DB Buyout Cost Ticks Up in April

June 11, 2014 (PLANSPONSOR.com) - The cost of purchasing an annuity to cover defined benefit (DB) plan liabilities continues to tick up, while the cost of maintaining pension plan liabilities remains flat.

During April, as indicated by the Mercer U.S. Pension Buyout Index, the average cost of purchasing annuities from an insurer increased from 108.6% to 108.9% of the accounting liability. The economic cost of maintaining the liability remained level at 108.7% of the same liability.

Mercer notes that 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 maintaining the plan. Since last October, the approximate cost of maintaining the plan continues to be approximately the same as the cost of transferring liabilities to an insurer for the sample plan modelled in the Mercer index. Plan sponsors who have evaluated a risk transfer may consider initiating the transaction given the attractive current environment.

The past several months have illustrated the volatility in insurer annuity pricing as the buyout cost has quickly moved from less than to greater than the economic cost, Mercer says, adding that the ability to frequently monitor insurer pricing against pre-determined thresholds, and be able to execute quickly, will be important for those plan sponsors who want to take advantage of this volatility and complete a buyout under favorable conditions.

Mercer suggests DB 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. 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.

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