November 2024 Annuity Purchase Update
After months of observing a steady decline in annuity purchase interest rates, we’ve finally seen a shift, with rates making a rebound.
Annuity purchase interest rates have risen this past month, with the average duration 7 rate increasing by 44 basis points and the average duration 15 rate rising by 36.
Plan Sponsors striving to de-risk before year-end is keeping the Pension Risk Transfer marketplace very busy. Plan sponsors should consider getting their data in order now to put themselves in a good position for transactions in early 2025.
The robust marketplace activity of 2024 is expected to continue into 2025, as elevated interest rates provide greater opportunities for plans to de-risk.
The average annuity purchase cost for retiree placements brokered by October Three Annuity Services has been 101.18% of the pension accounting value (GAAP PBO).
After witnessing a consistent decline in annuity purchase interest rates since early Q2, we’re finally seeing a shift, with rates bouncing back this past month. The average duration 7 annuity purchase interest rate rose to 4.74% while the average duration 15 rate climbed to 4.76%. As noted in the Pension Finance Update, stocks are on pace for another strong year, along with rising long-term interest rates. This duo is providing a tailwind for pension finances, as the general observation for 2024 has been an improvement in pension funding status. With the end of 2024 just around the corner and rates showing a positive shift, now is the perfect time for plan sponsors to connect with an annuity search firm to explore the best strategies for setting their plans up for success in the coming year.
So far in 2024, the duration 7 annuity purchase interest rate has averaged around 4.72% while the duration 15 rate has averaged 4.69%. In comparison, the 10-year treasury rate has averaged 4.17% and the 30-year treasury has averaged 4.38%. The 10-year Treasury rate correlates with the duration 7 annuity purchase interest rate. Similarly, the 30-year Treasury rate aligns with the duration 15 annuity purchase interest rate. As of the beginning of the month, we noted the 10-year treasury rate bump up to 4.37% along with the 30-year treasury rate which had an increase of 4.57%. Since then, both treasury rates have increased again.
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 November, the spread for Annuity Plan 1 decreased slightly to 0.12% while the spread for Annuity Plan 2 increased to 4.54%. 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 101.18% of GAAP PBO. At the start of the third quarter of 2024, October Three Annuity services closed two placements below GAAP PBO. Thus far, the 2024 average annuity purchase cost of retiree transactions placed by October Three Annuity Services is 101.26% of GAAP PBO.
This past month, month-to-month price volatility saw a significant decrease, with Annuity Plan 1 dropping to 2.45% and Annuity Plan 2 falling to 4.03%. It is important to remember that annuity purchase interest rates are market-dependent and can fluctuate daily. To hedge against this short-term volatility, a plan sponsor terminating their pension plan could settle the retiree portion of their liability to "lock in" favorable rates. It’s not too late to engage with an annuity search firm and start the process of entering the Pension Risk Transfer marketplace.
Additional Risk Mitigation Strategies to Consider
This year is on track to be a record year for the Pension Risk Transfer Market. The Pension Risk Transfer Market will continue to gain more traction. Given the robust market activity, purchasing annuities in 2024 may be unattainable, but plan sponsors should consider connecting with an annuity search firm and getting data in good order sooner rather than later to achieve their de-risking goals in 2025. Annuity purchases do not need to occur on an all-or-nothing basis so to capitalize on favorable market conditions, a plan sponsor could 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.
*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.