half, Palazzolo said.
The good news is that these extraordinary pension expenses are expected to disappear in 2005 and beyond, providing the stock market continues its recent turnaround. But a lingering effect could be that more hospitals and systems will suspend their defined-benefit pension plans, leaving employees with defined contribution plans such as the 401(k) and 403(b). Unlike defined benefit plans, defined contribution plans have predictable funding requirements for employers and shift investment risk to workers.
The percentage of hospital systems offering defined-benefit pension plans has slipped to 68% from 87% in 1997, according to the AHA-CCM survey, which includes all ownership categories. The percentage of hospitals offering defined benefit plans similarly dropped during that period to 51% from 72%, according to the survey.
Meanwhile, 401(k) plans have spread to 57% of systems and 41% of hospitals, versus 26% of systems and 19% of hospitals in 1997. The Taxpayer Relief Act of 1997 allowed not-for-profits to offer 401(k) plans. Only 36% of systems and 38% of hospitals offer 403(b) plans, down from 100% of systems and 90% of hospitals in 1997. Unlike the 401(k), 403(b) participants cannot invest in individual stocks.
Defined contribution plans already are the sole retirement option at most major investor-owned hospital companies, including HCA, Health Management Associates and Triad Hospitals.
Palazzolo said the DMC probably will switch to a defined contribution plan after it stabilizes its finances, following other hospitals and systems in the market that have already done so.
Memorial Medical Center in Las Cruces, N.M., froze its pension plan on Jan. 1, meaning that no new benefits would accrue after that date. For about five years, Memorial also has had a defined contribution plan, in which it matches employees' contributions. Hospital officials said they could not afford to continue offering both, especially after Triad opened a competing hospital last year. The hospital is in its second year of operating losses, and local governing bodies this month are expected to vote on whether to sell it.
Michael Nunez, Memorial's director of finance, said anticipation of a large increase in out-of-pocket pension expense "helped cement" the hospital board's decision to freeze the defined benefit plan. The hospital's annual contribution to the plan more than doubled, from about $700,000 in 2002 to nearly $1.8 million in 2003.
"The trend all across the country is for companies to get out of the liability of pensions," said Kim Hakes, Memorial's board chairman.
Nunez said an employee survey showed that workers "saw more value" in the defined contribution 403(b) plan than they did in the defined benefit plan because they could see funds accumulating in their quarterly statements.
But workers were naturally displeased that they would no longer accumulate retirement funds in the defined benefit plan. Nunez said, "We had to have several meetings with employees to explain why we were (freezing the traditional plan) and the cost to the organization of having both."