With interest in Pension Buyouts increasing, Mercer announced today the first multi-country third party insurer buyout pricing study. The Mercer Global Pension Buyout Index provides benchmarks from 18 independent third party insurers in four Defined Benefit (DB) markets with significant buyout interest, the US, UK, Canada and Ireland. This landmark index highlights how the cost of insuring DB retiree pension obligations differs between countries as well as the trends in cost over time. The index is designed to help global pension and benefit managers understand where best to focus their efforts on pension plan risk management and risk transfer.
Based on pricing research conducted in January 2014, the UK is the most expensive location to insure retiree defined benefit pension obligations relative to the liabilities reflected in company accounts, Mercer found. 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.
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.
Frank Oldham, global DB Risk Leader at Mercer observed, “As economic conditions and company finances improve, we are seeing interest in buyouts grow across the US, UK, Canada, and Ireland.”
As noted, the cost of insuring pension liabilities in the UK is higher than in the US because UK pension liabilities are normally indexed for inflation. This increases liability durations and because insurance companies charge an additional premium to take on inflation risk. Despite this, UK bulk annuities had a strong 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 regulator. 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.
Although the US lacked a repeat of the jumbo deals of 2012, 2013 remained a strong year for buyouts. Interest rates and equity markets both jumped in 2013, improving plan funding levels and reducing the potential cash outlay required for buyout. Mercer anticipates that this will lead to increased risk transfer arrangements in 2014. Mandatory contributions to the US statutory safety net for pensions, the PBGC, will increase significantly following the Budget agreement in December 2013. This increases the cost to the sponsor of retaining the liabilities and makes risk transfer even more attractive.
The difference between the US 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. There are indications that the volume of group annuities placed in 2013 has been the highest in the industry’s history – Q4 was particularly active. Mercer expects that this trend will continue and anticipates that historical records for size of annuity placements and volume will continue to be broken.
Note: Chart shows cost of estimated annuity prices for retirees from insurers as a percentage of accounting liability in each of the four countries. For example, where a line is at the 113% level, this means that Mercer expects the average cost of a pension annuity transaction to be broadly 13% higher than the equivalent accounting liabilities. The Global Index line (solid blue) shows the average cost of pension annuity transactions as a percentage of accounting liability across the four locations and draws upon information such as each country’s market size. To produce the estimates, pension liability has been measured according to local standards in each country.
Mercer is a global leader in talent, health, retirement and investments. Mercer helps clients around the world advance the health, wealth and performance of their most vital asset – their people. Mercer’s 20,000 employees are based in 43 countries and the firm operates in over 140 countries. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), a global team of professional services companies offering clients advice and solutions in the areas of risk, strategy and human capital. With 54,000 employees worldwide and annual revenue exceeding $10 billion, Marsh & McLennan Companies is also the parent company of Marsh, a global leader in insurance broking and risk management; Guy Carpenter, a global leader in providing risk and reinsurance intermediary services; and Oliver Wyman, a global leader in management consulting. Follow Mercer on Twitter @MercerInsights