Pension Buyout Costs Tick Up

The cost of purchasing pension annuities from insurers increased to 108.4% of liabilities during November.

This is up 10 basis points from the 2013 low observed at the end of October. The long-term economic cost of maintaining pension liabilities remained level at 108.2% of balance sheet liability, according to the Mercer U.S. Pension Buyout Index.

The index tracks the relationship between the accounting liability for retirees of a hypothetical defined benefit (DB) plan and two cost measures. These include the estimated cost of transferring the pension liabilities to an insurance company (i.e. the cost of executing a buyout) and the approximate total economic cost of retaining the obligations on the balance sheet.

Low margins between buyout costs and the economic cost of retaining liabilities are potentially attractive for sponsors considering pension risk transfer (PRT) activities, according to commentary from Mercer issued with the November numbers.

The commentary suggests a significant rise in interest rates during 2013 has led to a decrease in the absolute cost of a buyout. During November, interest rates increased and the market saw positive equity performance.

As such, the aggregate funded status of pension plans sponsored by companies in the S&P 1500 stands at an estimated 93% as of November 30, up from 74% at the end of 2012. For many plans, this rise in funding levels has reduced the potential cash and funded status impact of a buyout, according to Mercer’s analysis.

Sponsors considering a buyout in the future should review their plan’s investment strategy and consider increasing allocations to liability-hedging assets, according to Mercer’s commentary. This can reduce the likelihood of a company experiencing future declines in funding status or unexpected cash requirements during annuity purchases.