The Mercer US Pension Buyout Index (the “Index”) tracks the relationship between the accounting liability for retirees of a hypothetical defined benefit plan and two cost measures: the estimated cost of transferring the pension liabilities to an insurance company (i.e. a buyout) and the approximate total economic cost of retaining the obligations on the balance sheet.
During January, as indicated by the Index, the cost of purchasing annuities from an insurer remained level at 108.5% of the accounting liability. The economic cost of maintaining the liability increased slightly, from 108.6% to 108.7% of the balance sheet liability.
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Figure 1. Mercer US Pension Buyout Index
Some plan sponsors have been reluctant to transfer liabilities to an insurer arguing that it is too expensive, particularly compared with the accounting liability. However the accounting liability does not include all costs associated with the plan. Currently, the approximate cost of maintaining the plan is higher than the cost of transferring liabilities to an insurer for the sample plan shown.
PBGC annual per participant premiums were recently increased significantly, from $49 per participant in 2014 to $64 per participant in 2016, increasing with inflation thereafter. This more than 30% increase is a contributing factor to the increasing costs to plan sponsors of maintaining their defined benefit plan and is a large factor in many plan sponsors’ decisions to transfer liability.
Another source of increased costs to plan sponsors of maintaining a defined benefit plan occurs when participants live longer than expected. A recently released draft mortality table by the Society of Actuaries predicts longer life expectancies than those typically used to determine a plan’s accounting liability. If new mortality tables or longer life expectancies are required to be used, the result will be an increase in plan liabilities and is another reason many plan sponsors are viewing buyouts as effective risk management tools.
The current economic environment, together with the increase in PBGC premiums and mortality update on the horizon, makes 2014 an attractive time for sponsors to consider an annuity buyout. There are a number of steps involved in order to prepare for a buyout and so we recommend that sponsors act now to evaluate whether buyout is appropriate for them and develop an implementation strategy.
Sponsors considering a buyout in the future should also review their plan’s investment strategy and consider increasing their allocation to liability hedging assets, either immediately, given recent improvements in funded status, or over time as the funded status improves. This can reduce the likelihood of the funded status declining again, leading to unexpected additional cash being required to purchase annuities at a later stage.
About the Mercer US Pension Buyout Index
Published monthly, 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. This economic cost includes an allowance for future retention costs (administrative, PBGC premiums and investment expenses) as well as a reserve for better than expected future improvements in life expectancy. 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 comparison and evaluation. These costs will vary depending on the specifics of each plan. Based on this evaluation, sponsors can compare the approximate current cost of risk transfer through an annuity purchase with the total cost of retaining obligations on the balance sheet.
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.
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
|Default risk cost||0.40%|
|Asset management cost||0.10%|
|Future mortality cost||2.50%|
|Per participant admin||$ 30.00|
The Mercer US Pension Buyout Index and any related commentary has been created for illustrative purposes, is presented at a particular point in time and should not be viewed as a prediction of the hypothetical plan or a specific plan’s future financial condition. The Index and commentary may not be used or relied upon by any other party or for any other purpose; Mercer is not responsible for the consequences of any unauthorized use.
The future is uncertain, and a plan’s actual experience will likely differ from assumptions utilized and these differences may be significant or material. Decisions about benefit changes, investment policy, funding amounts, benefit security and/or benefit-related issues should be made only after careful consideration of alternative future financial conditions and scenarios and not solely on the basis of the Index.
We have not included an estimate of actuarial and other professional or administrative fees that are incurred during a plan termination in estimating the relative cost of purchasing annuities. Due to the large number of regulatory filings and the high level of scrutiny on plan census data and benefit calculations, professional fees for a termination or annuity buyout can be significant.
Circular 230: The information contained in this document (including any attachments) is not intended by Mercer to be used, and it cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code that may be imposed on the taxpayer.