• Average annuity purchase rates decreased this past month- with the average duration 7 annuity purchase rate at 4.69% and average duration 15 annuity purchase rate at 4.66%.
• Last month’s strong stock market returns offset the dip in interest rates.
• Although we observed a drop in average annuity purchase rates in December, rates are still up more than 250 basis points since the beginning of the year.
• Year to date, the annuity purchase cost of retiree placements made by October Three was consistently between 94% – 104% of the pension accounting value with the average at 100.67%.
• Pension Risk Transfer Market activity exceeded expectations and was at an all time high in 2022. This activity is expected to spill into 2023 so plan sponsors should consider connecting with an annuity search firm soon.
As mentioned in the Pension Finance update, low interest rates this past month offset the impact of higher stock market returns. Annuity purchase interest rates have steadily increased throughout the year but dipped slightly in December. Both the average duration 7 rate and average duration 15 rate decreased 50 points in the last month. Year to date, average rates have increased 250 basis points with the average duration 7 annuity rate at 4.69% and the average duration 15 annuity rate at 4.66%. The average rates observed in 2022 are over 180 basis points higher than the 2021 average annuity purchase interest rates. Market activity has exceeded expectations. Total market will likely surpass $50 billion in premium at the close of 2022. The market rush is expected to continue into 2023. It is crucial for plan sponsors to enter the market place sooner rather than later to exploit favorable pricing.
Although we recorded a drop in rates this past month, the overall upward trend in annuity purchase interest rates and treasury yields remain. As seen in the graph below, rates in 2022 have been higher than historical averages. Since January 2022, rates have more than doubled. In 2022, the average duration 7 annuity rate was 3.71% and the average duration 15 annuity purchase rate was 3.76%. Annuity purchase interest rates and treasury yield rates fluctuate over time. The 10 year treasury rates correlate with the duration 7 annuity purchase interest rates. Similarly, the 30 year treasury rates correlate with the duration 15 annuity purchase interest rates. Given the rapid increase in rates and surge in market activity, a timely entry into the market place is critical for plan sponsors to receive favorable pricing. Implementing a Pension Risk Transfer strategy can help a plan sponsor fulfill organizational goals, including reducing volatility in financial disclosures due to volatile interest rates.
The graph below displays the spread between annuity purchase price above GAAP projected benefit obligation (PBO). We refer to GAAP PBO and accounting book value interchangeably. In December 2022, the spread for Annuity Plan 1 and Annuity Plan 2 widened. However, the spread for both plans remains lower than twelve months ago. In 2022, we observed the annuity purchase cost of retiree placements was consistently between 94% – 104% of the pension accounting value with the average at 100.67%. An increase in annuity purchase rates inversely lowers annuity purchase prices relative to accounting book value. Please note, that the below PBO calculations exclude future overhead costs paid by plan sponsors to retain participants in the plan. Administrative expenses and PBGC premiums are examples of these overhead costs. Future overhead costs would narrow the spread, though the extent is plan specific.
Annuity purchase cost can jump from month to month. Given the decrease in rates this past month, we recorded an increase in annuity purchase cost in December. Since last month, The purchase price for Annuity Plan 1 increased 2.96% and Annuity Plan 2 increased 5.66%. Since January 2022, the purchase price for Annuity Plan 1 dropped 20% and the purchase price for Annuity Plan 2 reduced by 32%. An early entrance to the insurance market is a vital component of the planning stage because of the consistent short-term volatility of annuity pricing. By connecting with an annuity search firm early on, plan sponsors can capitalize on favorable fluctuations in a volatile market.
Additional Risk Mitigation Strategies to Consider
Annuity purchases for plan sponsors do not need to occur on an all-or-nothing basis. Many plan sponsors can benefit by purchasing annuities even for a subset of plan participants. This is especially true for retirees with small benefit amounts. In 2022, we have seen an increase in the number of lift-out transactions. We expect to see even more the remainder of the year. Plan sponsors pay PBGC premiums for participants that do not vary based on the size of the participant’s benefit. For retirees with small benefit amounts, the PBGC premium overhead burden is substantial and can be eliminated through an annuity purchase. Retiree carveouts have controlled a vast majority of market activity in 2022 so we are expecting to see more plan terminations in 2023.
Have a pension risk transfer need but not sure where to start? See our article, What to Look for in An Annuity Search Firm.
October Three advises plan sponsors through every step of the Pension Risk Transfer (PRT) process. Through long-established relationships with insurers in the PRT marketplace, October Three collects annuity purchase rates for Duration 7 years and Duration 15 years on a monthly basis. We have constructed two hypothetical annuity plans, which have been valued using the latest mortality tables and mortality improvement scales. Annuity Plan 1 contains retirees only and has a liability duration of 7 years. Annuity Plan 2 includes 70% retirees and 30% deferred and has a liability duration of 15 years. Using the collected annuity purchase rates and 2 hypothetical annuity plans, we have produced the following graphs representative of actual PRT market activity and the corresponding impact on pension plans.