Longer lives, falling rates put pressure on hospital pension plans

Healthcare systems face broader unfunded pension liabilities as they make long overdue updates to their assumptions for retiree longevity, and raise the level of assets they will need to account for a falling discount rate.

The adjustments are weakening balance sheets and forcing some systems to pour additional money into their plans, which puts pressure on margins for those systems, and makes it more difficult for healthcare leaders to invest in their operations.

The combined obligations of the nation's 50 largest not-for-profit health systems' pension funds rose 19% to $93.2 billion last year, dwarfing the 11.1% increase to $75.3 billion in pension fund assets set aside to meet those obligations, according to a Modern Healthcare analysis of health system financial statements.

Weighted for the size of their plans, the unfunded liabilities of the 50 plans rose from 14% to 19% of total long-term obligations, and are now only slightly above the threshold that analysts and the Government Accountability Office consider healthy. Plans should have at least enough assets to cover 80% of pension obligations.

“That's a good, comfortable place to be,” said Kevin Holloran, an analyst who follows not-for-profit health systems for Standard & Poor's. The agency reported the median health system pension in 2014 was 82% covered, down slightly from 83.6% the prior year.

One driver of the decline in pension sustainability is the latest mortality estimate from the Society of Actuaries, which shows more retirees will continue to collect their pensions into their eighth or ninth decades. Men at retirement age are now expected to live to 86.6 and women to 88.8, an increase of two years and two-and-a-half years, respectively, since the last actuarial adjustments were made in 2000. While hospital officials have made some revisions over the intervening decade-and-a-half, many systems are only now coming into line with the latest projections.

These changing demographics have increased pension obligations by 4% to 8% over that time period, the Society of Actuaries estimates. “It's one of those bad- news, good-news things,” said Gregg Nevola, vice president for total rewards at North Shore-Long Island Jewish Health System, where the cost of promised pension benefits increased about 16% last year to roughly $2 billion. “The bad news is we're all living longer. The good news is we're all living longer,” Nevola said.

The update was overdue and expected, but still surprising since the increased longevity was larger than anticipated. “That's what's taking the whole world by surprise,” said Lisa Schilling, a fellow of the Society of Actuaries.

The other major problem for pension plans is the persistent low interest rate environment created by the Federal Reserve, which is lowering the discount rates that plans use to determine what they must have invested now to cover future costs. Last year, the discount rates used for pension calculations dropped sharply to about 4% from about 5%, according to health system financial statements. Such a drop can boost pension liabilities by up to 15%, according to actuaries.

Those low rates, combined with seniors who are living longer, have contributed to the deterioration in pension-plan funding. The median health system pension had enough assets in 2014 to cover 84% of promised benefits, compared with 88% the prior year, according to Modern Healthcare's analysis of the 50 largest not-for-profit health systems' pension plans.

Those with the steepest rate drops had mixed responses to drawing on cash to fund pensions. Federal law requires private-employer pension plans to make annual payments to address pension shortfalls, but gives plans several years to adjust. Plans affiliated with religious organizations are exempt.

Some of the nation's largest and best-funded systems are pouring more money into their plans as they watch their once fully funded pension plans dip into the red. Sutter Health, based in Sacramento, Calif., ended last year short $128 million—about 96% of what it needed—even after putting another $240 million into its plan.

The year before, the pension plan had $71 million more than necessary, or 118% of the amount promised under its pensions. New mortality estimates were “definitely a factor” in the latest cash infusion, said Bill Gleeson, a Sutter Health's spokesman.

The Mayo Clinic poured $410 million into the Rochester, Minn.-based system's $7.4 billion pension plan, but ended the year with 89% of the cash needed to meet that obligation. The clinic froze entry into the pension plan this year.

Last year's $797 million shortfall occurred in part because of the new mortality tables. It is a setback after Mayo overfunded the plan in 2013 by $342 million. Mayo Clinic has struggled to fund its pension in recent years, even using debt to finance the plan.

Analysts see Mayo's pension plan as a possible risk to its financial strength. Mayo has borrowed $1.2 billion since 2010, in part to fund its pension, according to Moody's Investors Service. Mayo's pension portfolio returned $427 million last year, a decline of 45% from $771 million the previous year.

North Shore-LIJ ended 2014 with 72% of promised pension payouts covered by pension savings, after closing the previous year at 86%. Nevola said the system offered employees the opportunity to exit pension plans for a lump sum last year to reduce its pension liability, in part because of the new mortality estimates, as well as low interest rates and increasingly expensive premiums paid to the Pension Benefit Guarantee Corp., which insures most private employers' pension plans.

The system invested $63 million in its pension last year, compared with $160 million the prior year. It's too soon to say how that will change for 2015. “It's obviously very difficult and challenging to know what the funding is going to be year to year,” Nevola said. That changes with regulations, interest rates and demographics.

Kaiser Permanente, which has the largest not-for-profit health system pension, has the most poorly funded pension plan, according to the Modern Healthcare analysis, and suffered one of the steepest drops year over year. The system ended last year able to cover only 57% of its $16.4 billion in long-term pension obligations.

Kaiser officials cited the system's large workforce and its willingness to continue offering pensions to new employees. “The unfunded percentage is in line with other open and active plans,” said spokesman Ted Carr. “As with other pension plans across America, our future obligations continue to grow, and we are working hard to manage those.”

The coming year should see even more health systems grappling with higher pension obligations, because some waited to change their longevity estimates. Some have fiscal years that end in June and were unable to make the switch, said Lisa Martin, a Moody's Investors Service analyst who covers the not-for-profit hospital sector. The new stress could strain health systems' ability to borrow and their margins. Systems that have larger liabilities from unfunded pensions need more cash to catch up, Moody's said earlier this year.

In Wisconsin, Aurora Health Care ended the year with a bigger gap between its pension assets and the projected cost of promised pension benefits, thanks to the lower interest rates and the actuaries' new mortality assumptions. The system's pension plan at the end of the year was funded to cover 88% of pension obligations, down from 92% the prior year.

Aurora Health Care has moved to adjust its pension investment strategy to better hedge against interest rate volatility, though the move will require it to invest more cash upfront to fund the pension plan, said Steve Huser, senior vice president of treasury service for the system. Aurora lowered its estimated long-term rate of return to 6.25% from 7.5%.

Only 16 of the 50 large systems in the Modern Healthcare survey have lowered their long-term projected rates of return, which also raises the required asset levels needed to meet long-term obligations. As a group, when adjusted for plan assets, the long-term projections were unchanged.

Aurora is lowering its expectations in anticipation of investments not performing as well as they have historically in coming years. “The market is what it is, and active managers have a difficult time,” Huser said. “It's a very difficult time to be investing.”

—Research Associate Yonatan Gebre contributed to this story.