London Market Monitor – 31 May 2022
Our May review of the markets and Solvency II discount rates.
Pension risk transfers (PRTs) have been a growing trend in recent years. Sponsors of defined benefit (DB) pension plans (primarily corporate plans) will pay a life insurance company a one-time premium. In return the insurer will pay the ongoing annuity payments to a group of participants in the plan. Based on data from the Secure Retirement Institute (SRI) U.S. Group Annuity Risk Transfer Sales Survey, PRT sales in 2021 totaled $38.0 billion.1 This is up 42% from the $26.9 billion total in 2020! While in recent years the fourth quarter (Q4) typically has considerably more PRT sales than any other quarter, in 2021 Q3 was huge for PRT activity, with $16.5 billion in sales (as illustrated in Figure 1). That was then followed by a typically busy Q4 with $12.8 billion in PRT sales, resulting in a record-breaking year. This article will explore potential reasons for the surge in PRT activity in 2021.
One potential explanation is that 2021 is just a continuation of the accelerating PRT market that we’ve been seeing for years. As shown in Figure 2, PRT sales increased from only $13.7 billion in 2015 to $29.9 billion in 2019. This is an average increase of over 20% each year. If one were looking at the data back in 2019, one might have projected PRT sales in 2021 to be over $44 billion (represented by the dotted line in Figure 2). In this sense 2021 sales are more in line with recent trends, and 2020 was just an outlier with lower PRT sales (potentially due to the pandemic). However, exponential growth like this is unlikely to be sustainable. At some point this trend will probably peak and then either level off or fall back down (due to the finite and shrinking number of corporate pension plans). We’ll need to wait to see if history shows 2021 to be just another step in the increasing PRT market, or an abnormally high year.
During 2021, many plan sponsors saw improvements in the funded status of their plans. With equity markets soaring (the S&P 500 increased 26.9% in 2021), many plans experienced significant increases in plan assets. In addition, rising discount rates (the FTSE pension liability index increased by 31 basis points in 2021) resulted in decreases in the market value of the plan’s liabilities. A common risk management strategy for closed and frozen legacy pension plans is to reduce risk as the funded status improves. Thus, this improvement in the funded ratio may have been what many plan sponsors were waiting for to pull the trigger on PRT plans that they’d been considering.
In addition, many plan sponsors of these legacy plans are looking to fully terminate their plans (offer lump sums to participants and then transfer the remainder of the plan to an insurance company) to get the whole plan off their books and end their maintenance responsibilities. However, that requires the plan to either have sufficient assets to pay the entire insurance premium for the PRT, or the plan sponsor must be willing to pay the difference as plan contributions. The improvement in funded status of plans that started in Q2 2020 and continued into 2021 may have made plan termination affordable for many plan sponsors. Because plan terminations can take six to 18 months to complete, many terminations that began in 2020 likely wouldn’t have completed the PRTs until 2021.
According to the Milliman Pension Buyout Index (MPBI), 2021 saw record low PRT pricing. The MPBI shows the cost of a PRT for retirees relative to the plan’s accounting liability (a market liability measure). This is done by comparing sample PRT pricing interest rates, provided by various insurers, with the FTSE Above Median Double-A Curve (commonly used by plan sponsors to measure the accounting liability). Figure 3 illustrates retiree buyout costs with two different metrics: the red line represents only the most competitive insurers' rates from each month, while the blue line represents a straight average of all insurers' rates in the study.
Retiree buyout costs had dropped to record lows by the end of 2020 (competitive rates dropped from 103.3% at the beginning of 2020 to 99.3% at the beginning of 2021) and stayed low through all of 2021 (with competitive rates between 99.3% and 100.2%). Many plan sponsors may have seen these reduced prices for PRTs and jumped at the opportunity to offload retiree liabilities at historically good deals.
There may be another large year ahead for PRT sales in 2022. All the items discussed in this article for 2021 are looking to be true for 2022 as well. For many plan sponsors, the funded status will have continued to improve in the first few months of 2022 (with rising discount rates offsetting downturns in the equity markets). The MPBI index has remained low (dropping down to a record low competitive rate of 98.9% as of February 28, 2022). Also, many of the plan terminations that began in 2021 (and there may have been more than in prior years due to the improved funded status and low PRT pricing seen in 2021) will be completing their PRTs in 2022. With a continued increase in PRT, federal agency scrutiny may follow, which could have a dampening effect. Regardless, signs point to 2022 being another eventful year for the PRT market.
Definitions are from the SRI U.S. Group Annuity Risk Transfer Sales Survey.
Single premium buy-outs are group annuity contracts used to assume certain benefit liabilities of a terminating U.S. pension plan or, in some cases, a plan settlement of specific groups. A single premium group annuity contract is issued to the plan trustee or employer in exchange for a single sum; and certificates are issued to individual annuitants, which may be groups of immediate and/or deferred plan participants.
Single premium buy-ins are group annuity contracts used to assume certain benefit liabilities of a U.S. pension plan or, in some cases, a plan settlement of specific groups. The annuity contract is issued to the plan trustee or employer in exchange for a single sum. The plan trustee or employer holds the contract as a plan asset and retains overall plan liability. Certificates are not issued to individual annuitants.