Consumers Weigh Risks, Other Factors Affecting The Cost Of Annuities

By Cyril Tuohy

InsuranceNewsNet

With 2014 shaping up to be an active year in corporate pension risk transfer, institutional advisors may want to think about the factors affecting the cost for annuities that are used to guarantee pension obligations.

Every pension plan faces unique circumstances depending on the retiree population for which it provides benefits. The insurance companies issuing annuities also price them, pension risk experts say.

“The fundamental question a sponsor has to think through is how much do I care about pension risk,” Jonathan Barry, a Boston-based partner with the benefits consulting firm Mercer, said in an interview with InsuranceNewsNet.

A large company with a relatively small pension plan that fluctuates by a few million dollars from one year to the next isn’t likely to have much balance sheet exposure, Barry said. A midsize company with a huge pension plan is far likelier to feel the effects of pension plan volatility.

Alla Kleyner, assistant vice president and actuary with MetLife in New York, said that companies looking to bid their pension plans to insurance carriers need to think about general risk factors affecting the cost of annuities.

Those include longevity, duration, plan subsidies, interest rates and income spreads, and “nonstandard options” within a pension plan, she said.

Longevity assumptions are influenced by the industry, occupation of the participants, benefit amounts and mortality differences.

The difference between the accounting liability and the annuity price due to mortality differences could range from a low of 1 percent or 2 percent, to a high of 7 percent or 8 percent, or more in the case of a supplemental executive plan.

“So that’s an important consideration,” Kleyner said, during a webinar hosted by the benefits consulting firm Mercer.

Duration matters also, as insurance companies are under strict state rules that require matching the assets and liabilities within an insurance company’s portfolio. “This in turn, of course, determines our overall portfolio yield and ultimately the price of annuity,” she said.

In the case of long-duration plans in which the benefit to participants – the liability to the life insurer – is deferred for 25 years, insurance carriers have only one option: U.S. Treasury bonds. “So for this type of case, relative costs will be pretty high,” she said.

Early retirement subsidies, underused benefits and prior lump sum offers to retirees are an “often overlooked cost,” accounting for as much as 10 percent of the annuity price in the most extreme of scenarios, she said.

“These are all important factors to consider when thinking which part of the population to buy an annuity for,” Kleyner said.

Statutory reserve levels, set by states, change from one year to the next. That, too, affects the price of an annuity. A quote issued Dec. 31 may be different from one issued Jan. 1, even if the variables affecting the risks to the pension plan remain identical. “Those definitely affect the level of reserve and capital we have to hold and affects the pricing in return,” Kleyner said.

Administratively complex plans -- those with “unique provisions” sometimes present in legacy plans -- plans that have undergone multiple mergers, or plans filled with grandfathered benefits are likely to affect the number of insurers bidding on the plans and at what price, she said.

In the end, said Leah Evans, a principal with Mercer in New York, annuity prices boil down to the appetite for the amount of liability an insurer wants to take on. Some will be happy to take on more risk, and others less so depending on their portfolio exposures.

“In practice, pricing will vary by plan and so it is important to understand the potential cost of a buyout for your specific plan before making a decision to proceed,” Evans said. Evans, Kleyner and Barry spoke during a webinar titled “Seizing Pension Risk Transfer Opportunities in 2014,” sponsored by Mercer. Barry was also interviewed after the webinar.

Barry said he has seen “a little bit of everything,” in terms of whether companies are choosing to provide a lump sum, transfer the risk to an insurance carrier, or settle for a combination of both.

According to the Mercer and CFO Magazine Pension Risk Survey conducted earlier this year, 28 percent of respondents said they were “very likely” to consider lump-sum distributions for former employees who have not yet retired, and 39 percent said they were “somewhat likely” or willing to consider such an option.

In addition, 15 percent of respondents said they were “very likely” to buy annuities to transfer pension liabilities and 33 percent were “somewhat likely” or willing to consider it, the survey also found.

The percentage of fully-funded pension plans has improved with rising interest rates, and as the stock market continues to turn in a strong performance. Corporate pension plans are on track to finish the year at better than 90 percent funded, according to Milliman.

John Ehrhardt, co-author of the Milliman Pension Funding Index, said that at this time last year, the funded status of corporate pension plans had descended to “frightening” levels as interest rates reached historical lows.

“Twelve months and $392 billion worth of improvement later, we are on track to end the year better than 90 percent funded,” he said.

Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].

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Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected].