It may be tempting for healthcare organizations to relegate pension obligations to the back burner due to their long-term nature, as they face a current environment with a heavy emphasis on operating income.
However, you may want to act proactively to review your pension liability and have a long-term plan in place for whatever course of action you choose to take.
Why You Should Review Your Obligations
There are several compelling reasons to re-evaluate your pension plans in 2019.
- Recent Financial Accounting Standards Board accounting changes, effective after December 2018, move expected return on assets (EROA) out of operating income. Because a high EROA reduces the recognized pension cost, many health care entities have kept a high equity allocation. Moving EROA out of operating income, combined with significantly higher equity market volatility, gives a compounding reason to reevaluate your pension risk management strategy.
- Uncertainty resulting from underfunding. Maintaining an underfunded pension plan could add variability to your organization’s financials, with larger contribution requirements and administrative costs for underfunded plans. Assessing near-term costs versus discretionary contributions could reduce the plan’s long-term costs.
If your long-term goal is to ultimately terminate the plan and transfer risk off the balance sheet, this requires an intentional strategy, built specifically for your organization. Simply pursuing investment returns and hoping for the right day to write a check may leave your organization exposed to a growing liability.
Three Strategies to Improve Outcomes
For plans that remain underfunded, there may be opportunities to consider discretionary contributions in 2019.
- Rising Pension Benefit Guaranty Corporation (PBGC) Premiums Affect Administrative Costs. The 2019 scheduled increase in the PBGC premium (outside of inflation) is the last one scheduled based on a recent series of legislative changes. However it remains a pain point for many plan sponsors. In general, the penalty for being underfunded is 4.3% of the plan’s deficit in 2019, up from 3.8% in 2018 and 0.9% in 2013. Evaluate funding the plan in order to avoid this penalty. There is a potential to reap other benefits such as opportunities to de-risk the plan’s investments and improve the plan’s overall risk posture.
- Increased Minimum Requirements. Over the last several years, a number of funding relief measures were passed that kept both actuarial liabilities for contribution purposes and contribution requirements low. With these funding relief measures wearing off, liabilities will likely become more marked to market. This, combined with updated mortality tables, can lead to higher-than-expected and more volatile contribution requirements over the next several years as discount rates are adjusted.
We have seen an increasing number of plans adopt glidepath de-risking strategies that shift assets out of equities into liability-hedging fixed income as the funded status improves. During the first three quarters of 2018, when funded statuses were generally improving, plan sponsors with these strategies in place may have hit one or more de-risking triggers and removed some of the investment risk out of their plan. Such a strategy would have benefited these plan sponsors in the last few weeks of the year when both equities and corporate plan discount rates dropped, making liability-hedging fixed income the better-performing asset class.
We continue to recommend that plan sponsors not only work with their advisor to develop an appropriate glidepath for their plan, but also to execute in a manner where frequent review of the plan’s position could allow for quicker execution to avoid missing opportunities. If de-risking the plan makes sense as funded status is improving, consider a plan for situations when funded status falls.
Risk Transfer Strategy
Are you considering terminating your pension plan as deficits become smaller? If so, it’s advisable to get an estimate of the cost to terminate the plan and determine how the cost could be affected by market conditions and participant behaviors.
Though some plan sponsors are waiting for funding levels to improve before starting the process, others are considering trigger points based on how much funding the organization can afford to come up with a plan termination. This approach provides a basis for the plan to monitor progress toward that terminal funding amount, and potentially modify the investments as the plans gets closer.