In this episode, we are joined by John Lowell, Partner at October Three Consulting, to discuss how hospitals can deal with the costs and operation of pension plans.Learn how to listen to The Hospital Finance Podcast® on your mobile device.
Highlights of this episode include:
- How hospitals benefit from continuing pension plans and how they can afford to run them.
- Issues that hospitals face when freezing pension plans and how they can handle them better.
- Why now is the right time for hospitals to address frozen pension plans.
- What different strategies can hospitals implement to address pension plans?
- And more…
Mike Passanante: Hi, this is Mike Passanante and welcome back to the award-winning Hospital Finance Podcast®. Many hospitals have pension plans of one variety or another. However, managing pensions can become a complex financial task that many hospitals are not equipped to address internally. Joining me today is John Lowell, a partner and actuary at October Three Consulting and an expert in benefit and compensation issues with a particular focus on retirement benefits. John is here to help us understand more about how to deal with the costs and operation of hospital pensions. John, welcome to the show.
John Lowell: Thanks very much, Mike. I’m really happy to be here. I know this probably seems like an unusual topic for you and your listeners, but I think we’re going to make the connection for them quite well.
Mike: Yes. This is sort of the other side of the house when it comes to hospital finance. It’s not necessarily the revenue side, but just as important. So I’m really looking forward to the discussion. John, let me start off. Many hospitals still have pension plans, and they come in two varieties, as you explained it to me: ongoing plans and frozen plans. First, let’s talk about hospitals that have an ongoing plan as these are more rare these days. What benefits would they get from continuing to maintain a plan and how can they afford to run them?
John: Mike, what you say is absolutely true. There are probably at this point only about two to three hundred remaining ongoing hospital pension plans left. That said, those hospitals that have them are, for the most part, doing well financially and they’re fully committed to continuing them. If they were going to freeze them or completely get rid of them by now, they would have done that already. So the ones that are left really have made a commitment to each of them. Why? I think what we’ve learned is they see them as a competitive advantage, particularly from a human resources perspective. It gives them somewhat of an edge in recruiting talent and in retaining talent. And they simply view the cost of those plans as part of their total labor costs. So some of them might choose to reduce labor costs in other ways to compensate. But a number of them have looked at this issue fairly carefully, and they say that by decreasing unwanted turnover, they more than make up for the costs of the pensions. And when they design them carefully, these plans give them an opportunity to have what a few of our clients are calling supercharged 401k’s.
So let me explain that with an example. If, for example, you are recruiting a new head of, let’s say, Orthopedic Surgery and you tell that person they can have something like their current 401k, but with a deferral limit, which right now is around $20,000, that might be five times as large or even ten times as large as it is currently, that has a lot of value to them. So put differently, rather than being able to save $20,000 on a tax-favored basis, they can save $200,000 a year on a tax favored-basis. That really does have a lot of value. It adds value to them that they just can’t get in other places.
Another issue that’s bothered hospital finance chiefs about pension plans is the cost volatility. But frankly, that can be controlled. And in fact, by the 2020s, it should be controlled through plan design.
Mike: That’s great. So let’s talk about the other scenario, which are plans that are frozen. What are some of the issues hospitals run into when plans remain frozen? And could they handle them better?
John: Mike, you’re right. There are a lot of frozen pensions out there, particularly at hospitals. And there’s a reason that they exist at hospitals more than perhaps at any other industry, or maybe there are several reasons. But the genesis of this goes back many, many years. Certainly to the 1970s and 1980s. There just aren’t a lot of hospitals out there that are truly new organizations. They might be reformed organizations, but at some point, the actual hospital facility, the hospital incorporation, even if it’s been reformed from a business standpoint, probably in most cases goes back to the 80s, the 70s, or even earlier. And what we in the employee benefits business know about the 1970s and 1980s is virtually all employers gave their employees pensions. It was what you did back then. It was an expectation. The sort of calculus between an employer and an employee in 1980, for example, was you come to work for me, and if you come when you’re late 20s, early 30s, you’re going to make this your career. This is where you are going to spend your working lifetime. And in return for that, if you’re willing to spend your working lifetime with me, I’m going to give you this lifetime income. It’s going to be related to the number of years you spent with me and how much I paid you. But when you retire, you are going to get this pension and it’s going to pay you a benefit for the rest of your life.
Over time, the trend in the United States changed. There are a lot of reasons for it that are for a different time and a different day to discuss. But the fact is that organizations did begin to freeze these pensions. So over time, just as it happened in broader industry, more of these hospitals than not froze those plans. The difference is – and it seems to be very particular based on our research to hospitals – once these plans were frozen, the hospitals treated them as if they were gone. In other words, to use a kind of bad and overused term from late-night infomercials, they went into set it and forget it mode. The problem that that causes is these frozen plans are not at all inexpensive to maintain. And frankly, the less attention that you do pay to them, the more they cost. I guess that makes sense. But that more, so to speak, is usually far more than the cost of having someone on staff to manage them. Once an organization does freeze a plan, its goal should be to terminate it. In other words, make it exist no more. So the difference that we have here is if you have a plan that is frozen but not yet terminated, you are still required to administer that plan, contribute to that plan pay benefits from that plan. And all those things cost money. Once you terminate it you have given up all responsibility for the plan. You’ve taken all the benefits and either cashed them out or sent them to an insurance company. And from your standpoint, both from a cash flow standpoint and from a financial accounting standpoint, that plan is gone. It’s almost like it never existed. So that should be a hospital’s goal. Once they’ve decided they’re not going to provide these benefits anymore, their goal should be to basically eliminate the existence of that plan, eliminate the costs associated with the plan, eliminate what they probably view as the misery associated with the plan. And to do that, their plan should be twofold. It should be to get them to that destination faster and to get to that destination at less cost but most don’t. And most don’t even understand how to do it and that’s a problem. So at October Three, it’s part of our mission to help organizations like that to get to their goals in a more orderly, less expensive fashion. Let me give you an example of how bad it might be. So if you consider a pension plan and we’ll say it’s in a hospital and the size I’m going to use is not unlikely for a frozen hospital pension plan. Let’s suppose that plan has $100 million dollars in assets. So those would be assets that were accumulated over the years through employer contributions and earnings on those contributions. It wouldn’t be that unusual for such a plan to have annual overhead costs where I’m defining that as the cost of keeping the plan going without regard to having to pay down any underfunding in the plan of about 150 basis points. That’s a million and a half dollars per year. And it’s for no benefit to anyone. Nobody’s benefit is increasing while they’re spending that million and a half dollars a year. Nobody at the hospital currently or even who used to be at the hospital is getting an increased benefit. So they’re spending that money mostly for the right to pay people a benefit that they’ve already accrued at some point in the future. That’s expensive and it shouldn’t be. They should be able to get that for less than half of that number without hurting anyone, maybe not instantly but fairly quickly. And if they do that it’ll allow them to wind the plan down much more rapidly. And frankly, it’s just good business to do it.
Mike: Interesting. John, there’s a lot going on in the world that’s affecting the financial positions of hospitals from COVID to the markets to patient ability to pay and lots of other things. Is now the right time to address a frozen pension?
John: I think it is. Again, I like using examples. I think it lays things out well for your listeners, for people in general. About a year ago, and this is really not made up, this is a true story and admittedly, this was before the COVID problems hit us. I did an analysis of several hospitals and their financials and the effect of what I would call the frictional costs of frozen pensions on those margins. So frictional costs are these overhead costs that are not going to benefit any employees, current or past. Some of the results that we found were really staggering to me. If you can imagine, a hospital where operating margins were cut by three-fourths, due to nothing but mismanagement of a frozen pension. That’s right. We found costs that could have been eliminated with a 20-minute conversation, and some more informed decision-making, and doing that would have quadrupled the operating margins of that particular hospital. The sad thing is, this really is sad, this wasn’t their fault. It’s an extremely rare hospital that has deep pension expertise on staff. So they were apparently relying on the advice of the actuaries and other advisers they were paying. And either they were ignoring that advice, or they just weren’t getting it. So three-fourths of their margins went down the drain to legacy frozen pensions, and it was all avoidable. So I would say that now, despite the completely appropriate focus on COVID, and both the direct and indirect problems it’s causing, now is the appropriate time to focus on frozen pensions. I understand they might not be able to do it in-house. If they can’t, I or someone like me, and if it’s somebody at my firm or at one of our competitors, that’s okay. But somebody like me can help them. Their return, inevitably, is going to be one of the best they get in their organization. And if you think about it, if they can cut out three-quarters of a million dollars in annual, unnecessary costs, just by spending a little bit on consulting, that’s going to be a many-fold return on their investment. And they’re probably not getting that in very many places in their organization right now.
Mike: That seems pretty dramatic. John, if a hospital has a frozen pension, what steps would you recommend to address it and what are the benefits of doing that?
John: Great question. At this point, Mike, those hospitals know or maybe they haven’t thought about it, but if they do, they will know what their desired destination is. If they have frozen their pension plans, so they have said internally, we are not going to give any more benefits, then what they want to do is terminate the plan. We talked about this a little bit earlier. They want to make it as if the plan never existed. And on their books and internally, it won’t exist. The goal, their goal should be to set a reasonable time frame to get to that issue. And we’re all about picking destinations and then– or helping our clients pick destinations and then helping them get there, kind of like taking a vacation. And then develop a workable plan to get there. So that means they need several strategies. They need a contribution strategy. They need an investment strategy. They need an administration strategy. And to pay for all of that, and then some, they need a strategy to eliminate all these unnecessary overhead costs associated with the plan. I know it might be an evil word for a lot of people, but consultants or actuaries should be able to help them do that. We certainly can. If they’re committed to getting out of the pension, so to speak, and it sounds like they are if they’ve frozen their plan, our goal is not going to be to try to get them back into the pension business, to try to get them to do something that they’ve already committed to being out of. Our goal is to help them get to the destination that they’ve chosen, to get to that destination faster, and to get there at a lower, total cost. And, if we’ve done that, if we do that for organizations, they’ll be happier, they’ll be more successful, and frankly, we will as well. So, that’s really the best advice I can give somebody who’s committed to getting out of this, is find somebody who can help you along that journey, find somebody who will take that journey with you and get you on that path quickly, efficiently, and with as little pain as possible for you.
Mike: Great insights, John. If someone wanted to find out more about you or your firm, where can they go?
John: They can learn about our firm, Mike, at Octoberthree.com, with the word three spelled out. Or if they’d like to contact me directly, they can try me at firstname.lastname@example.org. That’s j-l-o-w-e-l-l at October three, which is spelled out, dot com. Or they can call me directly at 770-235-8566. And before you close, I really want to thank you for giving me this opportunity. I hope this conversation is useful for you and for all of your followers, and I look forward to hearing from some of them.
Mike: This is great information, John. Interesting view into an aspect of hospital finances we don’t often get into. So thank you very much for coming on the show today.
John: Thank you.