Pension liability: A hospital's opportunity to save millions

Hospital finance teams are missing an opportunity to save money in paying unfunded pension liability. Here's how to avoid that costly mistake.

Susan Morse, Senior Editor

Many hospital finance executives are losing money in the way they fund their defined benefit plans for employee pensions, according to experts interviewed.

A recent study by October Three Consulting shows that of 800 worst offenders for overpaying, hospitals rank at the top. An estimated 20 percent are losing money in paying premiums to the Pension Benefit Guaranty Corporation, according to John Lowell, a partner in October Three in Atlanta. The PBGC is a quasi-governmental agency that serves the role of trustee of the pension funds.

[Also: Pension funds linger, even make comeback, among healthcare providers]

Over six years, healthcare plan sponsors have missed out on approximately $60 million in savings, according to the study.

In 2015 alone, they missed out on potential savings of about $15 million. One hospital, for instance, overpaid by about $2.3 million between 2010 and 2015.

[Also: Stepping away from pension risk]

"We found most plan sponsors were paying more in PBGC premiums than they needed to," said Lowell, who is also president of the Conference of Consulting Actuaries.  

While pensions seem destined for extinction through corporations switching to 401Ks or other retirement plans, businesses, including not-for-profit hospitals, must still fund the pensions for retirees and for employees who signed on years ago and have yet to retire.

Also, many hospitals still offer pensions because they find them to be an attractive recruitment tool in hiring high-salaried physicians.

One carrot might be to tell doctors being recruited that their retirement plans "will be kept whole" if they transition to the hospital, according to Lowell.

"What they're looking for is deferral opportunities," Lowell said. "They're treating it like a 401K on steroids. There are good reasons for the right hospitals to have this. If I were a specialty hospital trying to recruit the best doctors, I would by all means offer something like this to my physicians. If you tell them I'm going to decrease your tax bill; that's worth a lot to them."

Health systems are subject to Employee Retirement Income Security Act of 1974, which mandates participants be paid. This means that even if the employer goes out of business, the pension is insured by the Pension Benefit Guaranty Corporation.

CFOs, who otherwise are keenly aware of opportunities in their budgets to save money, may miss some of the ways an organization can get a break on pension funding.

For one, in many organizations, pension funds are handled by committee, such as an investment committee that oversees all of the system's assets including the pension assets, or by a retirement committee.

What often happens, according to Attorney Dave Wolfe with Drinker Biddle & Reath in Chicago, is that actuarial firms often don't bring up the issue until the opportunity is about to expire. The CFO may not have time to go through process of determining which move makes the most financial sense.

The easiest way to reduce the premium is to fully fund the plan. But this is often not fiscally possible. The decision must be weighed against days cash on hand and needed capital projects.

"Days cash on hand is always troubling for hospitals," said Wolfe, a cofounder and member of the steering committee of the HR/Hospital Advisory Board for senior HR executives in tax-exempt healthcare systems. "It becomes an issue for a CFO, it's a cost benefit analysis. How will days cash on hand be affected? What are the capital needs? The healthcare industry is economically very complicated right now."

Another way to reduce the cost of funding these plans is to change how the variable rate premium is paid, according to Lowell.

The variable rate premium is one of two premiums owed to the PBGC. The other is a fixed rate premium, a flat dollar amount paid per person.

The variable rate premium is largely a penalty imposed by the PBGC for hospitals that are not fully funding their benefit obligations. It is dependent on the amount of underfunding. The worse a plan is funded, the more that must be paid.

For 2017, the flat-rate premium is $69 for single-employer plans and $28 for multiemployer plans. The variable rate premium per $1,000 of unfunded vested benefits is $34. For many plans, the variable rate premium may be five to eight times the size of the fixed rate premium, according to Lowell.

"It's at the point now you annually pay as much as 4 percent of your unfunded liabilities to the PBGC," Lowell said.

If say, a plan is 80 percent funded, at some point the hospital is going to have to pay the difference, he said. The hospital can reduce its variable rate premium by accelerating the contributions and funding the plan sooner.

Another way to reduce the variable rate premium is to maximize the credit for the contribution without actually increasing the amount being contributed.

This is done by timing.

The tax deduction for the variable rate premium can be taken in this plan year, or next year.  Sept. 15 is the deadline for calendar year plans to pay.

Waiting to pay saves money.

The PBGC looks at assets as of Jan. 1. For the 2018 premium, hospitals can wait to pay up until the plan year ends on Sept. 15, in a legal juggling that improves assets to liabilities.

"If they attribute to the year earlier, it can save money in write-offs and in other ways," Lowell said. "Paying in September results in a lower variable rate premium."

Say a provider contributes $5 million to the pension on Oct. 15. If instead, the hospital had made this contribution a month earlier on Sept. 15, it would have saved $250,000 in PBGC premiums, Lowell said.

"If you make a contribution on Dec. 20, it's clearly for that plan year," Lowell said. "But if the premium is paid on Feb. 1, executives can say it's for the prior plan year, and get to pretend the assets were in the plan though they weren't. If I make a big contribution for 2017 before Sept. 15, I can pretend it was made on Jan. 1. It will increase Jan. 1 asset value and it will reflect in 2017 premiums rather than in 2018."

All executives paying these premiums need to pay more attention to these defined benefit plans as the at-risk, or variable premium rates have been increasing and are projected to increase by another 25 to 50 percent in 2019.

PBGC premiums go up or down depending on how well the trust is funded, Wolfe said.

"When it's in a trough, when it's unfunded, that's when the premiums tend to go up," Wolfe said.

Wolfe agrees that many hospital executives are not taking full advantage of opportunities to reduce the risk portion of Pension Benefit Guaranty Corporation premium.

Hospitals can also off-load the pensions by transferring the risk, though that comes at a high cost.

"It does create the potential for significant savings," Wolfe said.

Also, hospitals and other corporations often offer employees lump sum cashouts.

"Organizations are trying to figure out how to (lessen) liability growth, some are providing cash-out opportunities, some are trying to offload a plan to an insurance company," Wolfe said.

It's also becoming more of an issue as discount rates have dropped, said Moody's Investor Services analysts Rita Sverdlik and Beth Wexler, from the not-for-profit healthcare team.

The discount rate is the rate at which participants' vested benefits are discounted to determine a vested benefit liability.

"Overall, broadly speaking we have seen it become a bigger issue as discount rates have dropped," Wexler said. "It a big component of the pension liability.  There's less growth, less rate of return. As the discount rate has dropped over the past 5-7 years, we've seen liabilities grow."

Also impacting the pension obligation and rates are mortality tables showing that people are living longer.

The liability of these defined benefit plans alone do not impact the credit rating of a hospital, the analysts said. But taken with other factors, it can create credit issues on a negative basis in the non-profit hospital area.

"It's definitely one of our main credit factors," Sverdlik said, "the unfunded pension liability."

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