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Administration August 20, 2013
Cost of Purchasing Annuities Down in July
August 20, 2013 (PLANSPONSOR.com) – The cost of purchasing annuities for retirees' pension liabilities decreased moderately over July, from 109.4% to 108.7% of the accounting liability.
Reported by Kevin McGuinness
According to the Mercer U.S. Pension Buyout Index, the economic cost of retaining the retirees in pension plans remained level at 108.2% of the accounting liability
The Mercer U.S. Pension Buyout Index allows plan sponsors to see at a glance the relative cost of a buyout by an insurer of retiree liabilities of a defined benefit plan, and how that cost changes over time. In addition, the index shows the approximate long-term economic cost of retaining the retiree liabilities on a plan sponsor’s balance sheet, which includes an allowance for the future expenses and risk margin needed to maintain the obligations. Based on this evaluation, plan sponsors can compare the approximate current cost of risk transfer through annuitization with the total cost of retaining obligations on the balance sheet.
Other findings from the index for the month of July include:
- The cost of annuitization relative to the economic cost of retaining the liabilities decreased during July and is currently only approximately 50 basis points, indicating that buyout premiums are potentially attractive for sponsors when compared with all-in retention costs—for example, Pension Benefit Guaranty Corporation (PBGC) premiums, administrative costs and investment expenses.
- Some plan sponsors are waiting until interest rates rise when buyout costs will be less expensive. The rise in interest rates recently has led to a decrease in the absolute cost of buyout, but importantly the margin of the buyout cost over the accounting liability has decreased in a month where interest rates have remained broadly flat.
- In addition to the decreasing buyout cost compared with the accounting liability, strong equity returns in recent months along with the increase in the yields of corporate bonds used in setting discount rates has led to a significant rise in funding levels for many sponsors, reducing the potential cash and funded status impact of a buyout. The aggregate funded status of pension plans sponsored by S&P 1500 companies increased to an estimated 89% as of July 31, 2013, up from 74% at the end of 2012.
- For plan sponsors that wish to incorporate annuity buyout options to their strategic planning, the recent improvement in funding level and the current small margin between the buyout and economic cost heightens the need to be prepared to act quickly.
More information about the index can be found here.