April 2023 Annuity Purchase Update
• Average annuity purchase rates dipped this month- with the average duration 7 annuity purchase rate at 4.53% and average duration 15 annuity purchase rate at 4.50%.
• Contrary to the historical lull in market activity we typically see in the beginning of the year, the Pension Risk Transfer Market was very active in the first quarter of 2023.
• Last month, annuity purchase cost for retirees placed by October Three Annuity Services averaged 100.77% of the pension accounting value (GAAP PBO).
•Insurance carriers are reaching capacity constraints given the high volume of placement inquiries in the first quarter. Plan sponsors should consider connecting with an annuity search firm soon.
Narrative
Annuity purchase interest rates experienced an upward climb in 2022, but rates have been more volatile in 2023. Average annuity rates in April were lower than last month with the average duration 7 annuity rate at 4.53% and the average duration 15 annuity rate at 4.50%. As seen in the graph below, average annuity purchase interest rates have fluctuated monthly since the beginning of the year. To hedge against a potential loss as a result of dropping rates, plan sponsors could consider a two part placement and settling the retiree liability earlier than the deferred population. As mentioned in the Pension Finance Update, pension funding slipped in March given the slump in interest rates. However, moderate stock market returns cushioned the dip in funding status. Plan sponsors have been making quick progress in effort to terminate their pension plans. It is crucial to enter the marketplace early so a plan sponsor can be ready to go when the time is right.
The average duration 7 annuity rate was 3.71% and the average duration 15 annuity purchase rate was 3.76% in 2022. In spite of the volatility in rates, average annuity interest rates have been higher in 2023 than the average rates observed in 2022. As seen in the graph below, annuity interest rates and treasury rates vary over time. Since January of 2022, we have seen rates hit a record high. 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 volatility in rates and surge in market activity, a timely entry into the marketplace 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.
Top 3 ways PRT is lowering plan costs
The graph below shows the spread between annuity purchase price above GAAP projected benefit obligation (PBO). We refer to GAAP PBO and accounting book value interchangeably. Similar to last month, the spread for Annuity Plan 1 and Annuity Plan 2 narrowed, jumping closer to the GAAP PBO liability. 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.
The graph below represents the annuity purchase price relative to GAAP projected benefit obligation (PBO) of the actual retiree cases placed by October Three Annuity Services since 2021. Historically, the annuity purchase cost was consistently between 95% – 105% of the pension accounting value with the average at 100.27%. Keep in mind that the below PBO calculations excludes fees. Historically, majority of market activity occurs in the third and fourth quarter. We typically see a rush closer to the end of the year however the first quarter has been vigorous. As of the first quarter of 2023, we have already completed five transactions. This exceeds our Q1 activity of 2021 and 2022 combined. The Pension Risk Transfer Market kicked off 2023 with a strong start and we anticipate this activity to continue throughout the year.
Annuity purchase costs continuously shift from month to month. Since last month, the purchase price increased for Annuity Plan 1 by 1.79% and Annuity Plan 2 jumped 3.13%. An early entrance to the insurance market is an important component of the planning stage because of the consistent short-term volatility of annuity pricing. The earlier a plan can enter the Pension Risk Transfer market the more likely plan sponsors can capitalize on favorable changes in the market.
Additional Risk Mitigation Strategies to Consider
It continues to be difficult to predict any market changes in the future, however the market has proven one thing – volatility. 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 saw an increase in the number of lift-out transactions. 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 when comparing Annuity Search Firms
*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 2 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 contains 70% retirees and 30% deferreds and has a liability duration of 15 years. Monthly annuity rates are determined by taking the average Duration 7 and Duration 15 interest rates provided from the insurers. Annuity Plan 1 was valued using the average of the Duration 7 year interest rates collected from insurers and Annuity Plan 2 was valued using the average of the Duration 15 year interest rates collected from insurers. 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.