The Mercer US Pension Buyout Index (“the 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 sponsor’s Balance Sheet, which includes an allowance for the future expenses and risk margin needed to maintain the obligations. Based on this evaluation, sponsors can compare the approximate current cost of risk transfer through annuitization with the total cost of retaining obligations on the balance sheet.

Published monthly, the Index tracks the relationship between the accounting liability for a hypothetical frozen traditional defined benefit plan and two cost measures: the approximate total economic cost of retaining the obligations on the balance sheet and the estimated cost of transferring those liabilities to an insurance company.

 Annuity pricing data from a number of leading US life insurance companies are used to compile the Index. These insurers include American General, Massachusetts Mutual Life Insurance Company (MassMutual), MetLife, Principal, Pacific Life, Prudential and United of Omaha (Mercer is not associated with any of the aforementioned insurers). On a given month the Index may be compiled from pricing data from some or all of these insurers.

In Figure 1 below, we show the estimated buyout cost for a sample plan comprised of retirees only. As of April 30, 2013 the indicative buyout cost for retirees was 109% of the accounting liability. This compares to an estimated long-term economic cost of retaining the plan of 108.5% of the accounting liability. This economic cost includes an allowance for future retention costs (administrative, PBGC premiums and asset related costs) as well as a reserve for future improvements in mortality. These additional costs and reserves are not included in the accounting liabilities published by plan sponsors, but do represent future costs that should be reflected in any risk transfer comparisons and evaluations.

Figure 1. Mercer US Pension Buyout Index

Commentary on the Mercer US Pension Buyout Index results for April 2013

• Figure 1 indicates that the cost of purchasing annuities for retirees reduced slightly over April 2013, from 110% to 109% of the accounting liability. 

• Comparing the cost of annuitization to the economic cost of retaining the liabilities indicates that the margin for buyout over the cost of retaining the plan continues to be relatively small at just under 1% as of April 2013, indicating that buyout premiums are currently attractive for sponsors when compared with all-in retention costs. Reviewing total retention costs in a more comprehensive way shows that annuitization may be a cost effective option for many sponsors, either today or when their plans become better funded. 

• In addition, strong equity returns in recent months have led to an increase in funded status for many plans over the first four months of 2013. The aggregate funded status of pension plans sponsored by S&P 1500 companies increased to an estimated 80% as of April 30, 2013, up from 74% at the end of 2012. For sponsors that wish to incorporate buyout options to their strategic planning, this stronger funding and transparent view of buyout costs heightens the need to be prepared. We believe many sponsors should evaluate the financial implications of buyout more closely as one of many steps to be taken to ensure that opportunities are captured if they are presented by the markets and increased plan funding levels. 

The above analysis has been performed for a sample retiree population only. The total economic cost of the sample plan includes allowances for on-going pension plan management costs, for example administration expenses, PBGC premiums and asset related costs. These costs will vary depending on the specifics of each plan.

About the Mercer US Pension Buyout Index

The Index is provided for a sample plan assumed to consist of retirees only with a duration of seven years. The Index is intended to illustrate general trends only as the actual premium can vary significantly for individual plans. Therefore, the Index should not be used to make plan design decisions. We would be happy to help you gain greater insight into insurer pricing for your plan.

It is important to note that the Index is based on a sample plan. Actual costs for terminating a plan including retirees and non-retirees will depend on a number of factors. Some of these may include:
 

– The plan’s benefit structure and timing of its anticipated benefit payments

– The demographic profile of the plan’s participants

– Market conditions prevailing at the time benefits are distributed and annuities purchased

– Insurer appetite and capacity for a transaction

– Which employees, if any, receive and accept an offer to take a lump sum instead of an insured annuity

Methodology for preparation of the Mercer US Pension Buyout Index

• Annuity buyout estimates are based on monthly quotations of discount rates for buyout purposes, provided by a number of leading insurers. The discount rates include risk and expense loads to cover all: 1) investment related risks including default, prepayment and reinvestment risk 2) margin against adverse experience; 3) margin for profit or return on capital and 4) expenses including overhead, set-up, per participant costs. The average discount rate is used.

• The accounting liabilities were valued using the Mercer Yield Curve (“MYC”). The MYC is used by numerous Mercer clients to set their discount rate under ASC 715. A full description of the methodology can be found at www.mercer.com/pensiondiscount

• The buyout liability estimates were calculated by using the single discount rate (the average of the monthly quotations) applied to the same cashflows. Since insurance companies may use a more conservative mortality basis in their pricing than that used to produce accounting liabilities, a load of five percent has been applied to reflect this.

• The accounting liability shown is assumed to be the Pension Benefit Obligation (PBO) under ACS-715.

Economic cost assumptions