Annuity Purchase Update: February 2020 Interest Rates

As mentioned in our January 2020 Pension Finance Update, pension plans lost ground last month. The strong equity market returns of 2019 were set back by a poor performance in January. The average duration 7 annuity purchase interest rates and average duration 15 rates have both decreased by roughly 35 basis points since last month. This decrease in rates led to a corresponding increase in annuity purchase prices of approximately 2% for Annuity Plan 1 and 6% for Annuity Plan 2. During our experience, insurers priced annuity purchases in 2019 aggressively and insurers are continuing to do so at the start of 2020.

History demonstrates annuity purchase interest rates fluctuate over time with varying degrees of peaks and valleys. We’ve observed an upward trend in both duration 7 and duration 15 annuity purchase rates since September of 2019. However, last month, duration 7 rates decreased 34 basis points and duration 15 rates decreased 37 basis points. Plan sponsors should consider getting their data in order for a Pension Risk Transfer. 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 spread of annuity purchase prices above the GAAP projected benefit obligation (PBO) remained fairly stable during 2019. This spread was around 3% for Annuity Plan 1 and 11% for Annuity Plan 2. In January 2020, the spread increased in part due to adoption of the new Pri-2012 mortality tables and MP-2019 mortality improvement scales, which generally lowered GAAP liabilities. In February 2020, the spread increased further as a result of the drop in annuity purchase interest rates and yield curve interest rates this month. Relative to GAAP, we have seen that an increase in annuity purchase rates generally lowers annuity purchase prices.

Keep in mind 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.

This past year, a significant month-to-month cost volatility has persisted. Timing an early entrance to the insurance market is a crucial part of the planning stage because of the consistent short-term volatility of annuity pricing. Sponsors can take advantage of favorable fluctuations in a volatile market by connecting with an annuity search firm early.

Looking ahead to future plan years, per our January Pension Finance Update, PPA funding relief will gradually sunset and this will generally lead to increased contributions from plan sponsors. Plan sponsors may wish to use these contributions to reduce the plan’s overall liability through Pension Risk Transfer.

In 2020, the PBGC Flat-Rate Premium will increase to $83 per participant, the Variable-Rate Premium will increase to 4.5% of unfunded vested benefits, and the Variable-Rate Premium Cap will increase to $561 per participant. Per our 2019 PBGC Premium Burden Report, PBGC premiums remain a major threat to pensions, and continued attention to premiums should be a central part of viable pension management for the foreseeable future. Through use of a Pension Risk Transfer, plan sponsors can eliminate or significantly reduce future PBGC premiums.

In October 2019, the Society of Actuaries published (1) a new Mortality Improvement Scale MP-2019 and (2) new base Pri-2012 Mortality Tables. Both the MP-2019 and Pri-2012 will generally reduce defined benefit plan liability valuations marginally.

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 collects annuity purchase rates for Duration 7 years and Duration 15 years from several insurers on a monthly basis. We have constructed 2 hypothetical annuity plans which have been valued using the latest mortality tables. 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. Using the collected annuity purchase rates and 2 hypothetical annuity plans, we have produced the following graphs representative of actual 2019 and 2020 Pension Risk Transfer market activity and the corresponding impact on pension plans.