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MERCER US PENSION BUYOUT INDEX


The Mercer US Pension Buyout Index (the “Index”) tracks the relationship between the accounting liability for retirees of a hypothetical defined benefit pension plan and two cost measures: the estimated cost of transferring the pension liabilities to an insurance company (i.e. a buyout) and the approximate total economic cost of retaining the pension obligations on the balance sheet.

The Buyout Index now reflects that many plan sponsors are using a new mortality assumption to measure their pension obligations, in response to the Society of Actuaries’ publication of the RP-2014 mortality table and MP-2014 mortality improvement scale last October. These updates increased pension liabilities and decreased the relative cost of buying annuities and plan retention costs.

During February, as indicated by the Index, the average cost of purchasing annuities from an insurer increased from 104.1% to 104.4% of the accounting liability. During the same period, the economic cost of maintaining the liability decreased slightly from 105.7% to 105.6% of the accounting liability.

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Commentary on the Pension Buyout Index results for February 2015

  • Interest rates used to value plan liabilities increased more than annuity pricing rates increased during February resulting in the relative cost of a buyout slightly higher.
  • Following the Society of Actuaries’ release of the new mortality table and mortality improvement scale many plan sponsors adopted new mortality tables to value their pension obligations. However, these new higher longevity expectations were likely previously recognized by insurers and have in general not affected the annuity purchase price. As such, a buyout is now significantly more attractive compared to the balance sheet liability.
  • Similar to the decrease in buyout cost, as plan sponsors recognize these longevity increases, the relative value of the economic liability compared to the balance sheet liability also decreases.
  • The Index also illustrates the variability of the buyout cost compared to the balance sheet liability over time. The ability to frequently monitor insurer pricing against pre-determined thresholds, and to be prepared for nimble execution, will help capitalize on varying market and insurer conditions.
  • Taking these factors into consideration we advocate an ongoing custom buyout monitoring process for sponsors interested in these opportunities, combined with a robust insurer due diligence process. This will ensure the best economics for plan sponsors while safeguarding the benefit security for plan participants.

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About the Mercer US Pension Buyout Index

Published monthly, the Index allows plan sponsors to see at a glance the relative cost of a buyout by an insurer of retiree liabilities of a defined benefit plan, and how that cost changes over time. In addition, the index shows the approximate long-term economic cost of retaining the retiree liabilities on a sponsor’s balance sheet. This economic cost includes an allowance for future retention costs (administrative, PBGC premiums and investment expenses). These additional costs are not included in the accounting liabilities published by plan sponsors, but do represent future costs that should be reflected in any risk transfer comparison and evaluation. These costs will vary depending on the specifics of each plan. Based on this evaluation, sponsors can compare the approximate current cost of risk transfer through an annuity purchase with the total cost of retaining obligations on the balance sheet.

Annuity pricing data from a number of leading US life insurance companies are used to compile the Index. These insurers include American General, Massachusetts Mutual Life Insurance Company (MassMutual), MetLife, Principal, Pacific Life, Prudential and United of Omaha (Mercer is not associated with any of the aforementioned insurers). On a given month the Index may be compiled from pricing data from some or all of these insurers.

 

 

 

The Index is provided for a sample plan assumed to consist of retirees only with a duration of nine years. The Index is intended to illustrate general trends only as the actual premium can vary significantly for individual plans. Therefore, the Index should not be used to make plan design decisions. We would be happy to help you gain greater insight into insurer pricing for your plan.

It is important to note that the Index is based on a sample plan. Actual costs for terminating a plan including retirees and non-retirees will depend on a number of factors. Some of these may include:

  • The plan's benefit structure and timing of its anticipated benefit payments
  • The demographic profile of the plan's participants
  • Market conditions prevailing at the time benefits are distributed and annuities purchased
  • Insurer appetite and capacity for a transaction
  • Which employees, if any, receive and accept an offer to take a lump sum instead of an insured annuity

 

Methodology
 

  • Annuity buyout estimates are based on monthly quotations of discount rates for buyout purposes, provided by a number of leading insurers. The discount rates include risk and expense loads to cover all: 1) investment related risks including default, prepayment and reinvestment risk 2) margin against adverse experience 3) margin for profit or return on capital, and 4) expenses including overhead, set-up, per participant costs. The average discount rate is used.
  • The accounting liabilities were valued using the Mercer Yield Curve (MYC). The MYC is used by many Mercer clients to set their discount rate under ASC 715. A full description of the methodology can be found at www.mercer.com/pensiondiscount
  • The buyout liability estimates were calculated by using the single discount rate (the average of the monthly quotations) applied to the same cashflows.
  • The accounting liability shown is assumed to be the Pension Benefit Obligation (PBO) under ASC-715.

 

Economic cost assumptions

 

Default risk cost 0.30%
 
Asset management costs 0.10%
Inflation 2.50%
Wage inflation 3.50%
Participants 700
Retiree age
72
Initial liability 50,000,000
Per participant admin $30.00

 

IMPORTANT NOTICES
 

The Mercer US Pension Buyout Index and any related commentary has been created for illustrative purposes, is presented at a particular point in time and should not be viewed as a prediction of the hypothetical plan or a specific plan's future financial condition. The Index and commentary may not be used or relied upon by any other party or for any other purpose; Mercer is not responsible for the consequences of any unauthorized use.

The future is uncertain, and a plan's actual experience will likely differ from assumptions utilized and these differences may be significant or material. Decisions about benefit changes, investment policy, funding amounts, benefit security and/or benefit-related issues should be made only after careful consideration of alternative future financial conditions and scenarios and not solely on the bases of the index.

We have not included an estimate of actuarial and other professional or administrative fees that are incurred during a plan termination in estimating the relative cost of purchasing annuities. Due to the large number of regulatory filings and the high level of scrutiny on plan census data and benefit calculations, professional fees for a termination or annuity buyout can be significant.

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