Just how much effect do interest rates have on generating retirement revenue streams from lifetime savings?
Two recent data sets for two unrelated sources of retirement income relate how a recent uptick in interest rates has significantly affected annuitized benefits.
That has yielded some good news for the country's sponsors of defined benefit plans, as well as for pre-retirees looking to guarantee income in retirement via deferred annuities.
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The latest quarterly analysis of defined benefit pension plans' funding ratios from Segal Rogerscasey and Sibson Consulting (each its own division of The Segal Group and a part of that group's consulting arm to defined benefit sponsors), shows significantly improved funding ratios in the second quarter of 2015.
The consultants say the funding status of sponsors implementing the "model pension plan" jumped from 79 percent to 87 percent in Q2.
Investment returns were not drivers of that improvement; both domestic and international equities posted negligible gains, as Greece's future in the Euro remained in question and new concerns over China's growth emerged.
Rather, the improved funding ratios were due almost exclusively to a 10 percent decrease in the cost of projected liabilities, as the average discount rate rose from 3.8 percent to 4.5 percent.
That 70 basis point increase came after discount rates had been flat for the previous year.
Treasury rate yields increased 45 basis points in the quarter, lowering the cost of sponsors' future liability estimates for model pension portfolios, which the consultants say is a simple allocation design of 45 percent of assets to passively managed domestic equities, 15 percent to international equities, and 40 percent to global bonds.
High-quality corporate bond yields, which sponsors also use to determine discount rates, as mandated by the Pension Protection Act of 2006, also increased 60 basis points in quarter, adding to the discounting of future liabilities, and further underscoring interest rates' affect on pension liabilities.
The improved yields also mean pre-retirees can fend longevity risk via deferred annuities at a cheaper cost, according to fund company BlackRock, which has a proprietary retirement income index that tracks, in part, the cost of annuitizing retirement savings.
Annuities are cheaper for pre-retirees as interest rates rise. BlackRock noted that the recent quarter's improved Treasury yield helped to deliver "first real improvement in retirement prospects since 2013," when the fund company first launched its CoRI Retirement Index.
The price of a deferred annuity was down 8.11 percent in the quarter, helping to offset the increased cost of deferred annuities for the year prior.
Increasing rates will bode well for pre-retirees looking to annuitize some portion of their savings, a potential hedge against other areas of volatility, as equity markets continue to digest a stronger dollar, the Eurozone continues to wrestle with Greece, and fallout begins to emerge from China's stock market plunge, said BlackRock.
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Nick Thornton
Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.
