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 in October of 2014. These updates increased pension liabilities and decreased the relative cost of buying annuities and plan retention costs.


During June, as indicated by the Index, the average cost of purchasing annuities from an insurer increased from 105.0% to 105.2% of the accounting liability. During the same period, the economic cost of maintaining the plan increased from 105.8% to 105.9% of the accounting liability. The economic cost reflects recently-passed legislation increasing future PBGC premiums, which increases the economic cost of maintaining the liability. .  

 

Commentary on the Pension Buyout Index results for June 2016

  • The spread between average insurance company annuity pricing rate and interest rate used to value the plan liabilities widened resulting in the relative cost of a buyout increasing compared to the prior month.
  • A Plan Sponsor's PBO basis, including accounting standard, mortality assumption, and discount rate methodology may impact the attractiveness of insurer pricing compared to plan's ongoing PBO.
  • 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. As plan sponsors recognize these longevity increases, the relative value of the economic liability compared to the balance sheet liability also decreases.
  • Recently-passed legislation increases PBGC premiums starting in 2017. This change increases the economic cost of maintaining the liability, making the business case for de-risking through an annuity buyout more attractive.
  • 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, Mercer has introduced the Mercer Pension Risk Exchange. The Exchange enables plan sponsors to continuously monitor pricing and supports rapid execution of transactions in a more competitive pricing environment. Combined with a robust insurer due diligence process, this will help optimize the transaction economics for plans sponsors while safeguarding the benefit security for plan participants.

Market update for June 2016

  • June was an eventful month in the pension risk transfer market as another jumbo transaction (>$1.5billion) was announced signaling continued growth and insurer appetite for the group annuity business. Financial markets experienced extreme volatility due to Britain’s decision to leave the European Union, which caused some investors to panic but has not had significant impact on the pension risk transfer market. These market events highlight the importance of timing for a successful buyout transaction.
  • Based on the increased activity for elective buyouts, the market is still on track to get very close to the ~$14Billion of pension risk transfer sales we experienced in 2015.
  • Finally, we have seen a number of annuity buyouts resulting from small plan terminations so far this year. The market for plan termination annuity purchases, which includes deferred liability, is still fairly segmented. Although there have been a number of new insurers enter the market, there are only a few who are willing to price and administer deferred provisions, especially with an evergreen lump sum feature. Mercer continues to provide innovative solutions, such as the Mercer Pension Risk Exchange, to support the growing need of plan sponsors to continue derisking activities.

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, United of Omaha and American United Life (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.
 

 MetLife Pacific Life American General Life Companies
     
Prudential Principal Massachusetts Mutual Life Insurance Company
     
United of Omaha American United Life  

 

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

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