Tim Weld
Gina Klein

At a Glance  

  • Proposed rules in accounting for defined benefit plans may affect hospitals' statement of operations and affect the time, effort, and cost to comply with periodic financial reporting requirements.  
  • The new standard would require immediate recognition of the full amount of plan amendments in determining operating income.  
  • Hospitals should consider the role of pension plans in their compensation programs. 

In the grand scheme of issues that hospital CFOs are facing these days, a future potential change in accounting rules for defined benefit pension plans probably doesn't top the list. It's one of those "I'll cross that bridge when I come to it" issues, still awaiting attention and decisions by U.S. standard setters about moving toward global uniformity in reporting requirements. But the prospect of pension accounting change on the horizon-coupled with rising pension costs, lower utilization rates, declining payment, and the convergence of sectors and organizations within the health industries-has created a perfect storm for hospitals and health systems, many of which are wondering if now is the time to make changes in their benefit plan strategies.

Whether following the guidelines of the Financial Accounting Standards Board (FASB) or the Government Accounting Standards Board (GASB), hospitals may face potentially significant changes in pension accounting requirements, which would affect their statement of operations and increase the time, effort, and cost to comply with periodic financial reporting requirements.

Reforming pension accounting has been a key priority for the FASB and the International Accounting Standards Board (IASB) for some time now. The GASB has also made significant progress on its own postemployment project and is currently redeliberating issues presented in its Preliminary Views publication issued in June 2010. In 2006, the FASB published rules requiring companies to report, for the first time, the current value of the net benefit obligation (or funded status) on their balance sheets. But it did not require changes in the values of benefit obligations and plan assets to be immediately reflected in determining net income, a key bone of contention.

Delayed recognition of plan amendments and gains and losses on the obligations and the fair value of plan assets have the effect of smoothing reported benefit expenses in the income statement from one reporting period to the next. Critics have argued that this treatment makes it difficult to get an accurate picture of the true economics of the plan. Concern was further heightened by the fact that many plans suffered significant losses during the financial crisis due to market volatility, and changes in the value of plan investments as well as assumptions used to measure plan obligations were not reflected in net income, but rather deferred over many years.

Impact of Proposed Accounting Rules

In 2010, the IASB proposed new rules in accounting for defined benefit pension plans, and is expected to issue a final standard this month. The IASB standard is not the result of joint deliberations with the FASB. Rather it is part of the IASB/FASB convergence project, although pension accounting is currently inactive on the FASB agenda. In January, the FASB's newly appointed chairman announced that the board's project on pension accounting is "not currently on the agenda" for this year. She did, however, say that the FASB plans to evaluate differences between its standards and the final IASB standards to determine whether the differences are important enough for the board to raise the priority of its pension accounting efforts, potentially accelerating adoption of converged standards to create a global pension accounting standard.

If that happens, the accounting change would affect approximately 30,000 qualified defined benefit plans in the United States, including those of hospitals and health systems, which have historically relied heavily on defined benefit plans as a means for attracting and retaining a highly skilled workforce, particularly physicians.

A significant impact of the proposed standard in pension accounting would be a requirement for immediate recognition of the full amount of plan amendments in determining operating income; the deferral and amortization method now used under U.S. GAAP would no longer be acceptable. Gains and losses would also be immediately recognized, but through other comprehensive income, again eliminating deferral and corridor approaches. Moreover, because the IASB does not permit "recycling" (reclassifying amounts from other comprehensive income to net income in future periods), this would be a significant divergence from U.S. GAAP.

Because the IASB did not consider the reporting for not-for-profit hospitals and healthcare organizations that do not report other comprehensive income, it is unclear how these changes would affect them. However, in considering not-for-profit organizations, the FASB generally appears to support the notion that external financial statements should provide information that allows present and future resource providers to make resource decisions.

The increase in merger and acquisition activity among hospitals, health systems, and other for-profit and not-for-profit healthcare organizations further complicates the matter. When companies and plans merge, the new entity ends up with different types of benefits based on different plans. A key consideration is whether to carry over the plan and/or amend it. Under the new standard, if it is adopted in the United States, amendments would need to be immediately recognized in net income.

Immediate recognition of gains and losses, including gains and losses related to plan asset performance, would mean significant balance sheet and comprehensive income volatility from one reporting period to the next, with limited means for offsetting losses that could affect credit ratings, debt covenants, and cost of capital, and thus would indirectly affect cash flow. The expected ROIs set aside to pay benefits would be determined on the basis of the discount rate used to estimate the present value of the benefit obligation; it would no longer be based on an expected long-term rate of return on plan assets. And benefit expenses would be disaggregated, with the components presented in different places in reporting net income and comprehensive income; it would no longer be presented as a single number. However, components included in net income may be aggregated.

The proposed changes in pension accounting come on the heels of the Pension Protection Act of 2006, which raised contribution requirements and risks for pension plan sponsors whose funding ratios fall below certain thresholds. The new accounting standard, if adopted, could focus more attention on the overfunded or underfunded status of a hospital's plan.

Many are confident that the new standard will eventually apply to U.S. companies either because the United States adopts International Financial Reporting Standards (IFRS) or because the FASB decides to converge with the IASB standard. Although the effective date of the new IFRS pension accounting standards is not expected until 2013 and it is unclear when the FASB will change U.S. GAAP, many hospitals and health systems already are considering whether now is the time to make changes to their existing plans-or eliminate their plans altogether.

Many alternatives are under consideration, ranging from changes in plan design to asset allocation strategies. Plan design changes could include terminating the plan altogether or freezing the plan, thereby eliminating the ability of participants to earn additional benefits under the defined benefit plan and future benefits would shift to a defined contribution plan, such as a 401(k) or 403(b). An additional plan design alternative could be to create a hybrid plan, which contains features of both defined benefit and defined contribution plans.

Asset management strategies might include increasing allocation to bonds, extending bonds' duration, or using interest rate swaps and other derivative instruments to hedge risks. In addition, the pension obligation can be settled either through lump-sum distributions directly to participants or by purchasing an annuity thereby shifting the risk to an insurance company.

What Hospitals Should Do

Each organization will need to assess the benefits of different strategies depending on its unique circumstances, risk tolerance, and legal obligations. As hospitals and health systems consider the role of pension plans in their compensation programs, they should address a number of key questions, including the following:

  • How does the pension plan fit into the organization's overall compensation and benefits packages? Will recruitment and retention be affected by any changes made to the plan?
  • How is the current plan viewed by the board, executives, clinical staff, unions, and the media? How would their views be affected by plan changes or revisions to asset mix?
  • To what extent would the impact of accounting changes affect plan design and asset management strategies? Should the plan remain unchanged regardless of the impact of the accounting change, and how will that affect the organization?
  • Will a change in plan design require collective bargaining with union groups?
  • Are there any legal constraints to making changes in plan design or asset management strategies?
  • What are the tax implications for participation should there be a change in plan design?
  • When is the best time to make changes in plan design or asset management strategy?
  • How should changes in the plan be communicated, and to whom?

Tim Weld is healthcare assurance provider leader, PwC, New York (

Gina Klein is a director, HR Accounting Advisory Practice, PwC, New York (


Publication Date: Monday, May 02, 2011

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