February 2025 Annuity Purchase Update
Aggressive insurance carrier pricing and Improved pension funding status -- Why now might be the time to de-risk.
Pension Risk Transfer activity is ramping up due to strong market momentum from 2024 carrying into 2025. This makes it essential for plan sponsors to engage with an annuity search firm early to closely monitor the annuity purchase market to exploit favorable conditions.
Insurance companies sharpen their pencils for 2025 as October Three Annuity Services records retiree pension risk transfer transactions settling at 97%-102% of GAAP PBO.
Surging pension funding status this past month signals an opportunity for frozen Pension Plan Sponsors to seize de-risking advantages.
Both the duration 7 and duration 15 annuity purchase interest rates have remained fairly stable this past month, recording a 5 basis points increase for both durations.
As PBGC costs increased again in 2025, implementing a retiree-carve-out, particularly for retirees with small benefits, can be a highly effective strategy for reducing PBGC premiums, resulting in substantial long-term cost savings.
This year continues to demonstrate a positive outlook as we progress through the second month of the year with annuity purchase interest rates rising once again. Both the average duration 7 and duration 15 annuity purchase interest rates remain relatively stable since last month and increased to 4.94%. As mentioned in October Three's Pension Finance Update, pension funding improved in January. As it states, "Traditional Plan A improved more than 1% last month, while the more conservative Plan B gained a fraction of 1%". U.S. corporate pension funding ratios reached recent highs this last month as well. Today's annuity purchase interest rates may not be the highest we've observed in the last 12 months as shown below, but still mark a historical high. Favorable annuity purchase rates and improved funding status opens the door for opportunity but begs the question: what exactly should a plan sponsor do? It all starts with a conversation. Since interest rates fluctuate daily and future changes are unpredictable, plan sponsors should connect with an annuity search firm immediately to convey derisking goals, assess their options, and get data in good order. At first glance, these tasks may seem quick to accomplish, but in reality, it could take time if not handled correctly, and in this market place timing is everything. Prioritizing these items will enable plan sponsors to act promptly when conditions are favorable.
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. We've seen an upward trend in both the treasury rates and annuity purchase interest rates over the last decade. These optimal conditions that we didn't see years ago are driving plan sponsors with frozen pension plans to act now and annuitize. By doing so, not only are they transferring the liability, but they are reducing plan related costs as well.
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. This past month, we observed that the Annuity Plan 1 spread decreased to 0.19% while the Annuity Plan 2 also decreased to 5.17%. This last month is the sharpest change we have seen since around June of 2024. This further showcases the aggressive pricing we're seeing from insurance companies in the pension risk transfer market place. 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. In 2023, annuity purchase cost for retirees was on average 102.52% of the accounting book value. In 2024 the average annuity purchase cost of retiree transactions placed by October Three Annuity Services decreased to 101.32% of GAAP PBO as the number of transactions and competition increased. Market momentum of last year is spilling into 2025, as we're observing retiree transactions come in as low as 97% of GAAP PBO.
As you can see from the graph below, this month we observed another decrease in annuity purchase price for hypothetical plans. We recorded a smaller fluctuation in price this month than we did last month. Lately there have been larger month-to-month fluctuations than what we observed in early 2024. While the graph below shows month-to-month pricing 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 market place 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.
With annuity purchase rates seeing positive progression in 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 which caused roll-over into the first quarter of 2025. 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. As mentioned in October Three's analysis, plan sponsors not subject to the PBGC Variable Rate Premium Cap, purchasing annuities for retirees receiving less than $350 monthly would be cost effective. For plan sponsors subject to the cap, purchasing annuities for retirees receiving less than $1,050 monthly will result in savings. Purchasing annuities for a subset of the population would guarantee PBGC savings.
*October Three advises plan sponsors through every step of the Pension Risk Transfer (PRT) process. Through long established relationships with insurers in the PRT market place, October Three collects annuity purchase rates for Duration 7 years and Duration 15 years on a monthly basis. We have constructed 2 hypothetical annuity plans which have been valued using the latest mortality tables and mortality improvement scales. Annuity Plan 1 contains retirees only and has a liability duration of 7 years. Annuity Plan 2 contains 70% retirees and 30% deferreds and has a liability duration of 15 years. Monthly annuity rates are determined by taking the average Duration 7 and Duration 15 interest rates provided from the insurers. Annuity Plan 1 was valued using the average of the Duration 7 year interest rates collected from insurers and Annuity Plan 2 was valued using the average of the Duration 15 year interest rates collected from insurers. Using the collected annuity purchase rates and 2 hypothetical annuity plans, we have produced the following graphs representative of actual PRT market activity and the corresponding impact on pension plans.