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U.S. Not-For-Profit Health Care Pensions: 2018 Funded Ratios Remain Solid And Benefit From The Increase To Bond Rate


S&P Global Ratings Definitions


This Time Is Different: An Anemic And Uncertain Passenger Recovery Will Challenge U.S. Airports' Credit Quality


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State Brief: North Dakota

U.S. Not-For-Profit Health Care Pensions: 2018 Funded Ratios Remain Solid And Benefit From The Increase To Bond Rate

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. 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 we view the 2018 increase as being within reasonable volatility expectations, so we don't consider it to be a fundamental change in the funded status of the plans. The funded ratios improved despite a more volatile investment market, given the fourth quarter of 2018 eradicated returns, resulting in an overall S&P 500 4.4% investment loss for 2018.

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. (For more information, see "U.S. Not-For-Profit Health Care Sector 2019 Outlook: Stable Overall, Yet Key Risks Remain," published Jan. 10, 2019, on RatingsDirect.) 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.

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.

The majority of not-for-profit hospitals report liabilities under the Financial Accounting Standards Board (FASB), which prescribes liability measurements using different sets of assumptions and methods than those under the Governmental Accounting Standards Board (GASB). Comparison between plans under different reporting entities isn't straightforward and this is represented in our opinion of overall creditworthiness.

Overall Funded Ratios Improve But This Trend Is Not Expected To Continue

In fiscal 2018, the not-for-profit median funded ratio rose to 85%, the highest level in the past 10 years (see chart 1). This boost was primarily due to an increase in the bond rate, which was strong enough to overcome a weak investment market (the S&P 500 posted a loss of 4.4% in 2018). In the near term, this should translate into lower statutory minimum contributions to DB plans. However, markets and bond rates are volatile, and this trend could shift quickly.

S&P Global Ratings has tracked the funding levels of the DB plans of not-for-profit hospitals and health systems since 2007, when, on average, they were at their highest level (90%). Funded statuses declined sharply in 2008 and 2009, by 20 percentage points, following the significant downturn in global investment markets during the recession. After the recession, funded ratios were essentially flat at about 70% through 2012, despite hospitals' healthy contributions to plans.

In our view, most hospitals and health systems have managed their pension burdens well, with no credit implications. However, we believe 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, we consider fully funded plans (plans funded at 100% or more) or the absence of a DB pension plan as positive factors in our assessment of an organization's financial profile. Conversely, we view DB plans that are considerably underfunded, or expected to be underfunded in the near-to-mid term, as risks to the financial profile. Of course, we also understand the existence of a DB plan is a positive long-term recruitment and retention incentive in tight labor markets.

Chart 1


While the year-over-year median funded ratio has remained fairly constant, variance among plans within our sample is high: between a low of 44.6% and a high of 144.5%. A low funded ratio might not drive a credit rating, but can be a drag if these obligations appear to be getting out of hand.

Table 1

Highest And Lowest Funded Plans In Fiscal 2018
State Rating* Outlook Accounting method Funded status (%)
10 highest funded pension plans
Pomona Valley Hospital Medical Center CA BBB Stable FASB 144.5
Jackson County Schneck Memorial Hospital (dba Schneck Medical Center) IN A Stable GASB 133.4
Northwestern Memorial HealthCare IL AA+ Stable FASB 129.7
El Camino Hospital CA AA Stable GASB 128.1
CaroMont Health NC AA- Stable GASB 127.6
Little Company of Mary Hospital & Health Care Centers IL A+ Stable FASB 124.4
Columbus Regional Healthcare System NC BBB Stable GASB 123.1
Guthrie Healthcare System PA A+ Stable FASB 113.5
Nash Health Care Systems NC BBB Negative GASB 112.7
Health Care Authority for Baptist Health AL BBB+ Stable GASB 111.0
10 lowest funded pension plans
Northern Inyo County Local Hospital District CA BB- Negative GASB 44.6
Kaiser Foundation Health Plan Inc. and Kaiser Foundation Hospitals CA AA- Stable FASB 52.5
Catholic Health System Inc. NY A- Stable FASB 53.9
Spartanburg Regional Health Services District Inc. SC A Negative GASB 54.0
Lexington County Health Service District Inc. SC A Stable GASB 54.1
Franciscan Missionaries of Our Lady Health System Inc. LA A Stable FASB 57.2
Providence St. Joseph Health WA AA- Stable FASB 58.0
Orangeburg-Calhoun Counties Regional Medical Center SC BBB Stable GASB 58.6
St Peter's University Hospital NJ BB+ Positive FASB 58.8
Health Quest Systems, Inc. NY A- Stable FASB 59.2
*As of April 29, 2019. Average rating for the top 10 funded pension plans is 'A'. The average rating for the bottom 10 funded pension plans is between 'A-' and 'BBB+'.

Future Developments

We expect continued volatility in the funding levels of pension plans, given annual fluctuation in the bond rate and uncertainty in the investment markets. However, most providers are making adequate contributions to their pension plans, and we expect overall pension costs to be somewhat lower and manageable for most issuers. In addition, a number of providers are moving to defined contribution (DC) plans and, in general, are finding ways to de-risk their pensions.

Net Periodic Pension Costs Remain Low And Manageable For Most Issuers

In fiscal 2018, the median net periodic benefit cost to total operating expenses continued declining and stood at a low 0.3%, compared with the much higher 1.3% in fiscal 2011 (see chart 2). Similarly, employer contributions as a percentage of EBIDA extended their largely declining trend and stood at a relative low of 9% in fiscal 2018 versus 15% in fiscal 2012 (see chart 3). These metrics reflect recent investment returns, which, by their nature, are inconsistent. The resulting lower employer contributions translate into greater financial flexibility for hospitals and health systems, as management teams spend less of their cash flow on pension contributions, freeing up cash for other uses such as debt repayment, capital expenses, and building reserves. Of note, employer contributions as a percentage of EBIDA in 2018 for the first time fell below the low point of almost 10% in 2007 and 2008, when we began this study (see chart 3). While annual changes in pension contributions and cash flow influence this measure from year to year, pension contributions have generally increased in the past 10 years, due to weaker market returns at times and updated demographic assumptions such as mortality (specifically people living longer). However, an increase in the contribution-to-EBIDA measure doesn't always indicate higher pension contributions, primarily because the ratio can be skewed during times of depressed cash flow; for example, in fiscal 2009, when cash flow was soft for many hospitals.

Chart 2


For many organizations, rising pension costs and underfunded pensions are issues that management teams, in general, are successfully managing, with no immediate credit implications. However, we consider DB plans and their funded status as a component of our assessment of an organization's financial profile. Employer pension contributions can directly affect unrestricted reserve ratios and crowd out other cash needs, although at times, management teams have meaningful latitude on the timing of contributions. Furthermore, the effect of swings in funded status is evident in several key ratios that we analyze, including debt to capitalization and pension-adjusted debt to capitalization.

Chart 3


Assumptions Drive Valuation

The discount rate is one of the most influential factors used in the measurement of pension liabilities. Higher discount rates result in lower liability measurements and correspondingly lower annual pension benefit costs, while lower discount rates will raise these amounts.

Over the past 10-plus years, inflation and real market return expectations have decreased and assumed asset returns have trended down slowly, as assumption changes lag experience. The median return on plan assets was flat in 2018, at 7.0% (see chart 4). Pension plan valuations can be somewhat volatile and are dependent on realization of actuarial assumptions over which sponsors have limited control. In addition to the assumed asset return and the discount rate, mortality assumptions can play a significant role in liability measurement. The most conservative mortality assumptions consider annual future longevity improvements, called "generational mortality" assumptions. Updating to a generational approach from a static table has led to one-time jumps in liabilities, but likely will mean fewer increases in the future because the tables include the expectation of longer lifespans.

A look at rating actions over the past few years indicates pension funding has sometimes contributed to credit strain. However, the issue has rarely, if ever, been the primary reason for a rating action in the not-for-profit health care sector, in part because pensions are long-term obligations whose values move with investment markets and actuarial changes. Because we expect changes over long periods, our ratings accommodate some volatility in the valuation of pension liabilities. In addition, most not-for-profit health care providers have strong unrestricted reserves to cushion year-to-year pension funding volatility.

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. 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. 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.

Chart 4


Pension De-Risking Continues To Be A Dominant Theme

Many issuers continue to focus on de-risking pension plans by closing the plan to new participants, terminating or freezing plans, or offering a lump-sum payout to some employees.

When a sponsor closes a DB plan to new participants, new employees aren't eligible for that plan. Furthermore, an employer might freeze a DB plan, where not only is the plan closed to new participants, but existing participants stop accruing benefits while still being entitled to all vested benefits at retirement. In most cases, after the plan is closed or frozen, the employees earn all future benefits in either a cheaper DB plan or a DC plan, which is a far more predictable expense for management because the investment risk is shifted from the employer to the employee. However, because employees hired before the plan's closure are still vested in the DB plan, the plan continues to pay benefits for many years, generally for the life of all vested beneficiaries. The 'tail' can be decades long. The closed plan no longer accepts new employees, so some funding methodologies and assumptions need to be made less volatile to ensure funds are available as the population ages into retirement. This typically translates into higher near-term contributions. Our credit analysis recognizes the benefits of reduced volatility in plan contributions, and eventually reduced contributions in absolute terms. Freezes often result in an actuarial gain, which increases the plan's funded status at the time of the freeze. However, the existing obligations still can pose financial risks for sponsoring organizations.

Outright pension terminations have been rare in recent years because when a plan is underfunded, the plan sponsor must first contribute enough to fully fund it before distributing assets to beneficiaries. Furthermore, low interest rates make it very expensive to purchase annuities for beneficiaries. The recent uptick in funded status and slightly higher interest rates could bring plan terminations into a more realistic price range for some sponsors.

Finally, we view cases where an entity issues debt to fund its pensions generally as an increased acceptance of market risk. Debt payments are made on a fixed schedule (as opposed to a schedule where management has some flexibility) and we incorporate this into our analysis through debt metrics.

FASB Versus GASB Reporting

While it may be reasonable to compare liabilities between different pension plans, it's important to note that there are major differences between reporting standards. Liabilities reported under FASB, as is the case for most health care plans, are discounted using a very conservative bond rate and point-in-time liability measurement. These liabilities tend to be quite conservative due to the low discount rate, but volatile because they change annually, as they tend to trend in line with broad interest rate movements. Liabilities reported under GASB are generally designed to have long-term costs spread out smoothly over time by incorporating the assumed asset return within the reported discount rate along with a more conservative liability measure.

There are also differences for reporting retiree OPEB liabilities. These liabilities may be more easily reduced than pensions, and this has led to the elimination of DB plans or conversion to DC plans for many GASB and most FASB OPEBs.

FASB ASU 2017-17 Should Provide More Year-Over-Year Consistency In Operating Income

In March 2017, the FASB issued ASU 2017-17, "Compensation Retirement Benefits (Topic 715) Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post Retirement Benefit Cost." This update requires that the net periodic benefit cost's service cost component be reported in the same line as other compensation costs in operating expenses while the other components of net periodic benefit cost, such as interest cost, experience gains and losses, or changes in assumptions, must be reported separately from service costs and outside of operating income in the statement of operations. ASU 2017-17 is effective for annual reporting periods beginning after Dec. 15, 2018, and interim periods within annual reporting periods beginning after Dec. 15, 2019. Many issuers are adopting the change early, restating their fiscal 2016 results to conform with the new requirement. We believe this has provided a more accurate representation of pension operating costs, given that asset returns and assumption changes influence many other components of net periodic benefit costs; as such, we are not adjusting the reported pension costs in our analysis. We expect this implementation to be credit neutral and note that some issuers have reported improved operating margins following early adoption, given that other net periodic pension cost items other than service cost are included in non-operating expenses. In our view, this change will bring more consistency to operations, while increasing volatility in non-operating income.

Ratios Provide Insights, But Each Plan Is Unique

This is our eighth study of the not-for-profit health care sector's pension plans. We use combined data from a broad sample of our rated universe, including 220 rated providers with fiscal years 2007-2018. The sample size is smaller for the 2018 data because most of the audits for the fiscal year ended Dec. 31 aren't yet available. Tracking the broad sample allows us to monitor pension funding trends using our considerable sample size to smooth any unusual effects from individual organizations. However, each plan has unique characteristics, including actuarial assumptions, workforce characteristics, payout amounts and timing, asset allocation, and changes such as a freeze in benefit accruals. In addition, we review issuers' asset allocation strategies for DB plans to ascertain if there might be excessive market and liquidity risk accepted within the investment portfolio. These unique characteristics can have a substantial impact on a plan's funded status, and in any given year, some plans' asset and liability valuations could change in a direction contrary to the broad sample. In our analysis, we recognize each plan's characteristics while applying our understanding of the broader trends gleaned from the median ratios.

Plan Sizes Vary Significantly

When analyzing DB plans, we believe in addition to the funding level, it's important to look at the plan's relative size. Some plans that are underfunded as a percentage of the projected benefit obligation (PBO) are relatively small. This can happen when plans have been closed or frozen for a long time, or if only some employee groups or hospitals within a system are covered.

As a proxy for relative size, we use balance sheet and revenue measures. The balance sheet measure is the PBO as a percentage of the health system's total assets. We use this measure to gauge a plan's size relative to an organization's total asset base. For this measure, a lower value indicates a lesser risk, all other things being equal.

Chart 5


Church Plans Don't Need To Adhere To ERISA

The Employee Retirement Income Security Act (ERISA), a federal law that sets minimum standards for employee benefit plans, governs most rated not-for-profit health care universe pension plans. However, many not-for-profit DB plans are classified as "church plans," so they don't need to adhere to ERISA guidelines, and therefore have more flexibility in determining underlying assumptions for funding levels and contribution amounts. While added flexibility can also mean added risk of underfunding, we review obligors with both church plans and ERISA plans in accordance with our criteria, examining funding levels, overall costs and cost trajectory, and underlying assumptions.

The June 2017 Supreme Court "Advocate Health Care Network v. Stapleton" ruling regarding the exemption of church-affiliated pension plans from ERISA have not fully settled the matter resulting in further litigation. Lower court decisions have been mixed and not entirely favorable for hospitals with church plans. As the status of church plans remains uncertain, we expect the matter will continue to be challenged in the courts. Although this adds risk to the financial health of issuers with church plans, we continue to evaluate the plan characteristics of each issuer individually in accordance with our criteria.

Defined Contribution Plans Are Still A Minority But Are Growing

We identified hospitals and health systems that have DC plans only (see table 3 for the 25 largest). This represents about 33% of our rated universe, indicating that DC plans are a significant minority in the not-for-profit health care world (see chart 6). We expect this number to continue increasing as more providers move away from traditional DB plans, although most hospitals that freeze their DB plans still have pension obligations and contribute to them for many years. For those organizations, we still include the DB plan in our medians, and they aren't part of the "defined contribution only" group. In our analysis, we recognize the benefits of reduced volatility in plan contributions, and eventually reduced contributions in absolute terms, as a frozen DB plan winds down.

Table 2

Largest 25 Hospitals And Health Systems Without Defined-Benefit Pension Plans
Hospital/health system State Rating* Outlook Fiscal 2018 operating revenue ($000s)
Texas Health Resources TX AA Stable 4,800,877
Methodist Hospital of Houston TX AA Stable 4,460,256
Adventist Health System-West CA A Stable 4,414,000
Orlando Regional Health System FL A+ Stable 3,810,783
Inova Health System VA AA+ Stable 3,402,835
Scripps Health CA AA Stable 3,243,046
Baptist Memorial Health Care Corp. TN BBB+ Negative 2,706,457
UAB Health System AL AA- Stable 2,473,674
Marshfield Clinic WI A- Stable 2,430,694
City of Hope (Hope National Medical Center) CA A+ Stable 2,123,689
Atrius Health MA BBB Stable 1,990,848
Children's Healthcare of Atlanta, Inc. GA AA+ Stable 1,781,140
Cook Children's Health Foundation TX AA Stable 1,725,386
Health First, Inc. FL A Stable 1,656,046
Methodist Hospitals of Dallas TX AA- Stable 1,618,531
Saint Francis Health System of Tulsa OK AA+ Stable 1,555,669
Children's Mercy Hospital MO A+ Stable 1,447,305
Childrens Hospital of Los Angeles CA BBB+ Stable 1,337,110
Gundersen Lutheran WI AA- Stable 1,303,044
H Lee Moffitt Cancer Center & Research Institute Inc. FL A- Positive 1,297,835
Covenant Health TN A Stable 1,296,515
Mcleod Regional Medical Center of the Pee Dee Inc. SC AA Stable 1,140,462
Denver Health & Hospital Authority CO BBB Stable 1,119,455
Aspirus Combined Group WI AA- Stable 1,092,541
Southcoast Health System Inc. MA BBB+ Stable 1,032,463
*As of April 29, 2019.

Chart 6


Table 3

Funded Status Ranges By Rating Category*
--Fiscal 2017-- --Total (fiscal year)--
AA A BBB SG 2017 2016 2015 2014 2013
Funded status (%)
More than 100 issuers 7 8 5 1 14 14 17 19 27
76-100 54 68 25 1 105 105 140 171 174
51-76 18 54 17 9 137 137 114 85 75
26-51 1 0 0 1 9 9 3 3 3
0-26 0 0 1 0 0 0 1 0 0
Total 80 130 48 12 270 265 275 278 279
*As of March 1, 2018. SG--Speculative grade.

This report does not constitute a rating action.

Primary Credit Analysts:Anne E Cosgrove, New York (1) 212-438-8202;
Wendy A Towber, Centennial (1) 303-721-4230;
Todd D Kanaster, ASA, FCA, MAAA, Centennial + 1 (303) 721 4490;
Secondary Contacts:Kenneth T Gacka, San Francisco (1) 415-371-5036;
Martin D Arrick, San Francisco (1) 415-371-5078;
Research Contributor:Prashant Singh, CRISIL Global Analytical Center, an S&P Global Ratings affiliate, Mumbai

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