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Stepping away from pension risk

The climate has improved for defined-benefit pension plans and that may signal an opportunity to make changes.

After several years of gloom, there was encouraging news for defined-benefit pension plans in the not-for-profit health sector last year. Median funded status improved to 80 percent in 2013 after four years at approximately 70 percent, according to a May report from Standard & Poor's Ratings Services. But the report also indicates that's still lower than the 90 percent seen in 2007, and the risks associated with such plans – such as vulnerability to stock market swings – remain.

"So much of the funded status is driven by the performance of the plan's assets," said Kenneth T. Gacka, director at Standard & Poor's and co-lead writer of the report, U.S. Not-for-Profit Health Care Sector's 2013 Pension Plan Medians: Time To Exhale? Last year, higher asset values contributed to the improvement in funded status improvement, thanks in part to strong investment markets, as well as a modest increase in discount rates that helped reduce pension liabilities. But, said Gacka, "so many of these variables that come into play with defined-benefit pension plans are just very unpredictable."

Not surprisingly, hospitals are looking to reduce the risk to that aspect of their financial profiles. "There is a considerable movement away from defined-benefit plans," Gacka said. "We are seeing some shifts of the various types of plan amendments, whether it be soft or hard freezes of a defined-benefits plan, or future benefits being accrued through defined-contribution plans or similar types of structures."

Switching lanes

Making big shifts in benefits packages can take time. But some of that time already has been lost when it comes to steering a stronger course to reducing pension plan risk by lowering liabilities. "The best time to reduce plan risk is when the plan is very well-funded," said Michael Horton, senior consultant in the retirement practice for Towers Watson, a global professional services company. "Over the course of 2013 we saw a significant increase in the funded status overall of pension plans, oftentimes more than a 10 percent increase."

In 2014, however, Horton speculates that pension plans' funded status may decrease if interest rates continue to stay where they are, on the heels of discount rates that have dropped about 50 basis points since the start of the year.

"You want to be able to take steps to reduce pension risks quickly when the funded status improves," he said. Towers Watson has been recommending that its clients, including not-for-profit hospitals, embrace a journey plan, which dictates pulling specific triggers as plan funding status improves. For example, when a defined-benefits plan reaches 100 percent funding status, a hospital could offer vested participants a lump sum benefit. At 110 percent or 115 percent funding status, it may purchase annuities for current retirees (a more expensive route than offering lump sum benefits).

Future state

Today, even as the hospital sector steps away from defined-benefit plans, it's still rare for institutions to offer only defined-contribution plans, Gacka noted. That said, Horton believes that the last five years have brought not-for-profit hospitals to the same place that corporate America has landed: making defined-contribution plans the primary retirement vehicle.

"More and more employees expect that, and if you have just entered the workforce, defined-contribution plans can be very desirable," he said. But for older employees, the lack of the defined benefits security they have known in the past may cause them to stay on the job longer.

Horton has seen the average retirement age increase from 62 to well over 65 for several hospital clients, based on experience of the last few years. This poses a risk to hospitals that need workers to be physically capable of meeting job demands. "If workers are staying on just because they can't afford to retire," he said, "that could be a significant business issue for hospital employers."

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