July 2024 Annuity Purchase Update
Insurers are approaching capacity limitations. Plan sponsors aiming to complete transactions this year should connect immediately with an annuity search firm to achieve their de-risking goals.
Annuity purchase interest rates have slightly declined since last month, dropping by 9 basis points for the average duration 7 annuity purchase interest rate and 3 basis points for the average duration 15 rate.
Despite the recent decrease in annuity purchase interest rates over the last few months, they remain higher compared to the average annuity purchase rates recorded in all of 2023.
With interest rates averaging higher than previous years as well as strong stock market returns, the Pension Risk Transfer marketplace remains active.
We are entering that time of year when insurers are beginning to be more selective in opportunities due to capacity constraints, so plan sponsors should act immediately to secure a spot in 2024.
As we look back on the first half of 2024, we initially observed an upward trend in annuity purchase interest rates. There was a gradual rise in the first few months of the year, but as we moved through Q2, we began to notice a consistent decline in rates. As we enter the third quarter of the year, we are still seeing a slight decline in rates. The average duration 7 rate has dipped slightly to 4.95%, while the average duration 15 rate has decreased to 4.89%. However, both average annuity purchase interest rates remain higher than the 2023 average. While annuity purchase rates have trended down slightly, we have seen a greater interest in de-risking in the second quarter. We expected this trend to continue to increase throughout the rest of the year. Many plan sponsors are trying to get ahead of any Federal Reserve rate cuts. As mentioned in the Pension Finance Update, strong stock market returns offset the low interest rates. This enabled pension plan sponsors to achieve steady monthly incremental gains throughout the first half of the year. With that, annuity purchase interest rates fluctuate daily, and there is no guarantee they will stay at these overall elevated levels. Plan sponsors should capitalize on these favorable rates and enter the marketplace timely.
So far in 2024, average annuity rates have remained relatively stable with the overall annuity purchase interest rates ranging from 4.47% to 5.12%. The spread between the 10-year treasury rate and 30-year treasury rate widened, placing the two rates 16 basis points apart. Since the beginning of the month, the treasury rates have declined again. The last two quarters in the Pension Risk Transfer marketplace are traditionally the busiest and insurers are often reaching capacity constraints and facing potential calendar conflicts with new cases. It is strongly encouraged for plan sponsors to enter the marketplace early to secure purchase dates and maximize insurer participation.
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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. For Annuity Plan 1, the spread increased to 4.48% above GAAP PBO, while for Annuity Plan 2 it also increased to 0.29% above GAAP PBO. An increase in annuity purchase rates inversely lowers 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. Future overhead costs would narrow the spread, though the extent is plan specific.
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. Since 2021, the average purchase cost was 101.00% of GAAP PBO. At the end of the first quarter of 2024, October Three Annuity services closed two placements below GAAP PBO. With attractive rates and aggressive pricing from carriers, one transaction closed at 97.25% of GAAP PBO and the other at 93.59% of GAAP PBO. Thus far, the 2024 average annuity purchase cost of retiree transactions placed by October Three Annuity Services is 99.29% of GAAP PBO.
This month, annuity purchase prices presented less volatility compared to previous periods. Annuity Plan 1 showed a slight increase by 0.49%, whereas Annuity Plan 2 had a minor decrease of 0.33%. While the graph illustrates month-to-month fluctuation, it is important to note that annuity purchase interest rates are market-dependent and fluctuate on a daily basis. By connecting with an annuity search firm early and entering the marketplace sooner rather than later, plan sponsors could leverage advantageous fluctuations of annuity purchase interest rates.
As we enter into the third quarter of 2024, it is crucial to remember the anticipated busy season that we've traditionally seen in the last two quarters of the year in the pension risk transfer marketplace. Insurers are known to reach capacity constraints during this time of year, which can limit participation opportunities for new purchases. Along with that, there is no certainty whether annuity purchase interest rates will continue to exhibit stability for the remainder of the year given the market volatility. In such a dynamic marketplace, it is very important to engage with an annuity search firm early to evaluate optimal options for de-risking your plan.
*October Three advises plan sponsors through every step of the Pension Risk Transfer (PRT) process. Through long established relationships with insurers in the PRT marketplace, 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.