It is slightly cheaper for pension plans to retain the liabilities associated with their plan than to purchase annuities for retirees in a buyout of the plan.
According to the Mercer U.S. Pension Buyout Index for May, the cost of purchasing annuities rose from 109 percent in April to 109.5 percent of the accounting liability, while the economic cost of retaining the retirees remained at 108.5 percent of the accounting liability.
Comparing the cost of annuitization to the economic cost of retaining the liabilities indicates that the margin for buyout over the cost of retaining the plan continues to be relatively small, at about 1 percent as of May 2013, indicating that buyout premiums are currently attractive for sponsors when compared with all-in retention costs, according to Mercer.
Reviewing total retention costs in a more comprehensive way shows that annuity purchases may be a cost effective risk transfer option for many sponsors, either today or when their plans become better funded.
Strong equity returns in recent months, along with an increase in discount rates of approximately 45 basis points, has led to a rise in funding levels to the highest point in almost two years. The aggregate funded status of pension plans sponsored by S&P 1500 companies increased to an estimated 86 percent as of May 31, 2013, up from 74 percent at the end of 2012.
Some plan sponsors have expressed a desire to wait until interest rates rise and buyout costs will be less expensive.
The Mercer US Pension Buyout 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, which includes an allowance for the future expenses and risk margin needed to maintain the obligations.