September 2024 Annuity Purchase Update
According to LIMRA, the total pension risk transfer premium for the first half of 2024 reached $26 billion, representing a 14% increase compared to 2023.
LIMRA recorded a total of 327 buy-out contracts in the first half of the year, marking the highest number of contracts ever sold in that period.
Annuity purchase interest rates remain higher than historical averages although rates have experienced a decline in recent months. Plan Sponsors looking to transact before year end must act now.
We have continued to observe a downward trend in annuity purchase interest rates, but the activity in the marketplace remains active.
As we enter into the busiest quarter in the marketplace, insurers are facing capacity constraints and resource shortages, which have started to limit their ability to participate in certain placements. This is expected to worsen, making it crucial that plan sponsors enter the marketplace immediately.
Another major purchase was settled, with IBM finalizing a $6 billion pension buyout with Prudential.
Annuity purchase interest rates have continued to present a steady downward trend since May 2024. As highlighted in the Pension Finance Update, pension funding has experienced a decline with lower interest rates leading to increased liabilities. As you can see in the graph below, the duration 7 annuity purchase interest rate has decreased to 4.48%, while the duration 15 annuity purchase interest rate has fallen to 4.51%. May of 2024 marked the peak for annuity purchase interest rates this year for both the duration 7 and duration 15 rates, and we’ve now learned that according to LIMRA, 183 single-premium buy-out contracts were settled during that period, representing an 11% increase compared to Q2 2023 figures. Since then, the duration 7 interest rate has dropped 64 basis points while the duration 15 interest rate has declined 49 basis points. Given the likelihood of continued interest rate drops and the clear trend of rate reductions, immediate action is necessary if plan sponsors want to secure the best possible rates.
Year-to-date, we have recorded an overall drop in both annuity purchase interest rates and Treasury yields, however, as shown in the graph below, annuity purchase interest rates and Treasury yields fluctuate over time. 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. This past month we noted the 10-year Treasury dropped to about 3.80% while the 30-year Treasury rate decreased to 4.20%. Since the beginning of the month, both treasury rates have further declined. It is crucial to note that we are approaching the busiest quarter in the pension risk transfer marketplace and rates are expected to continue declining. This should incentivize plan sponsors to act immediately and enter the marketplace now to secure rates before they continue to fall and ensure maximized insurer participation.
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, the spread for Annuity Plan 1 increased to 0.12% and just barely decreased to 4.58% for Annuity Plan 2. 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 101.01% 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 99.89% of GAAP PBO. Despite the decrease in rates, the marketplace has been very busy and carriers continue to price aggressively.
As illustrated in the graph below, annuity purchase costs presented relatively less volatility this month compared to previous periods. Annuity Plan 1 showed a decrease of 1.24% while Annuity Plan 2 declined to 1.96%. This graph serves as a valuable reminder of the daily fluctuations in annuity purchase interest rates, highlighting that changes can range from minimal movement to significant jumps or drops. Given that potential rate drops are still on the radar for 2024, annuity purchase prices are expected to continue climbing. Therefore, it is crucial to enter the marketplace now before prices increase further.
The fourth quarter is consistently the busiest time for the pension risk transfer marketplace. Insurers are facing capacity constraints and running out of resources which can limit participation opportunities for new purchases. Along with that, due to market volatility, there is no certainty about whether annuity purchase interest rates will remain relatively stable or will present sharp drops as we close out the rest of the year. Annuity purchases can be made selectively rather than all at once. Since PBGC premiums for participants remain consistent regardless of benefit size, plan sponsors should consider purchasing annuities for a portion of the retiree population with smaller benefits to maximize PBGC savings. In such a dynamic marketplace, it is crucial to engage with an annuity search firm promptly to assess the best strategies 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.