Buyouts More Attractive Despite Cost Increase

The change represents a 10 basis point buyout cost increase over the 108.4% of liabilities measured by the Mercer U.S. Pension Buyout Index in November 2013. The index tracks the relationship between the accounting liability for retirees of a hypothetical defined benefit plan and two cost measures: the estimated cost of transferring the pension liabilities to an insurance company (i.e., a buyout) and the approximate total economic cost of retaining the obligations on the balance sheet.

Results from December 2013 show the economic cost of maintaining pension liabilities also increased, moving from 108.2% to 108.6% of the balance sheet liability. Mercer’s analysis finds the increase is primarily due to recent rise in certain PBGC premiums, which in effect make it more costly for plan sponsors and advisers to maintain a plan (see “Strategies to Address PBGC Premiums”).

Flat per-participant premiums were increased as a part of the Bipartisan Budget Act of 2013, to $57 in plan year 2015 and $64 in 2016, increasing with inflation thereafter. For the sample plan considered in Mercer’s analysis, the change increased the total economic cost of maintaining retiree liabilities by 40 basis points and drove the index across the attractive buyout cost threshold as of December 31, 2013. This increase in retention costs makes a buyout potentially very attractive to sponsors from an economic perspective. 

Other factors influencing buyout considerations during the closing weeks of 2013 included continued strong equity market performance and a rising interest rate environment. In fact, the aggregate funded status of pension plans sponsored by companies in the S&P 1500 increased by over 20% during 2013, to an estimated 95% as of the end of 2013, up from 74% at the end of 2012. For many plans, this rise in funding levels has reduced the potential cash and funded status impact of a buyout, Mercer says.

The improvement in funded status, together with the increase in PBGC premiums, means 2014 could be an attractive time for sponsors to consider annuity buyout. There are a number of complex steps involved in preparing for a buyout, so Mercer suggests sponsors and advisers act soon to assess the appropriateness of a buyout.

Sponsors considering a buyout in the future should review their plan’s investment strategy and consider increasing allocations to liability hedging assets, Mercer says. This should be done either immediately, given recent improvements in funded status, or over time as the funded status improves further.

More on December 2013’s index results are available here.