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Challenges have emerged in the annuity purchase marketplace in recent weeks, as rapidly falling interest rates have led to increased purchase prices.
Experts have indicated that it is likely the Federal Reserve will cut interest rates in coming months prompting plan sponsors to act quickly and secure a spot in the Pension Risk Transfer Marketplace if they want to transact before year-end.
As we approach the end of the year, insurers are expressing capacity constraints and calendar conflict. These issues are expected to intensify in the last few months of the year so plan sponsors should act immediately to secure a spot in 2024.
Despite the recent decreases in annuity purchase interest rates, rates remain 21 basis points higher than annuity purchase interest rates observed at the beginning of the year.
In the first few months of 2024, annuity purchase interest rates trended upwards, building on the record-breaking rates seen in 2023. Starting in May, we observed a shift in interest rates, marking the beginning of a downward trend that persisted through August. So far in 2024, the average interest rate for the duration 7 annuity purchase interest rate is 4.81%, while the duration 15 interest rate averages around 4.75%. As shown in the graph below, this month the duration 7 rate has fallen to 4.70% and the duration 15 rate has decreased to 4.68%, both now below the overall 2024 average. As noted in the Pension Finance Update, Pension Plan Sponsors experienced their first funding setback this year with the recent decline in interest rates. The probability of interest rates declining has continued to increase throughout 2024 and rate reductions now seem imminent. Plan sponsors have increased their interest in de-risking their plans. The market is starting to become saturated and insurance companies are being more selective. For those who are still deciding, immediate action is necessary.
Both the 10-year and 30-year treasury rates have fallen since last month. The 10-year treasury rate was 3.99% at the start of the month while the 30-year treasury rate was 4.27%. Both treasury yields continued to decline since the beginning of the month. The spread between the 10-year and 30-year treasury rates has also widened, making them 28 basis points apart. Despite the declining rates, the market remains robust, and insurers are facing capacity constraints due to the high volume of placements. Entering the marketplace in a timely manner is important in order to maximize savings and insurer participation.
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. In August 2024, the spread for Annuity Plan 1 slightly decreased to 0.09%. This is one of the lowest we have witnessed in both 2023 and 2024. For Annuity Plan 2, the spread increased to 4.59%. 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 retiree cases placed by October Three Annuity Services since 2021. In 2023, annuity purchase cost for retirees was on average 102.52% of the accounting book value. Since 2021, the average purchase cost was 101.01% of GAAP PBO. At the start of the third quarter of 2024, October Three Annuity services closed two placements below GAAP PBO. Thus far, the 2024 average annuity purchase cost of retiree transactions placed by October Three Annuity Services is 99.89% of GAAP PBO. Despite the decrease in rates, the marketplace has been very busy and continues to get busier.
Although the graph below illustrates month-to-month fluctuations, annuity purchase costs vary daily. As you can see, the cost for both plans increased. Annuity Plan 1 saw a rise of 1.39% while Annuity Plan 2 jumped up to 2.36%. Ongoing fluctuations in annuity purchase interest rates serves as a reminder that rates and prices can change quickly. Despite the recent rise in prices, they remain at a favorable level compared to what we’ve seen historically. However, there is still potential for costs to continue climbing, so plan sponsors should enter the marketplace promptly to avoid further price increases.
As we approach the end of the third quarter of 2024, the pension risk transfer marketplace is thriving, and insurance companies are starting to face capacity constraints and calendar conflicts. The fourth quarter is typically the busiest time in this marketplace, and historically, insurer participation can start to lower. Additionally, with rates trending downward, annuity purchase prices are rising, and this trend is expected to persist through the end of the year. To secure the most favorable rates and ensure maximum insurer participation, plan sponsors should contact an annuity search firm immediately and secure a spot to complete a purchase in 2024. Annuity purchases can be made selectively rather than all at once. Since PBGC premiums for participants remain consistent regardless of benefit size, plan sponsors should consider purchasing annuities for a portion of the retiree population with smaller benefits to maximize PBGC savings.
*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.