DB Plans Eye Annuity Buyouts Despite Pricing Fears

Total buyouts could reach $500 billion by 2016 if interested plan sponsors annuitize just half of their liabilities, according to Mercer.

Most plan sponsors believe annuity buyouts to be more costly than they actually are, as appetite for risk transfers continues to rise, according to Mercer.

In a survey of more than 200 US financial executives, the consulting firm—in conjunction with media brand CFO Research—found only 3% of respondents thought pension buyouts were inexpensive.

More than half thought annuities were expensive (48%) or very expensive (17%), and would exceed 110% of the pension benefit obligations held on their balance sheet.

Just 32% said they found buyout costs affordable or competitively priced.

“There’s a misconception about the cost of a buyout—most of the respondents overestimated the costs associated with annuity buyouts,” said Richard McEvoy, partner at Mercer. “Those assumptions could weigh heavily on action—or lack of—in the buyout market.”

However, according to the survey, plan sponsors’ interest in annuity buyouts is on the rise despite any concerns about the price.

More than one-third of respondents said they were likely or very likely to purchase an annuity in either 2015 or 2016. Mercer added that if these interested sponsors chose annuities for at least half of their liability, the total amount would reach roughly $400 billion to $500 billion.

Furthermore, some 59% of surveyed plan sponsors said they already offered some type of one-time lump sum payment to vested defined benefit (DB) participants. Nearly half also said their employers were likely to choose some form of lump sum payout in the next two years.

“An increase in interest rates could lead to a fast increase in demand for buyouts,” McEvoy said. “Sponsors need to prepare in advance in order to position themselves to move quickly in response to changing market conditions.”

Various factors contributed to plan sponsors’ increasing appetite for a range of de-risking options, Mercer said, including updated mortality assumptions, dipping funding status, and increases in Pension Benefit Guaranty Corporation premiums.

In addition, 81% of sponsors said they adopted or were considering dynamic de-risking strategies to improve their funded statuses and “get themselves on a sounder footing.”

Some 22% said they had already closed plans to new employees, while more than a quarter had partially or completely frozen their DB plans.

Mercer-CFO Source: Mercer & CFO Research

Related: Why Pension De-Risking Could Threaten Financial Stability; De-Risking Activity Picks Up After Slow Q1; The End of De-Risking