May 2024 Annuity Purchase Update
Annuity purchase interest rates have reached their peak since the start of 2024.
Annuity purchase interest rates have surged to their highest level yet in 2024, with the duration 7 rate at 5.12% and the duration 15 rate at 5.00%. These rates are the highest we've seen since November 2023.
Plan sponsors should be proactive with their planning to allow ample time to enter the marketplace and avoid potential issues with insurers reaching capacity constraints towards year-end.
If the remainder of 2024 mirrors the beginning, 2024 could present another record-breaking year in the Pension Risk Transfer Market.
The significant decrease in prices for both hypothetical plans has presented the largest observed drop thus far in 2024, presenting an excellent opportunity for plan sponsors to enter the marketplace.
As we continue into Q2 of 2024, annuity purchase interest rates have reached their highest point so far this year. These are the highest rates we have recorded since November of 2023. As depicted in the graph below, 2024 has demonstrated a consistent increase in rates since the year’s commencement. As mentioned in the Pension Finance Update, the significant impact of lower stock markets was largely balanced out by higher interest rates. In the last month, the average duration 7 annuity rate increased 32 basis points, while the average duration 15 annuity rate increased 26 basis points. High annuity purchase interest rates and enhanced funding status are motivating plan sponsors to settle either all or a portion of their pension liabilities. Given the expectation of continued robust marketplace activity, it is crucial that plan sponsors connect with an annuity broker promptly to achieve de-risking goals.
Annuity purchase interest rates and treasury yields continue to exhibit fluctuations over time. Thus far in 2024, we have seen a consistent upward trend overall in both annuity purchase interest rates and treasury rates. This month, spread between the 10-year and 30-year treasury rate has decreased slightly, placing them 11 basis points apart. The 10-year treasury rate has jumped to 4.63% while the 30-year treasury rate increased to 4.74%. Since the beginning of the month, both treasury rates have slightly dipped. Understanding that rates are highly volatile and subject to daily fluctuations, timely entry into the marketplace is crucial for plan sponsors to secure favorable pricing.
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 May, we observed a spread between annuity purchase price above GAAP PBO for both plans widen. Annuity Plan 1, the spread increased to 5.08% while the spread for Annuity Plan 2 increased to 0.55%. The spread for Annuity Plan 2 is showing to be lower than historical averages. 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 101.05% 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. Consistent with the marketplace, October Three Annuity services also hit a record high in volume of transactions in 2023.
With interest rates rising month-to-month, annuity purchase prices are presenting very favorable trends. This month the annuity purchases price decreased for Annuity Plan 1 by 1.74% and also decreased for Annuity Plan 2 by 2.82%. This drop in prices marks the most substantial we’ve observed since the beginning of 2024, offering excellent opportunities for plan sponsors to secure these advantageous rates upon entering the marketplace. Entering the marketplace early is crucial for completing a Pension Risk Transfer transaction due to the short-term volatility of annuity pricing. To hedge against short term volatility, a plan sponsor terminating their pension plan could settle the retiree portion of their liability to “lock-in” favorable rates.
With promise evident in 2024, pension funding is improving, and the annuity purchase prices are becoming more attractive, which will continue to generate more traction in the Pension Risk Transfer Market. 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 a participant benefits. 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 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.