September 2022 Annuity Purchase Update
• The average Annuity Purchase Interest rates jumped this past month, with the average duration 7 rate at 4.24% and average duration 15 rate at 4.25%.
• Pension funding status varied last month as high interest rates offset the impact of poor stock market returns.
• Annuity Purchase costs for Annuity Plan 1* and Annuity Plan 2* dropped significantly this past month, the lowest we have observed year to date.
• Average annuity purchase rates have increased over 240 basis points in the last twelve months.
• Pension Risk Transfer market remains lively as plan sponsors transact at record pace to exploit favorable rates.
As mentioned in the Pension Finance update, stock market returns were poor last month resulting in varied plan funding status. However, high interest rates offset the low returns. Average annuity purchase interest rates hit record setting highs this month. In the last twelve months, average rates surged roughly 240 basis points with the average duration 7 annuity rate at 4.24% and the average duration 15 annuity rate at 4.25% . There has been a rapid increase in the Pension Risk Transfer market since 2021. Year to date, there have been roughly 200 placements with over $17 billion in premiums. The market rush is expected to continue into the second half of 2022. It is crucial for plan sponsors to enter the market place sooner rather than later to exploit favorable pricing.
Year to date, we have observed an overall spike in annuity purchase interest rates and treasury yields, however, as seen in the graph below, annuity purchase interest rates and treasury yield rates vary 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 difference between annuity purchase price above GAAP projected benefit obligation (PBO). We refer to GAAP PBO and accounting book value interchangeably. In September 2022, the spread for Annuity Plan 1 slightly decreased to 1.49% and increased to 4.72% for Annuity Plan 2. The spread for both plans remains lower than the observed average. 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 alter from month to month. Although the annuity purchase cost for both plans increased last month, we have seen a general downward trend in cost in 2022. Since last month, The purchase price for Annuity Plan 1 decreased 2.75% and Annuity Plan 2 decreased 3.87%. 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.
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. 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.
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.