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.
During December 2016, as indicated by the Index below, the average cost of purchasing annuities from an insurer decreased from 105.5% to 104.7% of the accounting liability. During the same period, the economic cost of maintaining the plan increased slightly from 105.7% to 105.8% 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 Mercer US Pension Buyout Index results for December 2016
- The spread between average insurance company annuity pricing rate and interest rate used to value the plan liabilities narrowed resulting in the relative cost of a buyout decreasing 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. This phenomenon caused a wave of buyout, predominantly plan termination activity starting in 2012.
- Legislation passed in 2016 provides for continuous increases in 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. As a result, in 2016 we saw yet another buyout trend of purchasing annuities for small benefit retired participants which significantly reduces the expense associated with the defined benefit plan. More than half of the premium placed in 2016 was as a result of discretionary retiree-only annuity buyouts.
- 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. There are currently over 100 clients globally using the platform, which is further detailed in our Press Release.
- Interestingly, the cost of doing a buyout decreased noticeably after the presidential elections given rocket movement in capital markets. There has been considerable market volatility as experts try to understand the prospective of the Trump political agenda, but the expected shift towards fiscal stimulus and tighter monetary policy should cause an increase in funded status for defined benefit pension plans, leading to more plan termination and elective buyouts.
Market update for December 2016
- Mercer continues to take a market-leading role in advising plan sponsors on jumbo buyout deals, having been the lead advisor in a recent transaction to settle $2.5 billion in pension obligations. This was the largest buyout transaction in 2016 and the largest deal done solely by a consulting firm. For further information, please go to the press release.
- By the end of 2016, pension risk transfer premiums are expected to have exceeded the ~$14 billion pension risk transfer sales threshold experienced in 2015.
- The Pension Risk Transfer market experienced increased activity during the fourth quarter and as a whole, 2016 has seen a surge of small annuity buyouts. With rates increasing and plan sponsors reaching PBGC caps, we expect buyout activity to increase in 2017.
- Mercer executed a total of 42 annuity placements in 2016, totaling more than $5 billion in Pension Risk Transfer premiums, a premium volume higher than any other strategic advisor in the market.
- Up to two additional insurers are considering entering the market, likely supporting a combination of plan termination and retiree-only obligations.
- An expected IRS update of the base mortality tables and projection factors that defined benefit pension plans must use to determine required contributions, PBGC variable-rate premiums, and minimum lump sums won’t take effect until the 2018 plan year. This delay in change may increase lump sum cash out, active / spin termination, and plan termination activities as plan sponsors take advantage of the lower cost before a possible increase. This, along with expectations for rising interest rates, will likely drive 2017 buyout sales higher than the already high levels we have experienced over the past 5 years.
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 I ndex shows the approximate long-term economic cost of retaining the retiree liabilities on a plan 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 held 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, American United Life Insurance Company, Massachusetts Mutual Life Insurance Company (MassMutual), MetLife, Minnesota Life Insurance Company, Principal, Pacific Life, and Prudential (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
- 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 Mercer's Pension Discount Yield Curve and Index Rates in the US.
- 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%|
|Per participant admin||$30.00|