While recent changes to specific pension fund accounting standards are credit neutral, the move impacting near two-thirds of non-profit healthcare insurers could produce higher pension expenses and depress margins for some who fall under the US Financial Accounting Standards Board (FASB) standards.
Last week the FASB issued new guidance on how income statement expenses inside defined benefit plans are treated. Moody’s, for its part, doesn’t change its opinion on the credit quality resulting from the changes but remains cautious overall regarding pension funding.
“We expect the presentation changes required by accounting standards update (ASU) 2017-07 to be credit neutral, with only a modest effect on FASB-reporting not-for-profit and public healthcare organizations and universities,” Rita Sverdlik wrote in a February 8 report.
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Moody’s pro forma analysis from 2016 audits showed negligible change in the operating cash flow margin, with slight a positive difference for not-for-profit hospitals and universities. The new guidance is viewed favorably in that it “will help provide a clearer picture of operating income and operating cash flow.”
Moody’s still considers pensions and other post-employment benefits (OPEBs) long-term liabilities and thinks this relative to balance sheet burden. But the rating agency has a sharp eye on the impact the moves will have on pensions and OPEBs on operating expenses.
The changes “will be largely credit neutral” for most issuers. Moody’s calculates that if this accounting method were applied in 2016, pro forma margins would show slight improvement overall:
The median percentage change in the operating cash flow margin for not-for-profit hospitals and universities would be a minimal positive 0.1% and 0.2%, respectively, because of lower pension expenses recognized under the new rules. The operating cash flow margin, like the operating margin, is a measure of profitability that adds back non-cash expenses (including depreciation and interest) to income.
But like any accounting or tax change, there are winners and losers:
However, in other cases, the accounting change will produce higher pension expenses and thus depress margins, because service costs alone may exceed net pension expenses. Under the current FASB reporting rules, the inclusion of expected investment returns and the amortization of gains and losses can more than offset service costs, particularly for well-funded plans. Based on fiscal 2016 audits, about 40% of the affected healthcare entities would be negatively affected by the new accounting rule. We estimate the range of negative impact to operating cash flow margin for impacted issuers to be negative 1.5% to negative 0.1%. The range of negative impact on universities would be similarly modest.
The new guidance began December 15, 2017, for some programs and one year later for others.