February 2024 Annuity Purchase Update
Marketplace momentum spilled into 2024 as we observed the first jumbo purchase of the year with Shell USA offloading nearly $5 billion in pension liability.
The influx of market activity we observed in 2023, lead some insurance carriers to revisit their underwriting guidelines - increasing their minimum transaction size and even requiring more lead time to review placements.
Prudential Financial Inc. successfully concluded a Pension Risk Transfer deal with Shell USA, Inc. covering approximately 21,500 of the companies' retirees and totaling nearly $5 billion in pension obligations.
Historical observations reveal that insurers face substantial capacity constraints during the final two quarters of the year, underscoring the importance of entering the marketplace as early as possible to allow ample time for de-risking plans.
Primarily driven by high annuity purchase interest rates, last year marked a record high with an estimated 700 annuity transactions.
As PBGC costs increased yet again, implementing a retiree-carveout, particularly for retirees with small benefits, can be a highly effective strategy for reducing PBGC premiums, resulting in substantial long-term cost savings.
After experiencing a record-breaking year in 2023, the Pension Risk Transfer Market is seeing some spillover into 2024. As mentioned in the Pension Finance update, at the start of 2024, there was mild improvement in funded status, as mixed stock market returns were offset by higher interest rates. As of February 1st, average annuity purchase interest rates presented stability, with both the average duration 7 rate and average duration 15 rate tracking together at 4.55%. Since January, the average duration 7 rate increased 6 points and the average duration 15 annuity purchase rate increased 8 basis points. As we move through the first quarter of 2024, interest rates are presenting a steady pattern, yet their trajectory could potentially shift in the coming months which is why it is important for plan sponsors to act quickly as we continue into the year. Competition among insurers in the marketplace intensified throughout the last year fueling competitive bids. By the second half of the year, insurance companies were hitting capacity constraints leading them to reevaluate their underwriting guidelines – raising their minimum liability criteria and even requesting more lead time to review placements. It is crucial for plan sponsors to connect with an annuity search firm sooner rather than later to achieve their derisking goals, navigate the changes we are seeing in the marketplace, and achieve competitive pricing.
As we drive through the second month of the year, annuity purchase interest rates have been consistent. Historical data illustrates that annuity purchase interest rates and treasury rates exhibit variability over time, undergoing fluctuations in response to market dynamics. 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. Despite a decline in interest rates towards the end of 2023, there has been a gradual uptick as we begin to approach the end of the first quarter. The Pension Risk Transfer market experienced a shock by the latest rate of inflation, prompting a rise in interest rates for the 10-year treasury. This pushed the probability of a rate cut by the Fed later in the year. The higher rates suggest an opportune time for Plan Sponsors that want to take advantage of the favorable market conditions. Historically, the pension risk transfer market experiences its peak activity during the last two quarters, indicating that plan sponsors should take the initiative during the earlier months to secure their purchase and position themselves so they can later exploit favorable pricing conditions.
Top 3 ways PRT is lowering plan costs
The graph below shows the spread between annuity purchase price above GAAP projected benefit obligation (PBO). We refer to GAAP PBO and accounting book value interchangeably. In the previous month, the spread between annuity purchase price above GAAP PBO slightly narrowed. For Annuity Plan 1, the spread decreased to 0.62% and Annuity Plan 2 reduced to 3.83%. The present margin remains lower than the average for the entirety of 2023. A decrease in annuity purchase rates inversely increases annuity purchase prices relative to accounting book value. Please note that the below PBO calculations exclude future overhead costs paid by plan sponsors to retain participants in the plan. Administrative expenses and PBGC premiums are examples of these overhead costs.
The graph below represents the annuity purchase price relative to GAAP projected benefit obligation (PBO) of the retiree cases placed by October Three Annuity Services since 2021. We kicked off 2024 with a purchase that closed at 102.53% of GAAP PBO. In 2023, annuity purchase cost for retirees was on average 102.52% of the accounting book value. Since 2021, the average purchase cost was 101.16% of GAAP PBO. Consistent with the marketplace, October Three Annuity services also hit a record high in volume of transactions.
As you can see below, this month we observed a marginal decrease in prices across both hypothetical plans. This month the annuity purchase price decreased for Annuity Plan 1 by 0.92% and for Annuity Plan 2 by 0.34%. While the graph below shows month-to-month data changes, it is important to note that interest rates are subject to market conditions and fluctuate daily. As evident below, short-term volatility is present in the annuity purchase market and given this frequent volatility, it is wise to enter the marketplace early and be strategic with planning. Plan sponsors looking to derisk their pension plans could leverage the fluctuations and “lock-in” favorable rates by settling their retiree portion of their liabilities.
Last year was a record year in terms of the number of transactions for the Pension Risk Transfer Market. Although annuity purchase rates took a hit the last few months, plan sponsors are taking strides to de-risk their pension plans. Robust market activity made it impossible for plan sponsors to transact as the fourth quarter was closing. Plan Sponsors should consider connecting with an annuity search firm and getting data in good order sooner rather than later to avoid the capacity constraint hurdles that will arise later in the year. Annuity purchases do not need to occur on an all-or-nothing basis so to capitalize on favorable market conditions, a plan sponsor should consider purchasing annuities for a subset of the retiree population with small benefits. PBGC premiums for participants do not vary based on the size of the participant's benefit. Purchasing annuities for a subset of the population would guarantee PBGC savings.