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 September, the index also showed that the retiree buyout cost relative to the economic cost of retaining the liabilities remained level and remains low at approximately 70 basis points. This indicates that buyout premiums are potentially attractive for sponsors when compared to the cost of retaining the liabilities (i.e., allowing for on-going costs such as PBGC premiums, administrative costs and investment expenses). Reviewing total retention cost in a more comprehensive way illustrates that annuity purchases may be a cost effective risk transfer option for many sponsors, either today or when their plans become better funded.
The index also showed that interest rates have risen significantly during 2013, leading to a decrease in the absolute cost of a buyout. During September, interest rates decreased slightly but for many plan sponsors this was offset by a positive equity market performance. As such, the aggregate funded status of pension plans sponsored by companies in the S&P 1500 stands at an estimated 91% as of September 30, 2013, 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.
For plan sponsors that wish to incorporate annuity buyout options to their strategic planning, the index showed that the recent improvement in funding levels and the current small margin between the buyout and economic cost heightens the need to be prepared to act quickly. The index recommended that plan sponsors should consider evaluating, well in advance of any planned buyout, the steps required to facilitate an annuity buyout and gauge the financial impact.
Finally, the index recommended that plan 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 further. 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.
This monthly 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. It also shows the approximate long-term economic cost of retaining the retiree liabilities on a sponsor’s balance sheet.