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PlanSponsor: A Look at Hospital and Health Care System Pensions

November 3, 2020

NEPC's Gary Wyniemko and Kevin Novak were quoted in a PlanSponsor article discussing the recent survey on corporate and healthcare pension plan sponsors’ views on strategy, risks and investments. You can view the piece here. 

Health care organizations face an uphill battle financially, but the right strategies for investing and controlling PBGC premiums can help them get to the other side.
 
ONE WOULD HOPE THAT PENSIONS for health care system employees working on the front lines of the pandemic would remain viable, and many industry experts still believe they will.

However, S&P Global Ratings’ outlook for hospitals and health care services was negative pre-COVID-19 and still is. And, recently, the outlook for not-for-profit hospitals was downgraded from stable to negative.

S&P Global Ratings says hospitals and health care services, as well as pharmaceuticals, were already at negative before the pandemic due to increasing disruption in the industry, payor pressures and increasing merger and acquisition (M&A) activity taking a toll on credit metrics.

John Lowell, an Atlanta-based actuary and partner with October Three Consulting, explains that the delivery model in the U.S. has changed from a provider-based model to a consumer-based model. “In theory, hospitals have less ability to set their own prices. Most people are in a network and the incentive to use in-network care is so high,” he says. “Hospitals no longer have the margins they once did on procedures, but, at the same time, costs of operating have increased with inflation or perhaps more. For example, real estate and electricity costs don’t go down because the delivery model changes.”

During the beginning of the coronavirus pandemic, most health care systems reserved their capacity for COVID-19 patients and canceled elective procedures, notes Gary Wyniemko, a partner in NEPC’s Philanthropic Practice Group. “They were burning through cash until the government provided liquidity,” he says. “Since then, they have reinstated elective surgeries, but some revenue is lost and some people are still putting off care for safety concerns.”

An NEPC flash poll in April found that more than half of health care organizations were seeing daily burn rates increase more than 10%, and about one-quarter saw an increase of more than 25%, notes Kevin Novak, a senior consultant in NEPC’s Philanthropic Practice Group. The burn rate measures how quickly it’s spending its financial reserves

In addition, hospitals saw their expenses go up, says Wyniemko. “The cost of PPE [personal protective equipment] substantially increased, and is again now with a new surge in cases,” he says. “The cost of syringes is going up in anticipation of a vaccine. And there have been unforeseen expenses, such as refrigeration units to store vaccines when they become available.”

Problems With Pensions

Novak says NEPC saw that about 54% of health care organizations had a pension funded status of more than 90% in 2019, but as of June 30, only 25% have a funded status of more than 90%. “It’s not surprising if you think about what’s gone on in the capital markets and with interest rates,” he says. “Assets have gone down from the lasting impact of Q1, and rate decreases have caused liabilities to go up. It’s a double whammy.”

Half of health care pension plan sponsors responding to a September NEPC poll of corporate and health care pension plan sponsors reported their organizations have issued debt in 2020, but none said they did so to make additional contributions to their defined benefit (DB) plans. Seventy percent of health care plan sponsors said they are using debt proceeds for “other.” Novak explains that refinancing old debt falls into the “other” category; many hospitals are taking advantage of low rates to refinance. He adds that financing company operations is a big component, and it comes before making DB plan contributions.

Three-quarters of health care pension plan sponsors reported they are not planning any pension risk transfer (PRT) activities in 2021. “PRTs could reduce the costs of pension plans,” Novak says. “It’s hard to say why many in the survey are not planning to do so, but maybe reduced funded status makes those transactions cost prohibitive.”

As far as their DB plans, one thing that has gotten out of hand for many in the hospital industry is Pension Benefit Guaranty Corporation (PBGC) premiums. Lowell says he had a conversation recently with the chief financial officer (CFO) of a large, well-run hospital that has recently gotten its PBGC premiums under control to the point it is paying no variable-rate premiums. “I pointed out that most of her peer group hasn’t done that. Based on our data, hospitals are the worst-performing [group] when it comes to premiums,” he says. “The CFO said that hospitals compare themselves to other hospitals; they don’t compare themselves to other industries. As long as they are not doing worse than their peer group, they think they are doing OK. And, if others are not doing well with PBGC premiums, they think it’s normal and something they’re stuck with.”

Lowell says part of the problem is that hospitals, as a group, and especially those with frozen plans, tend not to have pension specialists. They have hospital financial professionals, but many of those professionals haven’t dealt with or thought about pensions. “I recently came across one hospital with a plan that has been frozen for 28 years and not yet terminated,” he says.

The advisers these plan sponsors are using might not be showing them how much money the plan is really costing them, so they don’t do anything about it, Lowell says. “Hospitals, in my experience, are not asking questions that would lead to creative solutions for their plans,” he notes. “Generally, they don’t have an inclination to spend large amounts of money with traditional benefits consulting firms, so they may not be getting absolute top tier consultants assigned to them.

“They need to say, ‘My pension plan has been frozen for a long time and I’m still spending a lot of money on it. Is that necessary? Are there suggestions you can make to help me cut those costs?’” Lowell adds. “If the only answer is to contribute more money, ask the consultant, ‘Can you help me build a model to show the value of additional contributions, so I can see if the value exceeds costs?’”

He says hospitals should also ask whether there are any creative financing strategies that other hospital clients have come up with.

If a consultant is not helpful, Lowell suggests hospitals find another one that is willing to be more creative. He also says, “I believe if a hospital hired somebody part of whose job is to help get pension costs under control, it would save more than the compensation it pays for that person.”

PBGC premiums for single-employer plans are calculated as the sum of a flat-rate premium ($83 per participant in 2020) plus a variable-rate premium (4.5% of unfunded PBGC liability in 2020, with a cap of $561 per participant). Lowell points out that if a DB plan’s situation puts it far over the variable-rate premium cap, then contributing to the plan won’t help right away because it will take a large amount to get closer to the cap. However, if the plan is at cap or slightly under, contributing to the plan gives an immediate 4.5% return because it is reducing that amount of PBGC premiums.

Creating a More Positive Outlook

The hospital with the CFO Lowell was talking with had an enormous revolving credit line that was almost untapped and it used that to make a contribution to its DB plan. Lowell notes that most hospitals can’t do that. “So, if I were them, I would not just look at traditional sources of access to cash and capital; I would look at all assets and determine whether some assets are potentially convertible to cash for pension contributions,” he says. “A hospital probably can’t convert an MRI machine to cash, but there might be other things they don’t need that can be.”

Lowell also notes that some hospitals are doing well and their credit is good, so they can consider borrowing to fund the plan. “Those that are less creditworthy may have to consider whether there are some other sacrifices they could make,” he says. “Would a hospital cut pay for employees? Would they cut other benefits? These are hard decisions, but if they’re in a situation where the cost of a legacy pension is so high, they may consider making them.”

Wyniemko says those hospitals that are able to should contribute to their plans. However, he notes that most are protecting their liquidity right now. They are anticipating a strong new wave of COVID-19 cases that might disrupt business.

Respondents to the September NEPC poll of corporate and health care pension plan sponsors cited COVID-19 as the biggest threat to their investment program (38% of corporate pension plan sponsors and 45% of health care pension plan sponsors). “In a market where it doesn’t look like there are a lot of screaming buys, DB plan sponsors should make sure they are comfortable with their asset allocation,” Wyniemko says. “Having liquidity is the first, second and third conversation clients want to have.”

NEPC is encouraging health care clients to revisit liquidity needs to make sure they have one quarter’s worth of cash needs on hand, remain disciplined and stick to their long-term asset allocation, confirm their risk profile and ensure they have an enterprise risk framework, and be mindful of short-term rebalancing opportunities. “Q1 was a test for health care organizations in terms of their comfort with the investment risk they have in place,” Novak says. “And, as we’ve seen market volatility on the upside and downside, which shifts the weights of different asset classes, rebalancing makes sure plan sponsors are adhering to the long-term investment framework they have in place.”

“I do think, overall, things will improve,” Wyniemko says. “Obviously, we’re at historic low interest rates, and the expectation is they will be lower for longer. But health care systems have a playbook now, so if we see a resurgence [in COVID-19 cases], they’re in a better position than at the start of the pandemic. The more certainty health care systems feel, the more comfort they will have to do activities they’re maybe not considering now, such as pension risk transfer.”

Novak notes that health care systems’ financial situations have improved somewhat since NEPC did a survey in June. “The third quarter of this year, we saw a few percentage points gain in funded status in general. Asset gains outpaced the increase in liabilities,” he says. “Going forward, while I think things will improve, it will do so at different magnitudes for different organizations. In part, it will be based on interest rates and, in part, how assets are managed. Our clients follow a range of investment frameworks—from LDI [liability-driven investing] to a total return approach. If things continue the way they are, we might see that those with a total return approach will have a higher funded status.”

Topics: Press, Press Coverage

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