High Bond Yields Drive Increase in PRT Contracts

Higher interest rates are a powerful driver and predictor of pension risk transfer activity and help explain the relatively high number of PRT contracts seen since rates started rising in 2022. However, interest rates do not necessarily help predict the size of transactions, which tend to be driven by the specific sponsors that happen to be involved in a PRT.

Interest rates drive both sides of the decision for plan sponsors, as pension-funding levels rise when discount rates are higher, while the prices for insurance products, including the investments and annuities that pay beneficiaries fall.

A PRT is a contract in which a pension fund sponsor transfers the liability of that pension benefit to an insurer. The sponsor uses plan assets, and possibly their own finances if the plan is underfunded, to annuitize the plan. The insurer then is responsible for making annuity payments to the participants. A sponsor may do a complete buyout PRT and terminate the plan, or a partial PRT, sometimes called a “lift out,” that removes some participants but not others.

Mark Unhoch, the pension risk transfer practice leader at consulting firm October Three, explains that “the present value of the liability drops as interest rates increase,” which makes the PRT cheaper for the sponsor to purchase when rates are higher. This is because when the sponsor buys the annuity, the insurer then invests those assets into fixed income securities to “lock in” that rate and “get the cash flows to guarantee those benefits.”

Since the insurer traditionally holds the securities it buys for an annuitization until it that obligation matures, “whether rates go up or down really doesn’t matter to them,” Unhoch says.

A paper published by Aon in March 2023 attributed record PRT volume to interest rates. “Total PRT premium in 2022 was record-breaking despite lower premium size in individual transactions, due to higher interest rates,” the company wrote. The report added that “rising interest rates served as a catalyst for increased PRT activity in 2022 despite periods of volatility creating temporary challenges.”

There were 568 PRT transactions totaling $51.8 billion in 2022, according to Aon, both record highs.

A large part of the premium record was due to IBM’s $16 billion lift out in 2022, the report notes. That event inflated the PRT figures but it is not something that can be relied upon to infer a broader trend, “an IBM-sized transaction is not something that can be counted on each year,” the report explained, and “the premium volume can change quickly if one or two plan sponsors decide to, or decide not to, transact” in a given year.

Aon’s data on PRT contracts and total premium amounts collected from 2012 to 2023 shows no statistically significant relationship between the average ten-year Treasury bond yield and the total PRT premiums. There is, however, a strong relationship between ten-year yields and the total number of PRTs, regardless of total value, even when controlling for other factors such as inflation or the year.

When controlling for inflation, a 1 percentage point increase in the yield on ten-year Treasuries is associated with an increase of 66 PRT contracts.

When Aon published its PRT data for 2023, the firm found that total PRT premiums fell to $45 billion in 2023 from $51.8 billion in 2022. However, total PRT contracts executed increased to 773 from 568, setting another record. Sure enough, the average ten-year yield rose to  3.96% in 2023 from 2.95% in 2022 .

In other words, higher rates can persuade sponsors to consider a PRT when they otherwise might not, to get more favorable pricing and remove equity-market risk from their books.