Annuities Stay In Play Even As Pension Funding Drops
January 7, 2015 by Linda Koco
Although equities hit new highs last year, funding levels at corporate pension plans didn’t. In fact, the levels went down. That’s keeping demand going for annuities that fund pension takeover deals.
First, what happened. According to Towers Watson, the defined benefit (DB) pension funded status of the nation’s largest corporate plan sponsors dropped 9 percentage points in 2014 — from 89 percent to an estimated 80 percent in 2014.
This returns funding levels back to where they were just after the financial crisis, Alan Glickstein, a senior retirement consultant at Towers Watson, said in a statement.
In 2008, the “aggregate funding level” for the 411 Fortune 1000 companies that sponsor DB plans was 77 percent and in 2009, it was 81 percent. By comparison, the 14-year high was 124 percent in 2000.
The 2014 data show that DB plan assets did get a boost from last year’s record-setting stock market growth. In fact, plan assets rose by an estimated 3 percent, to an estimated $1.4 trillion in 2014, from $1.36 trillion at the end of 2013, according to Towers Watson. The underlying investment return was about 9 percent.
But companies contributed 29 percent less to their plans in 2014 (about $30 billion in all) than in 2013, the researchers said, noting that this decline was due in part to legislated funding relief.
The new SOA mortality tables
What is to explain the decline in funding level? Falling interest rates increased plan liabilities, the researchers said. Many retirement experts probably expected that.
But another factor may be less widely recognized. This was the release of the 2014 mortality tables from the Society of Actuaries (SOA). The new tables show that longevity has increased between 2000 and 2014. For instance, for men age 65, overall longevity rose 2 years (from age 84.6 to age 86.6), and for women age 65, it rose 2.4 years (age 86.4 to age 88.8).
Since many DB plans factor the SOA tables into plan liability and other assessments, these increases are having a ripple effect. The longer lifespans mean that DB funding must be enough to support pension payments for a longer period.
For most plan sponsors, the discussion around the SOA study in 2014 was “the most significant pension event of the year,” Dave Suchsland, a senior retirement consultant at Towers Watson, said in a statement. The SOA study drew the attention of plan sponsors and auditors, he said, and that resulted in “many plan sponsors updating that key (mortality) assumption.”
The Towers Watson analysis also found that the pension deficit increased to $343 billion at the end of 2014, more than twice the deficit at year-end 2013. Overall pension plan funding weakened by $181 billion in 2014.
“A one-time strengthening of mortality assumptions alone is responsible for about 40 percent of the increased deficit,” Glickstein observed.
Even before the new SOA tables came out, researchers were looking at how longevity increases impact pension funding. For instance, at year-end 2013, a team of economists led by Michael Kisser found that that each additional year of life expectancy increases pension liabilities by about 3 to 4 percent.
In addition, “a one-year shock to longevity would more than double the aggregate pension underfunding,” this team said. The findings appear in “Longevity assumptions and defined benefit pension plans,” a paper available at the American Economic Association website.
The annuity solution
Fluctuations in funding status have become a key factor that prompted increasing numbers of plan sponsors to purchase annuities that assume plan responsibilities as part of an overall “de-risking” strategy. Called pension risk transfer (PRT) agreements, these deals are being used as a means of reducing pension liability to the company while ensuring promised pension payouts to retirees.
The April 2013 issue of the CIPR newsletter pointed out that pension plans can use a group annuity contract as part of a pension buyout or PRT transaction. “This transaction provides the insurer with complete ability to control and manage the underlying assets,” it noted.
The group annuity product shifts the risk to the insurer, noted the Center for Insurance Policy and Research publication. The center is affiliated with the National Association of Insurance Commissioners.
Other tools and strategies for risk mitigation do exist, including loans and asset-liability matching. However, the group annuity/PRT deals are gaining in popularity.
For example, a report from Mercer in early 2014 noted that the number and size of PRTs increased “significantly” in the past five years, with some very large “jumbo” deals taking place in the U.S. in 2012 as well as in the United Kingdom and in Canada.
The Towers Watson study found that there was “significant” activity in both annuity purchases and lump sum buyouts in 2014. It was a “big year of pension de-risking,” Suchsland said.
Many experts say this is happening because many employers — large, medium and small — no longer want to be in the pension business. This high interest was heightened in 2014 by news of premium increases slated by the Pension Benefit Guaranty Corp. (PBGC), which takes over severely underfunded private pension plans.
One potential hurdle, at least for 2015, is that PRT deals are more attractive to annuity companies when funding levels are higher — for example, when interest rates are rising and equities are up. Now that pension funding status has declined at some major corporations, it may be harder for some companies to interest an annuity carrier in a PRT deal, or to find a PRT package at a competitive price.
No problem, say some onlookers. Certain companies have such a strong desire to get out from under their pension liability that they will work diligently to find a buyer — or some other solution.
“Given the change in funded status, we expect many plan sponsors will need to reevaluate their retirement plan strategies in 2015,” Suchsland predicted.
“Last year’s results surrendered most of the funded status gains earned in 2013. This year will most likely bring higher expense charges and unless there is an uptick in interest rates or equity market performance, eventually additional contribution requirements.”
