• The average Annuity Purchase Interest rates slightly dipped this past month, with the average duration 7 rate at 3.78% and average duration 15 at 3.93%.
• Pension funding status increased last month as the stock market experienced their strongest month year to date.
• Annuity Purchase costs for Annuity Plan 1* and Annuity Plan 2* increased this past month, but still remain well below the average cost for 2022.
• Although the average annuity purchase rates decreased this month, annuity purchase costs relative to pension accounting value (GAAP PBO) has narrowed making Pension Risk Transfer solutions attractive to Plan Sponsors.
• Pension Risk Transfer market activity is at a record high in the first half of 2022, with the number of transactions nearly double than the first half of 2021.
As mentioned in the Pension Finance update, stock market returns were strong last month resulting in and increase in plan funding status. On the contrast, average annuity purchase rates slightly dipped with the average annuity 7 rate at 3.78% and average duration 15 rate at 3.93%. Although rates declined, they still remain up over 160 basis points since the beginning of the year. There has been a rapid increase in the Pension Risk Transfer market since 2021. Year to date, there have been roughly 200 placements in over $17 billion in premium. 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.
We have seen an overall spike in annuity purchase interest rates and treasury yields thus far in 2022, 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. Although treasury yields decreased as of August 1, 2022, they increased roughly 100 basis points since January 2022. 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 July 2022, the spread for Annuity Plan 1 slightly increased to 1.79% and 5.89% for Annuity Plan 2. Although it widened, the spread is still substantially lower than the historical averages. An increase in annuity purchase rates generally 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 increased 1.60% and Annuity Plan 2 increased 1.51%. 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. 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. As a result, we have seen an increase in the number of lift-out transactions in 2022.
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.