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January 2023 Annuity Purchase Update

• Average annuity purchase rates increased this past month- with the average duration 7 annuity purchase rate at 4.76% and average duration 15 annuity purchase rate at 4.73%.

• 2022 marked a record setting year for Pension Risk Transfer as the market closed at roughly $52 billion in premium and about 300 transactions.

• Average annuity purchase rates are up more than 250 basis points since January of 2022.

• In 2022, the annuity purchase cost of retiree placements made by October Three was consistently between 94% – 105% of the pension accounting value with the average at 100.55%.

• Pension Risk Transfer Market activity exceeded expectations and was at an all time high in 2022. This activity is expected to spill into 2023 so plan sponsors should consider connecting with an annuity search firm soon.

Narrative

As mentioned in the Pension Finance update, 2022 was a turbulent year in terms of stock market returns, however pension finance remained relatively stable due to the increase in interest rates. Annuity purchase interest rates followed an upward trend in 2022. Both the average duration 7 rate and average duration 15 rate increased slightly in the last month. Since January 2022, average rates have increased over 250 basis points with the average duration 7 annuity rate at 4.76% and the average duration 15 annuity rate at 4.73%. Market activity exceeded expectations in 2022. At the close of the year, the total market exceeded $50 billion. The market rush is expected to continue into 2023. It is crucial for plan sponsors to enter the market place sooner rather than later to exploit favorable pricing.

As seen in the graph below, rates in 2022 were higher than historical averages. In 2022, the average duration 7 annuity rate was 3.71% and the average duration 15 annuity purchase rate was 3.76%. As of January 2023, rates are over 100 basis points higher these average rates. Annuity purchase interest rates and treasury yield rates fluctuate 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.

Top 3 ways PRT is lowering plan costs

The graph below represents the annuity purchase price relative to GAAP projected benefit obligation (PBO) of the actual retiree cases placed by October Three Annuity Services in 2022. We refer to GAAP PBO and accounting book value interchangeably. In 2022, the annuity purchase cost was consistently between 94% – 105% of the pension accounting value with the average at 100.55%. Keep in mind that the below PBO calculations excludes fees. As seen in the graph below, majority of market activity occurred in the third and fourth quarter. We typically see a rush closer to the end of the year. We anticipate this activity to carry into 2023 so plan sponsors should use this time to connect with an annuity search firm and get data in good order. It is crucial for plan sponsors to enter the market place sooner rather than later to exploit favorable pricing.

Annuity purchase cost fluctuate from month to month. Given the slight increase in rates this past month, we recorded a decrease in annuity purchase cost in January. Since last month, The purchase price for Annuity Plan 1 dropped .99% and Annuity Plan 2 dipped .83%. Since January 2022, the purchase price for Annuity Plan 1 dropped 20% and the purchase price for Annuity Plan 2 reduced by 32%. 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. 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. Retiree carveouts have controlled a vast majority of market activity in 2022 so we are expecting to see more plan terminations in 2023. The PBGC premium overhead burden is substantial and can be eliminated through an annuity purchase. Retiree carveouts have controlled a vast majority of market activity in 2022 so we are expecting to see more plan terminations in 2023.

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.

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