The U.S. not-for-profit health care sector has benefited from an increase in the median funded status of its pension plans in fiscal 2018—increasing from 80.6% to 85%, according to S&P Global Ratings.
S&P says this boost is primarily due to an increase in the discount rate used to measure pension liabilities, which reduced those liabilities. The discount rate is based on a conservative municipal bond rate, and S&P views the 2018 increase as being within reasonable volatility expectations, so it says it doesn’t consider it to be a fundamental change in the funded status of the plans.
In the near term, S&P Global Ratings believes a higher funded status should mean lower statutory minimum contributions to defined benefit (DB) pension plans, which could help overall financial profiles because operating performance in the health care sector remains under stress. However, the bond rate may be volatile from year to year, the projected benefit obligation for many plans remains large, and many plans have updated assumptions such as mortality to more accurately recognize longer lifespans and higher benefits to be paid out. Therefore, the advantages to organizations’ financial profiles from lower statutory minimum contributions may not fully materialize.
S&P notes that many not-for-profit issuers continue to focus on de-risking strategies that lower pension funding risks, including increasing annual contributions to improve the funded status with less dependence on volatile markets, closing current plans to new participants, freezing plans, and in some cases, terminating plans altogether.
According to S&P’s analysis, most hospitals and health systems have managed their pension burdens well, with no credit implications. However, it believes that even without a direct negative credit impact, in some circumstances, a high funding burden has inhibited improvement in credit quality. Furthermore, not all hospitals’ pension funding improved in 2018, and for providers already struggling with thin income statements and balance sheets, underfunded pension plans could contribute to credit stress.
In general, S&P says, it considers fully funded plans (plans funded at 100% or more) or the absence of a DB plan as positive factors in its assessment of an organization’s financial profile. Conversely, it views DB plans that are considerably underfunded, or expected to be underfunded in the near- to mid-term, as risks to the financial profile.Whether the average funded status will remain at the current level or improve depends on a number of factors, including market returns, discount and bond rate trends, other actuarial assumptions, and benefit design changes, according to the S&P Global Ratings report. S&P notes that many hospitals and health systems are moving to mitigate risks through more conservative asset allocation strategies, while others are focusing on reducing liabilities by making benefit design changes. Still, some are reluctant to change or curtail DB plans that have long been a part of their benefits packages and that they see as a powerful recruitment and retention tool.