Global Institutional Annuity Market Update

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1 Global Institutional Annuity Market Update Liability De-Risking/Plan Terminations Second Quarter 2014 Hewitt EnnisKnupp, An Aon Company 2014 Aon plc Brief Description: This report reviews the international annuity market in the second quarter of 2014, sample annuity rates in the market, and timing considerations for pension annuity settlement quotes. There is also a special announcement foreshadowing third quarter purchase activity for large U.S. pension risk annuity transfers. Consulting Investment Consulting

2 Second Quarter International Market Update United States The second quarter of 2014 saw an increase in placements over both the first quarter of 2014 and the second quarter of There were about 50 cases settled with a total premium of over $600 million in the second quarter of Total Settlements Total Number of Cases Settled Total Premium (billions) Year $40 Total Premium $35.3 $7 $6 $5 $4 $3.8 $3 $2.7 $2.3 $2 $1.8 $1 $0.6 $0.8 $0.7 $0.9 $0.8 $0 Insurance companies currently surveyed include: American General Life ING Life Insurance & Annuity (now Voya) Massachusetts Mutual Life ( MassMutual ) Metropolitan Life ( MetLife ) New York Life Pacific Life Principal Life Prudential Insurance Company of America Transamerica Life United of Omaha Life Year The data comes from a Hewitt EnnisKnupp survey of true pension annuity closeout deals (in addition to buy-ins and carve-outs in advance of full closeouts) from insurance companies active in the annuity marketplace. Other industry sources report similar data but may include other types of placements, such as early retirement incentive programs, annuitization of defined contribution plan balances, and internal conversions of unpurchased defined benefit annuities. Consulting Investment Consulting 1

3 Market participants reported a number of large deals in the second and third quarters. This is creating a dynamic where some insurers decline smaller and some decline riskier deals, making them difficult to settle. Quote activity in Puerto Rico is consistent, but the market is limited for those cases, too. We will continue to monitor and analyze the transaction data in the quarters ahead to validate placement trends. No single U.S. insurance carrier has monopolized the industry in the last several years. Industry sales leaders in terms of total premium have been: Year Market Leader 2005 Principal 2006 John Hancock 2007 Transamerica 2008 MetLife 2009 MassMutual 2010 MetLife 2011 Prudential 2012 Prudential 2013 MetLife The data comes from a Hewitt EnnisKnupp survey of true pension annuity closeout deals from insurance companies active in the annuity marketplace. In spite of the second quarter 2014 annuity placement data, client inquiries are consistently high, even with the continued low interest rate environment. As sponsors decide to de-risk their pension plans, they are contemplating various options such as partial plan settlements, dollar cost averaging strategies, and other liability risk management solutions. Consulting Investment Consulting 2

4 Special Announcements. On September 25, 2014, it was announced that Motorola Solutions Inc. had entered into an agreement with Prudential to transfer 30,000 retirees via purchasing of a group annuity contract. With an estimated annuity contract premium of $3 billion, this transaction represents the third largest transaction in pension buy-out marketplace history (2012 transactions involving General Motors and Verizon are the largest and second largest market transactions, respectively). Furthermore, the Motorola retiree annuitization was part of a larger strategic de-risking project that involved voluntary lump-sum offers to terminated vested participants. A few days later, on September 30, 2014, Bristol-Myers Squibb announced the latest in a series of jumbo U.S. pension risk annuity transfers. The company will transfer approximately $1.4 billion in pension obligations for existing U.S. retirees and beneficiaries. Prudential was again chosen as the insurer and will assume approximately 8,000 lives as part of the transaction. We expect the transfer to Prudential to occur in December 2014 subject to satisfaction of closing conditions. These two transactions, although they occurred in the third quarter, may continue to accelerate the consideration of annuity transactions in the U.S. as a standard de-risking tool. We will continue to assess marketplace sales in the quarters ahead and expect to report more extensively on what appears to be a growing trend of large retiree annuity settlements. Purchase Rates. Annuity rates have fallen from the end of the first quarter of 2014 to end August at levels not seen since mid The chart below illustrates annuity pricing and market interest rates since January % Historical Sample Annuity Pricing Rates Deferred Rate (Duration=15) 6.0% Immediate Rate (Duration=7) 10-Year Treasury Rate 5.0% Interest Rate 4.0% 3.0% 2.0% 1.0% Feb-07 May-07 Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12 Feb-13 May-13 Aug-13 Nov-13 Feb-14 May-14 Aug-14 Note: Rates are derived from a Hewitt EnnisKnupp survey completed monthly by insurance companies active in the marketplace. The rates since 2011 are derived from the highest (most aggressive) interest rates available in the marketplace on plain vanilla cases as of the last working day of the calendar month. Since rates vary so much intraday, quotes are generally held open for only a few hours on the day they are published. Consulting Investment Consulting 3

5 Immediate Annuity Rates Deferred Annuity Rates Rates as of Low High Low High 8/31/ % 2.94% 3.27% 3.65% 7/30/ % 3.15% 3.42% 3.80% 6/30/ % 3.13% 3.43% 3.81% 5/31/ % 3.10% 3.43% 3.81% 4/30/ % 3.30% 3.62% 4.00% 3/31/ % 3.33% 3.73% 4.11% 2/28/ % 3.41% 3.79% 4.17% 1/31/ % 3.42% 3.86% 4.24% 12/31/ % 3.66% 4.11% 4.49% 11/30/ % 3.52% 4.02% 4.40% 10/31/ % 3.39% 3.82% 4.20% 9/30/ % 3.47% 3.88% 4.26% Note: Rates are derived from a Hewitt EnnisKnupp survey completed monthly by insurance companies active in the marketplace. Pricing interest rates can vary for many reasons. For estimate purposes, the low end of the range should be the starting point for cases that have complex plan provisions, contain data that has not been scrubbed, have cash balance and/or employee contributions, etc. Extra conservatism for such circumstances possibly should be considered to reduce the estimated rate even further. According to the Aon Hewitt Pension Risk Tracker, the aggregate funded ratio of pension plans in the S&P 500 Index climbed slightly from just under 89% to 89.5% at the close of the second quarter of Pension funded ratios are impacted most by two key market factors: interest rates (composed of changes in treasury rates and credit spreads) and equity markets. During the second quarter: Pension liabilities increased by 2.4% as rates declined over the quarter. The 10-year Treasury rates were down by 0.20% over the quarter and credit spreads remained flat, resulting in a 0.20% drop in the discount rate over the quarter for an average pension plan. Return-seeking assets rallied with the Russell 3000 Index returning 4.9%. Bonds matched the performance of equities during the quarter with the Barclay s Long Gov/Credit Index returning 4.9% over this time frame. Overall pension assets increased by 3.2% over the quarter. Over the last 12 months, the aggregate S&P 500 funded ratio has improved. This improvement is due to a $180 billion increase in pension assets, dampened by a $112 billion increase in liabilities. Consulting Investment Consulting 4

6 Canada The second quarter of 2014 closed with total annuity placements of $693 million (compared to $579 million for second quarter 2013) based on information provided by LIMRA. After six months, total annuity purchases totaled $1,049 million ($759 million last year for the same period). An increased interest in de-risking among defined benefit pension plans was seen in the market. During this quarter, three insurance companies dominated the market with a bit more than 80% of the purchases. In August 2014, the Canadian Institute of Actuaries (CIA) published its revised discount rate guidance for estimating the cost of purchasing non-indexed group annuities for hypothetical wind-ups and solvency valuations. Since June 2013, the cost of purchasing non-indexed annuities has been estimated using the duration of the liabilities plus the Government of Canada (GoC) long-term bond yields (maturities over 10 years, CANSIM series V39062), in conjunction with the UP94 generational mortality tables (based on the AA scale). Effective June 30, 2014, the discount rate guidance above unadjusted CANSIM series V39062 is: Low duration (<8.0) +0 basis points Medium duration +40 basis points High duration (>12.9) +60 basis points Over the second quarter of 2014, interest rates have been declining. The GoC bond yield decreased from 2.82% on April 1 to 2.68% on June 30 with an average at 2.75%. Rates reached a low of 2.60% during the quarter on May 28. For more information, please contact Eric Tardif at or Frédérik Faille at Consulting Investment Consulting 5

7 United Kingdom Risk Transfer Settlements The second quarter of 2014 lagged the record first quarter. There were 41 cases with a total value of 2.5 billion in the second quarter, versus 44 cases totaling 4.4 billion in the first quarter. The risk settlement market is already recording a record year. Over 20 billion of risk transfer from company pension schemes has been disclosed since June. The year has seen new records set for the largest bulk annuity and longevity swap deal to date (for the BT pension scheme covering 16 billion of liabilities, on July 4, 2014), in addition to six announced deals totaling about 21 billion. The total volume has been heavily dominated by large deals, with three pensioner buy-ins representing 75% of the business placed in the first half of the year: 3 billion and 600 million annuities for AkzoNobel s ICI scheme (with L&G and Prudential, respectively) in Q1 and a 1.6 billion annuity for Total in Q2 (with PIC). There were also substantial transactions for Phillips (a 304 million buy-in with Prudential in Q2), GKN and the Vestey Group in this half-year. The Phillips transaction follows a 470 million pensioner buy-in with Rothesay Life in 2013, and shows how even relatively large schemes are now gradually starting to secure their liabilities. PIC, Rothesay Life, and Legal & General have tended to be the dominant writers in this market in recent quarters. A notable feature of 2014 so far has been that Prudential has itself already written over 1 billion of business, reflecting a significant increase in bulk market appetite. This is an example of the increasing focus of the multiline insurance groups on the bulk market, following the significant drop in demand for individual annuities triggered by the government s planned changes to the DC pension regime. Several insurers not yet operating in the bulk market are considering a 2015 launch. Some schemes have transacted at pricing that represents a lower cost than funding the same liabilities from a gilt portfolio. This reflects short-term asset opportunities underlying the pricing of several recent deals. To benefit, being ready to trade is a key criterion. Aon Hewitt s new Pathway service simplifies and accelerates the process of choosing an annuity to put schemes in a strong position. Other Specialists Partnership and Just Retirement continue to write bulk deals to develop medically underwritten transactions from company pension schemes, with deals up to 40 million. For more information, please contact Paul Belok at +44 (0) Consulting Investment Consulting 6

8 Mexico In Mexico, pension plans are relatively new. As mentioned in previous issues, the retirement savings culture is not widespread. However, the Mexican government has been making efforts to promote it since the social security law change took effect in In 1997, social security law passed from a defined benefit scheme (Law 73) to a defined contribution scheme (Law 97). Employees in Law 73 are the transition generation. They will be entitled to select the benefit they want to receive (either Law 73 or Law 97). The annuity market is linked to social security pension payments, and there are 10 insurance companies that provide social security life annuities. Only a couple of companies offer private retirement life annuities. Cumulative Premiums From 2010 Period Ending March $276,450 $288,034 $336,527 $348,713 $374,350 June $591,354 $555,705 $650,583 $830,410 September $884,334 $877,212 $1,010,902 $1,211,807 December $1,219,116 $1,211,473 $1,356,385 $1,546,080 Obtained from the Mexican Commission of Insurance and Guarantees. Exchange rate: $1 USD = 13 Mexican pesos. Figures are in $USD (thousands). Every year, more pension plans are implemented. Due to the aging population, the market grows every year, and there are more campaigns in terms of retirement savings. As the transition generation of social security shrinks and the new generation grows, the annuity market and retirement savings culture will acquire greater importance in Mexico. For more information, please contact Patricia Barra at +52 (55) x2821. Consulting Investment Consulting 7

9 Important Considerations for Timing on Obtaining a U.S. Pension Annuity Settlement Quote Over the last few years, pension de-risking activity has increased steadily in the United States. Executing liability settlements is one of the key tools in the pension de-risking tool kit, utilizing two recently popular methods: 1) Voluntary lump-sum offers to terminated vested employees 2) Purchase of annuity contracts from a private insurance company Both of these options effectively remove pension obligation and all associated costs/risks from the sponsor s balance sheet, which is often an end-state objective for many pension sponsors. The following discussion focuses solely on the annuity option, and helps pension stakeholders consider the most appropriate time and considerations for engaging the insurance marketplace. Insurer Pricing Considerations Insurers develop annuity pricing based upon the following variables: Specific plan benefits covered Daily available spot rate investment yields Insurers individual views of mortality, profit, and risk Competitive market environment These factors create a dynamic where, generally, specific insurer pricing is somewhat fluid and ultimately difficult to pinpoint until a competitive bidding process is underway and a fiduciary formally selects an insurance company. This challenges the ability to precisely determine annuity cost early in the strategic business planning process, when sponsoring organizations are evaluating pension settlement possibilities. Market-Based Annuity Estimates Given the variables above, HEK provides proxy rates to assist pension actuaries in estimating annuity liabilities. HEK maintains a historical monthly database of annuity rates that provides actuaries with a current marketbased indication of where annuity costs might settle. There are many considerations for developing an appropriate estimate, and we outline some of them below. These considerations allow actuaries the flexibility to employ the rates in their cost planning estimates with clients. Duration Liability cash flow characteristics will matter and are the initial baseline for any estimate Expenses Rates should include all insurers costs and risk charges Mortality Appropriate proxy that considers an insurer s perspective on mortality and will differ based upon on insurer-specific views and specific plan demographics Historically, these estimated annuity rates provide effective results for actuaries and sponsors, giving them a general direction on the purchased liability. Consulting Investment Consulting 8

10 Annuity Transaction Types Annuity transactions come in two basic varieties: 1) total settlement and 2) partial settlement. The decisionmaking process for formally engaging the insurance marketplace may vary based upon the transaction type. A total settlement involves an annuity purchase as part of the distribution phase of the PBGC Standard Plan Termination process. These purchases typically, but necessarily, follow a voluntary lump-sum election process and contain a mixture of retired and non-retired participants to annuitize. Given the election process uncertainty and its impact on the final annuity purchase, obtaining insurer pricing in advance of the completed lump-sum elections may not be optimal. The rationale is that there may be significant changes to the ultimate population once a sponsor compiles the final election decisions. In the case of a plan termination, HEK recommends engaging the insurance marketplace immediately following the completion of the lump-sum election process. This requires close coordination between stakeholders to ensure they adhere to distribution deadline requirements. The second annuity transaction type is a retiree lift-out annuitization where sponsors annuitize only current retirees outside a formal plan termination process. This is an increasingly popular option, as an alternative to total plan termination, for sponsors that wish to partially settle plan liabilities. A retiree-focused transaction avoids the plan termination-related complexity that often interconnects the lump-sum election and annuitization processes. Thus, in the case of an all-retired annuity purchase, one can obtain insurer pricing and can rely upon the quotes for business planning purposes much earlier than in a full plan termination. In practice, receipt of actual insurer pricing for all-retired annuity placements may be part of a sponsoring company s work (in its settlor capacity) to validate the annuitization business case and to obtain internal stakeholder approval to authorize a transaction. Please note that the above information does not contemplate use of a spinoff termination, which involves removing part of the liability from the original plan and terminating, plus annuitizing, that portion of the plan. Although a valid option, we will explore its ramifications more extensively in another article. Other Considerations While one can rely on the general guidance referenced above in most situations, there are client-specific considerations that may require additional consultation with an annuity placement consultant. Here are a few examples: Cash balance plans/variable benefits Generous plan provisions (subsidized early retirement, disability benefits, COLAs, etc.) Very small or very large transactions (<$1 million or >$1 billion) Asset-in-kind premium funding Existing legacy group annuity contracts Consulting Investment Consulting 9

11 Conclusion: Estimate, Validate, Consummate While this article provides some basic guidelines and rules of thumb on insurance company annuity pricing considerations, each client circumstance may dictate a more tailored approach. In conclusion, we offer a simple graphical illustration of the process outlined above. Consulting Investment Consulting 10

12 Contact Information U.S. Team Steve Shepherd Partner Hewitt EnnisKnupp Jay Dinunzio Senior Consultant Hewitt EnnisKnupp Jennifer Lawrence Consultant Hewitt EnnisKnupp Canada Eric Tardif Senior Consultant Aon Hewitt Mathieu Bouvrette, CIM Consultant Aon Hewitt United Kingdom Paul Belok Partner Aon Hewitt +44 (0) Mexico Patricia Barra Retirement Practice Leader Mexico Aon Hewitt +52 (55) x6011 Consulting Investment Consulting 11

13 About Hewitt EnnisKnupp Hewitt EnnisKnupp, Inc., an Aon plc company (NYSE: AON), is an SEC-registered investment adviser, and provides investment consulting services to over 470 clients in North America with total client assets of approximately $2 trillion as of 12/31/2013. More than 270 investment consulting professionals in the U.S. advise institutional investors such as corporations, public organizations, union associations, health systems, endowments, and foundations with investments ranging from $3 million to $700 billion. For more information, please visit About Aon Hewitt Aon Hewitt empowers organizations and individuals to secure a better future through innovative talent, retirement, and health solutions. We advise, design, and execute a wide range of solutions that enable clients to cultivate talent to drive organizational and personal performance and growth, navigate retirement risk while providing new levels of financial security, and redefine health solutions for greater choice, affordability, and wellness. Aon Hewitt is the global leader in human resource solutions, with over 30,000 professionals in 90 countries serving more than 20,000 clients worldwide. For more information on Aon Hewitt, please visit Legal Disclaimer The information contained herein is given as of the date hereof and does not purport to give information as of any other date. The delivery at any time shall not, under any circumstances, create any implication that there has been a change in the information set forth herein since the date hereof or any obligation to update or provide amendments hereto. This document is not intended to provide, and shall not be relied upon for, accounting, legal, or tax advice or investment recommendations. Any accounting, legal, or taxation position described in this presentation is a general statement and shall only be used as a guide. It does not constitute accounting, legal, and tax advice and is based on Hewitt EnnisKnupp s understanding of current laws and interpretation. This document is intended for general information purposes only and should not be construed as advice or opinions on any specific facts or circumstances. The comments in this summary are based upon Hewitt EnnisKnupp s preliminary analysis of publicly available information. The content of this document is made available on an as is basis, without warranty of any kind. Hewitt EnnisKnupp disclaims any legal liability to any person or organization for loss or damage caused by or resulting from any reliance placed on that content. Hewitt EnnisKnupp reserves all rights to the content of this document. No part of this document may be reproduced, stored, or transmitted by any means without the express written consent of Hewitt EnnisKnupp. Consulting Investment Consulting 12

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