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.

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Key takeaways

  • At the end of March, a retiree buyout costs 0.3% more than the economic cost of maintaining the liability for this sample plan, increasing 2.0% since last quarter. (See green line below.) This increased cost can make a buyout less attractive than in the recent past, but may still be an effective way to manage pension risk, depending on a variety of circumstances.

Commentary on the Mercer US pension buyout index results for Q1 2020

  • The average cost of purchasing annuities from an insurer was 106.3% of the accounting liability, while the economic cost of maintaining the plan was 106.0% of the accounting liability. This bucks the recent trend over the past few years of annuities costing less than the economic cost, but an annuity can still make sense as a tool to manage risk and reduce liabilities. The economic cost reflects increasing future PBGC premiums, administrative costs and investment expenses which increase the economic cost of maintaining the liability.
  • The index is based off the arithmetic average of indicative quotes received from carriers. In real deal pricing, we’ve generally seen actual transaction prices 4% to 8% below the index levels. This is driven both by competitive market dynamics and the tendency of the sponsor to select an insurer with a price below the average. Given the dispersion of bids, the index may become particularly disconnected from actual pricing during periods of significant market volatility.
  • During Q1 2020, the average insurance company annuity pricing discount rate decreased while the discount rate used to value plan liabilities slightly increased. The net result of these change is an increase in the relative cost of a buyout.
  • 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.

Market update

  • Over the quarter, we conduced diligence calls with several of the insurance companies. The carriers stated they will continue to bid on pension liabilities however they may be more selective in certain situations. While the rating agencies have downgraded some carriers, we believe the carriers generally remain in strong financial and operational health. We will continue to carefully monitor this area.
  • Credit spreads widened substantially during March. It appears many insurers have not passed on the full benefit of this widening in their pricing. The implication is that annuity prices will be higher than financial reporting obligations, holding all else equal. We saw this relationship manifest itself in the spike in buyout index cost discussed above.
  • Interest rates have been highly volatile during this time. One option to manage this volatility is through Asset in-Kind (AiK) transfers, in which bonds are transferred directly to insurers to pay for the annuity. This helps protect both insurers and plan sponsors against sudden interest rate movements. In addition, executing via AiK allows carrier to avoid elevated transaction costs that might otherwise be transferred to plan sponsors. 
  • Mercer continues to monitor the COVID situation. We are producing coronavirus webcasts every Thursday, providing our latest insights into how it is affecting companies and employees. Some of these webcasts touch specifically on issues related to pensions, investments and risk transfer 

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. It is based on a hypothetical retiree population with duration of 9 and accounting liability of $50 million, using the Mercer Yield Curve to value the accounting liability. In addition, the Index 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. 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.

Annuity pricing data from a number of leading US life insurance companies are used to compile the Index. These insurers include American General Life Insurance Co., American United Life Insurance Company, Massachusetts Mutual Life Insurance Co. (MassMutual), Metropolitan Life Insurance Co., Minnesota Life Insurance Co., Principal Life Insurance Co., Pacific Life Insurance Co., and Prudential Insurance Co. of America (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. Actual annuity pricing can vary significantly from these sample prices.

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For the current value of the Mercer US Pension Buyout Index and full information about the Index, including Methodology for preparation and Important Notices, please visit our website at:
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