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Average annuity purchase interest rates peaked again this month, hitting a record high, with the average duration 7 rate at 5.52% and average duration 15 rate at 5.46%.
Annuity purchase cost for retiree placements brokered by October Three Annuity Services has on average been 100.83% of the pension accounting value (GAAP PBO)
As the busiest season of the Pension Risk Transfer Market nears its end, insurance carriers are declining opportunities due to capacity constraints and having reached their quota for the year. Plan Sponsors should consider getting their data in good order to transact in early 2024.
The robust activity of 2023 is expected to carry into 2024 as elevated interest rates empower plans to de-risk.
Strong pension risk transfer market momentum carried through the first half of the year has extended into the latter of 2023. As mentioned in the Pension Finance Update, over the last three months, pension funding has experienced a decline due to falling stock markets, but have been partially offset by higher interest rates. This month witnessed a substantial rise in annuity purchase rates, reaching a new all-time high. The average duration 7 annuity purchase interest rate peaked at 5.52% and the average duration 15 annuity purchase interest rate rose to 5.46%. Since the beginning of the month, rates have slightly decreased, but remain above average. From the second quarter onward, we have noted a consistent month-to-month rise in rates. Higher annuity interest rates are enticing plan sponsors to consider de-risking their defined benefit plans. In the last month, the average duration 7 annuity rate increased 23 basis points, while the average duration 15 annuity rate increased 24 basis points. Insurance carriers are busier than ever with their calendars quickly filling up. Carriers are being very selective in the placements they choose to partake in. Although many have expressed minimal bandwidth left for 2023, it is encouraged to connect with an annuity broker sooner rather than later to achieve de-risking goals in 2024.
Annuity purchase interest rates and treasury yields continue to demonstrate variations over time. In 2023, we have observed an overall upward trend in both annuity purchase interest rates and treasury rates. Since last month, the spread between the 10-year treasury rate and 30-year treasury rate shortened, placing the two rates 19 basis points apart. Since the beginning of the month, both the 10-year and 30-year treasury rates have decreased presumably due to easing inflation.
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 November, we noted the spread between annuity purchase price above GAAP PBO for both plans narrowed even more so than the previous month. For Annuity Plan 1, the spread decreased to 1.79% and Annuity Plan 2 dropped to 3.69%. The current spreads for both hypothetical plans are lower than historical averages. 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.
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. Year to date, annuity purchase cost for retirees was on average 102.03% of GAAP PBO. Since 2021, the average purchase cost was 100.83% of GAAP PBO. Although 2023 has proven to be a busy year as a whole, the fourth quarter continues to be the busiest time in the Pension Risk Transfer marketplace. As we inch closer to year end, we will continue to see more placements at October Three, but insurance carriers have already expressed reaching capacity for 2023. For optimal competition and increased participation, it is wise for plan sponsors to collaborate with an annuity search firm sooner rather than later.
Throughout 2023, Annuity Purchase interest rates have displayed a consistent upward trend. This month, the annuity purchase price decreased for both hypothetical plans. For Annuity Plan 1 by 1.26% and for Annuity Plan 2 by 2.47%. Annuity Purchase interest rates in 2023 have been less volatile than 2022. Although the graph below shows a month-to-month fluctuation, annuity purchase interest rates are market dependent and actually fluctuate daily. To hedge against this short-term volatility, a plan sponsor terminating their pension plan could settle the retiree portion of their liability to "lock in" favorable rates.
Additional Risk Mitigation Strategies to Consider
This year is on track to be a record year for the Pension Risk Transfer Market. Although pension funding took a hit the last few months, annuity purchase rates have become more attractive. The Pension Risk Transfer Market will continue to gain more traction. Given the robust market activity, purchasing annuities in 2023 may be unattainable, but plan sponsors should consider connecting with an annuity search firm and getting data in good order sooner rather than later to achieve their de-risking goals in 2024. Annuity purchases do not need to occur on an all-or-nothing basis so to capitalize on favorable market conditions, a plan sponsor should consider purchasing annuities for a subset of the retiree population with small benefits. PBGC premiums for participants do not vary based on the size of the participant's benefit. Purchasing annuities for a subset of the population would guarantee PBGC savings.