Annuity Market Quarterly Update

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1 Annuity Market Quarterly Update November Aon Corporation Brief Description: Despite the rebound in the third quarter, many pension plans remain underfunded. On top of that, annuity interest rates are falling to all-time lows, making this among the worst times to purchase annuities. In this article, we focus on preparing for the annuity purchase aspect of a plan termination. We begin with a review of market activity during 2010, provide an update on interest rates and continue with an update of the buyin concept very popular in the UK that US insurance companies are beginning to explore.

2 2010 Sales Update Due to the decline in interest rates, year-to-date 2010 sales numbers are indicative of yet another very slow year for annuity placements. Of the $433 million placed through September 30, 2010, 34% of the total premium placed was facilitated by - making us #1 in the marketplace this year. The majority of our placements were carryovers from 2008, when the plan terminations were filed. Some of these plan sponsors waited as long as 18 months for their IRS determination letters. surveyed the 11 insurance companies that have been active in the annuity marketplace since 2005 to gather information on true pension annuity close-out deals. Other industry sources report related data, however they include other types of placements, such as early retirement incentive programs, annuitization of defined contribution plan balances, and internal conversion of unpurchased defined benefit annuities. Our findings on the volume of actual annuity closeouts are as follows: Insurance companies surveyed were AIG Life, Hartford Life, John Hancock Life, Massachusetts Mutual Life ( MassMutual ), Metropolitan Life ( MetLife ), New York Life, Pacific Life, Principal Life, Prudential Insurance Company of America, Transamerica Life and United of Omaha Life. Hartford Life Insurance Company exited the Single Premium Group Annuity (SPGA) marketplace in October of There were no new entrants into the market. AIG Life Insurance Company was renamed American General Life Insurance Company of Delaware and continues to sell and actively market this product. 1

3 It is interesting to note that no single insurance carrier has monopolized the industry in the last several years. Industry sales leaders in terms of total premium have been as follows: Year Market Leader 2005 Principal 2006 John Hancock 2007 Transamerica 2008 MetLife 2009 MassMutual 2010 YTD Prudential has been among the top three consultants in terms of actual placements over the past 10 years. Is This the Right Time to Purchase Annuities? As a result of low interest rates and a lack of risk appetite among insurers, we feel this may not be the most economical time to purchase annuities. Sponsors that have not completely immunized their pension risk may potentially benefit from improved markets, rising interest rates, or a more normal carrier risk appetite. Also, the decreased level of activity has made for a more competitive environment on the cases that have settled. Plan sponsors with fully-funded or nearly fully-funded plans should be taking steps now to prepare for plan termination. While interest rates are low, it is a great time to prepare in order to get the best possible pricing when a moment of opportunity does arise. Outlined below are steps recommended for getting ready: 1. Gather a team to get started. This should include the plan sponsor and key management, an ERISA attorney or in-house counsel familiar with pension law, the plan actuary, the investment consultant, and an annuity placement consultant. Getting everyone on the same page beforehand can help ensure a smooth process and transition. Meetings should be held at regular intervals to keep the team abreast of any new regulatory issues, changes in the interest rate environment, etc. 2. Clean up the data. Very accurate data can reduce the purchase price by as much as 10 basis points or as much as 1% of the purchase price depending on the liability duration. 3. Review the plan provisions. There are certain plan provisions that insurance companies do not like and are costly. Some of these provisions can be amended out of the plan. Discuss these provisions with your actuary and annuity placement consultant. Availability of lump sums is another provision to discuss beforehand. 4. Understand the mechanics behind the plan s funded status. Consider the current funded status of the plan, its asset allocation, any unrealized accounting gains or losses and the amount of time expected until the annuity purchase. There are investment strategies that can increase the likelihood of maintaining the current funded status or, with sufficient time, increase the likelihood of reducing the funding shortfall. 2

4 5. Assess the cost of your plan s liabilities. Request that your annuity placement consultant get real time preliminary pricing from qualified insurance companies in the marketplace. This will provide a good indication of what your liability is at any given point in time. Interest Rate Update Underlying interest rates and spreads are at historic lows for annuity purchase rates. The chart below illustrates interest rates since January Rates are derived from an survey completed monthly by nine insurance companies currently active in the marketplace. Partial Risk Transfer Update from the PBGC In our prior update, we addressed partial risk transfer, or carve out, as an option for plans that want to settle a portion of their liability prior to plan termination. As we noted, plan sponsors who are considering this type of transaction should be aware that the Pension Benefit Guaranty Corporation (PBGC) had concerns regarding these transactions. On November 23, 2009, the PBGC issued a Request for Comments on the Purchase of Irrevocable Commitments Prior to Standard Terminations. One concern was that statutory and regulatory protections afforded under a standard plan termination are circumvented with this process. For example, a participant would not receive the standard disclosures such as the Notice of Intent to Terminate, advance notice of the insurer(s) being considered as annuity 3

5 provider, and a Statement of Plan Benefits, which would allow the participant time to correct any personal information used to calculate benefits. The PBGC also expressed concern that the benefit security for the remaining participants in the plan could be adversely affected if the annuity purchase is detrimental to the plan s funded status. According to a PBGC representative, we anticipate an opinion from them in response to the Request within the next six months. We will continue to update you on these regulatory issues. Buy-In vs. Buy-Out We have been hearing much buzz in the marketplace about the buy-in concept that has gained popularity in the United Kingdom in recent years. MetLife and Prudential are now marketing these products to consultants and plan sponsors. The concept provides an alternative to the traditional buy-out concept. A buy-in is very similar to a buyout, because they are both non-participating group annuity contracts that transfer risks such as interest rate, investment and longevity risk to a qualified annuity provider, and similar pricing (mortality, interest, etc.) is used. Unlike a buy-out, no settlement or associated costs occur, and no irrevocable risk transfer takes place. However, the plan is still responsible for items including the administration, reporting and payment of PBGC premiums. The insurance company does not make the benefit payments to the current retirees but instead makes a bulk payment to the plan each month. The plan must still make individual annuity payments. Rather than purchasing the annuities and transferring the liability to the insurance company, the annuity contract is held by the plan and kept in the plan as a plan asset. This differs from other plan assets because (in theory) it provides a perfect match of assets and liabilities and is thought of by some industry professionals as an effective de-risking strategy. This potentially eliminates balance sheet volatility. Key questions remain on the basis used to value assets and liabilities for funding and accounting purposes. Since there is no product uniformity, it will also be critical that your actuary or accounting professional review this product. Finally, as a plan asset, due diligence will still need to be conducted. Debate is ongoing whether the DOL s 95-1 safest available standard is applicable or not. It s possible that as a plan asset, a fiduciary will need to perform on-going due diligence using the prudent man rule consideration to assess the buy-in asset. Aon Hewitt continues to explore this concept and investigate the contract structure issues including liquidity, accounting and funding implications, unwind provisions, and other issues related to this strategy. 4

6 The charts below illustrate the buy-in and buy-out approaches: 5

7 * * * We will continue to monitor the single premium group annuity market for you. If you have specific questions, please contact your Aon Hewitt consultant. Contact Information Robin Gantz Jennifer Lawrence Steve Shepherd

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