The Mercer Global Pension Buyout Index provides benchmarks from 18 independent third-party insurers across four defined benefit (DB) markets showing significant buyout interest—the U.S., UK, Canada and Ireland. The index highlights how the cost of insuring DB retiree pension obligations differs between countries, as well as the trends in cost over time.
Based on pricing research conducted in January 2014, Mercer found the UK is the most expensive location to insure retiree DB pension obligations relative to the liabilities reflected in company accounts. According to the index, the cost of insuring £100 million worth of retiree obligations in the UK would be around 23% more than the equivalent accounting liabilities. This compares to 17% in Ireland, 8.5% in the United States and just 5% in Canada.
According to Mercer, the main reason for the higher cost in the UK is mandatory indexation of pension benefits—the automatic increase of pensions in line with inflation. The index also takes account of regional market conditions which are reflected in the liability shown in company accounts.
Although the U.S. lacked a repeat of the jumbo deals of 2012, 2013 remained a strong year for buyouts, Mercer says. Interest rates and equity markets both jumped in 2013, improving plan funding levels and reducing the potential cash outlay required for buyout. Mercer anticipates this will lead to increased risk transfer arrangements in 2014. Mandatory contributions to the U.S. statutory safety net for pensions, the Pension Benefit Guaranty Corporation (PBGC), will increase significantly following the budget agreement in December 2013 (see “PBGC Premium Hikes Shake Up Buyout Landscape”). This increases the cost to the sponsor of retaining the liabilities and makes risk transfer even more attractive.
The difference between the U.S. and Canada is mainly caused by the different mortality tables in use in each country. Mercer expects the annuity market to balloon in size as more employers review the implications of a potential annuity buyout or buy-in for their plans. The firm says there are indications that the volume of group annuities placed in 2013 has been the highest in the industry’s history—and Q4 was particularly active. Mercer expects this trend will continue and anticipates historical records for size of annuity placements and volume will continue to be broken.
As noted, the cost of insuring pension liabilities in the UK is higher than in the U.S. because UK pension liabilities are normally indexed for inflation. This increases liability durations and also has the effect of increasing premiums to meet greater inflation risk. Despite this, UK bulk annuities had a strong year in 2013 with an estimated 200 transactions, including the £1.5 billion EMI Group Pension fund buyout, the largest ever, on which Mercer advised. The market remains in flux, which is both a positive and a negative for those looking to buy out.
Like other markets, 2013 was a record year for bulk annuity transactions in Ireland, with Mercer transacting the majority of contracts in terms of assets. Activity was driven largely by a statutory deadline for submitting deficit repair plans to the country's regulators. In addition, the introduction of sovereign annuities (backed by Irish government bonds) allowed plan trustees to settle liabilities at a cheaper cost than traditional annuities, with additional risk being passed to the annuitant. This lower cost resulted in sovereign annuities being used in a large number of transactions.
There are several applications of the Mercer Global Pension Buyout Index. Mercer notes that multinationals considering a buyout need to balance the risks and costs associated with de-risking in one country against other factors and determine if de-risking in another country might be a more appropriate course of action. A buyout represents only one of a range of strategies for managing pension risk, but it remains appealing for some since it can eliminate a large chunk of pension liabilities from a company’s balance sheet at once.
Since it can be expensive compared to other risk management tactics, such as longevity swaps and hedging or the use of member cash out and retirement options, Mercer’s index is a guide to changes in cost. Timing, preparation and regular monitoring is the real key to mitigating the cost—in current volatile market conditions it is all too easy for a real opportunity to pass by, Mercer says.
The index is free to all subscribers, published monthly and can be accessed at http://info.mercer.com/global-pension-buyout-index.html.