The Winston-Salem, N.C.-based system made a number of moves to shore up its pension liabilities. In addition to closing the plan to new entrants, it injected $25 million into the fund and changed its investment strategy—choosing less risky, longer-term assets and implementing an equity hedge program.
As a result, Wake Forest Baptist had the most improved funded ratio, at 96.2%, among the health systems examined in a Standard & Poor's report last year.
While the report showed a brighter situation for 2011, record-low interest rates may negate some of that turnaround when S&P releases its report for 2012.
Last year, S&P found that the median funded status of defined benefit plans in 2011 was 78.6% among the not-for-profit health systems that it tracks, besting the previous year's 71.7% but still well below the 90% seen in 2007.
The Government Accountability Office and others in the field have defined a “healthy” pension plan as one that is at least 80% funded—which means that more than half of not-for-profits in S&P's universe are below the comfort zone.
And underfunded plans can have real consequences. Mounting pension liabilities can force some systems to rethink how they spend their cash—putting off improvements like facility and equipment upgrades in order to fund retirement benefits.
They can also raise a red flag in deal negotiations. Trey Crabb, who focuses on mergers and acquisitions at investment bank Ziegler, noted that bidders often want to know that pension liabilities have been funded.
Hospitals grooming themselves for a sale realize they need to clean up their balance sheets.
“That's an increasing drag on the free cash flow of not-for-profit hospitals,” Crabb said. “As interest rates have continued to plummet, defined benefit plans have become more expensive for not-for-profits.”
Although employees with 403(b) and 401(k) retirement plans have seen their balances grow with the recovering stock market, many employers are funding their pension obligations with less risky fixed-income investments.
In that way, they're protected from volatile stock prices—but they may not get the benefit from a bull market either.
“The other side of the equation is historically low interest rates and that's a lot of it,” said William Courson, president of the investment advisory group at Lancaster Pollard & Co. “It ends up being an overlay of a number of pressures.”
All companies calculate their future pension liabilities based on what's known as a discount rate, which is based on the rate of return from their investments. As interest rates fall, so does that rate of return.
“With interest rates historically low, liability has been going through the roof,” said Tal Heppenstall, senior vice president and treasurer at the UPMC health system in Pittsburgh.
It's an issue that has rankled not just not-for-profit providers, but investor-owned chains as well, Courson said.
In its annual report, publicly traded Tenet Healthcare Corp., Dallas, calculated that for every 100 basis-point decrease in the discount rate, its pension expense would increase by about $2 million.
Like Wake Forest, Christiana Care Health System, Wilmington, Del., closed its defined-benefit plan to new employees in August 2006 and moved all new hires into a defined-contribution plan.
“We didn't want to get in the position of having a pension liability that (restricted) our ability to access capital,” said Rob McMurray, vice president and controller for the system, which operates a 988-bed hospital in Newark, Del.
Three years later, the system, which has more than 10,000 employees, also introduced what McMurray described as a “liability investment approach,” increasing its investments in fixed-income securities in order to mitigate volatility.
It also gave employees who were leaving the company the option of cashing out their pension plans—a move that took 1,500 people off its books.
“It was well-received and it gave us the opportunity to reduce the funding liability,” McMurray said.
As a result, Christiana Care's plan was 83.6% funded in 2011, up from 65.9% in 2010. Yet despite a 15% increase in plan assets, the 2012 funded status dipped to 74.7%, largely due to a decrease in the discount rate, according to McMurray.
In a survey last year of 86 not-for-profit healthcare organizations, financial advisory firm Commonfund found that while the majority (62%) had a defined benefit plan, only 34% planned to maintain it, down from 38% the previous year. The larger the organization, the more likely it was to stay the course.
A healthy cash balance can cushion market volatility.
Even though UPMC saw its funded ratio decline to 80.6% in 2012 from 86.8% in 2011, “it's not a problem for us because we have plenty of liquidity,” Heppenstall said.