Global Institutional Annuity Market Update

Transcription

1 Global Institutional Annuity Market Update Liability De-Risking / Plan Terminations Fourth Quarter 2011 Hewitt EnnisKnupp, An Aon Company 2012 Aon Corporation Brief Description: This newsletter reviews the international annuity market in the fourth quarter of 2011, helps plan sponsors think about how improved mortality can affect their pension liabilities and discusses the value proposition of insulated guaranteed separate accounts.

2 Fourth Quarter International Market Update United States There were more single premium group annuity placements in 2011 than in 2009 or 2010, with a total of about 200 cases. This marks the first increase in the number of settlements since The total premium placed in 2011 was about $900 million, also the first increase in the total premium settled since The majority of premium in 2011 was placed with Prudential, MassMutual, and MetLife, respectively. The data comes from a survey of true pension annuity close-out deals (in addition to buy-ins and carve outs in advance of full close-outs) from 11 insurance companies currently active in the annuity marketplace, or active within the past several years. 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. Insurance companies surveyed include: American General 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 United of Omaha Life 1

3 No single 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 Annuity placement inquiries have been consistent, even with the continued low interest rate environment. As sponsors continue to contemplate end-game strategies, we continue to anticipate an increase in placements over the next 12 to 24 months. 2

4 Immediate and deferred annuity purchase rates rose in the early part of the fourth quarter, but ended the quarter lower than they started. The chart below illustrates interest rates since January % Historical Sample Annuity Pricing Rates 6.0% 5.5% Deferred Rate (Duration=15) Immediate Rate (Duration=7) 30-Year Treasury Rate 10-Year Treasury Rate 5.0% Interest Rate 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Note: Rates are derived from a Hewitt EnnisKnupp survey completed monthly by eleven insurance companies currently active in the marketplace. (3/31/2012 excludes Transamerica, which is currently on bidding hiatus.) The rates for 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 only held open for a couple of hours on the day they are published. 3

5 Immediate Annuity Rates Deferred Annuity Rates Rates as of: Low High Low High 3/31/ % 3.24% 3.65% 4.03% 2/29/ % 3.18% 3.55% 3.93% 1/31/ % 3.20% 3.51% 3.89% 12/31/ % 3.27% 3.45% 3.83% 11/30/ % 3.53% 3.66% 4.04% 10/31/ % 3.39% 3.68% 4.06% 9/30/ % 3.37% 3.60% 3.98% 8/31/ % 3.58% 3.96% 4.34% 7/31/ % 3.71% 4.22% 4.60% 6/30/ % 4.16% 4.57% 4.95% 5/31/ % 3.96% 4.41% 4.79% 4/30/ % 4.12% 4.51% 4.89% 3/31/ % 4.27% 4.57% 4.95% Note: 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 should possibly be added to lower the estimated rate even further. The Aon Hewitt Pension Risk Tracker reported that the aggregate U.S. funded ratio of plans in the S&P 500 recovered somewhat during the fourth quarter but were down for the year. The aggregate funded ratio fell from 90.2% to 77.5% over the third quarter, and then rose to 81.5% at the end of the fourth quarter. Overall, the funded ratio was down about 3% for the year. A steep decline in corporate bond yields used to discount pension liabilities caused pension liabilities to increase by 2.3%. Ten-year treasury yields remained nearly unchanged at the end of the quarter, while credit spreads narrowed by about 0.12%. This decreased corporate bond yields by about 0.15% during the quarter. Pension assets increased by about 7.5% due to strong performance in the equity markets during the quarter. Over 2011, 10-year Treasury yields decreased by 141 basis points from 3.30% to 1.89%. AA credit spreads increased by 61 basis points from 202 to 263. Combined with the decrease in 10-year Treasury yields, corporate AA yields fell by 80 basis points from 5.32% to 4.52%. Even with significant contributions from plan sponsors, the S&P 500 pension deficit ballooned from $240 billion to $320 billion in The weak performance in the equity markets for 2011 along with a significant decrease in corporate AA yields led to about a 3% decline in the aggregate S&P 500 funded ratio. 4

6 Canada The year 2011 has closed with total annuity placements of $1.362 billion, compared to $750 million observed for the year The volume of group annuity purchases contracted with the Canadian insurance companies more than doubled in the second half of 2011 relative to the first half. A group annuity placement with a $400 million premium was placed in September with a single Canadian insurance company, which has been recorded as the largest placement in The Office of the Superintendent of Financial Institutions (OSFI), which is the sole regulator of the banks, and the primary regulator of insurance companies, trust companies, loan companies, and pension plans in Canada, is considering allowing federally regulated pension plans to utilize annuities. In this sense, dated January 27, 2012, the OSFI has issued a draft policy advisory on the acceptability of "buy-in annuities" as a potential investment option for federally regulated pension plans. Comments have been required by March 9, The formalization of this policy may contribute to greater opportunities for federally regulated pension plans in Canada. For more information, please contact Tony Ioanna at United Kingdom There were a record number of risk settlement transactions in the fourth quarter of 2011 in the UK, leading to a total of 5.3 billion for the year. This was second only to Combined with longevity hedging deals covering 7.1 billion of liabilities, the total risk settlement market was a record-breaking 12.4 billion. The two largest ever buyout deals for insolvent schemes both occurred during the fourth quarter: T&N for 1.1 billion with Legal & General, and Uniq for 830 million with Rothesay Life. Aside from these, there was a significant increase in the volume of pensioner buy-ins completed. There were also three large longevity hedges placed in the fourth quarter: a 3 billion hedge that Rolls Royce secured with Deutsche Bank, a 1 billion hedge for Pilkington with Legal & General (both advised by Aon Hewitt), and a further 1.3 billion hedge to add to British Airways' longevity protection with Rothesay Life. Legal & General was the leader in 2011, both in terms of the value of business written ( 1.46 billion) and number of cases (85). Aviva and Rothesay also wrote in excess of 1 billion of business, with Rothesay having written no business in PIC and MetLife ranked 4 th and 5 th in terms of placement value. Prudential, which was top-ranked in 2010 due to the substantial GSK pensioner buy-ins placed, then fell to 6 th place for Note that Alico's bulk annuity portfolio has been taken on by MetLife, and Aegon is not currently writing UK bulk annuity business. 5

7 UK Provider Market Consolidation and Expansion There has been a recent flurry of activity in the marketplace with respect to the number of providers developing and entering the fray. For example, PensionsFirst has announced its intention to launch a bulk annuity insurer (Long Acre Life) with former Pensions Regulator David Norgrove named as Chairman. Part of its offering will be an option for pension scheme sponsors to invest capital into the insurer to allow them to benefit from any profit that would otherwise have accrued to the insurers. This would be intended to reduce the overall longer term cost of insurance. Aon Hewitt sees any expansion of the market as positive, particularly if it helps drive development of solutions that fit the needs of schemes and their sponsors. On the consolidation front, following Rothesay s acquisition of Paternoster, the Part VII transfer to merge the two annuity books formally took place on December 14, This process required approval to ensure that policyholders rights would be protected. MetLife is expected to follow the same path in relation to combining with its Alico subsidiary in Rothesay Life also agreed to a longevity reinsurance contract with RGA UK which went into effect on July 1, The reinsurance contract will provide benefit payments for the remaining lifetime of pensioners from 10 Schemes held by Rothesay and Paternoster, covering 1.1 billion of liabilities. A further 450 million of longevity risk was transferred by Rothesay to US-based Prudential Retirement in November Insurers also showed signs of rebalancing risks, perhaps in preparation for the new Solvency II regime (despite this being delayed until 2013). There were several substantial longevity reinsurance contracts entered into, where insurers took advantage of pricing in the longevity reinsurance market to hedge their exposure. There were also increasing signs of interest in investments wider than the traditional asset classes backing annuity business, i.e. beyond corporate bonds, gilts and swaps. For more information, please contact Paul Belok at +44 (0) Mexico Aon Hewitt Mexico knows that there are significant opportunities and challenges in transferring pensions to the insurance market through annuities of private retirement plans that are still covering benefits directly from the trust fund. In such cases, the sponsor is responsible for financing potential additional costs of bearing the mortality and interest risks. There is no information to report for the fourth quarter. For more information, please contact Patricia Barra at +52 (55) x

8 Studies Show Plan Participants are Living Longer than Expected Longevity studies performed by the Society of Actuaries (SOA) over the past few decades have shown that life expectancies in the United States have been increasing at a relatively consistent rate. Two recent studies: a report on individual annuity experience issued in September 2011 and an Exposure Draft on Mortality Improvement Scale BB released in March 2012, have shown that since calendar year 2000, life expectancies in the U.S. increased at an even faster pace than predicted by the most frequently used pension projection scale. The most typical mortality assumptions used by pension actuaries in the U.S. start with base mortality rates effective as of 2000, which are then projected into the future with a table of improvement factors, i.e., reductions to the underlying mortality rates. Scale AA has been the most frequently used table of pension mortality improvement factors since 1994, the year it was issued. Insurance companies in the annuity marketplace use similar mortality assumptions as pension consultants but often add their own mortality experience as another data point when projecting future longevity trends for pricing purposes. These variations in mortality assumptions reflect each insurance company s unique book of business and/or industry or plan specific independent studies. In March 2012, the SOA issued an exposure draft with results of recent research based primarily on Social Security mortality data. The results of this study showed that U.S. life expectancy has improved at a faster pace than anticipated using Scale AA. Accordingly the SOA has developed a new scale for projecting longevity, Scale BB, which has the effect of increasing plan liabilities. While pension actuaries can start using the new Scale BB immediately for accounting purposes, it s too early to tell whether the IRS will ultimately adopt it for minimum funding purposes as well. Why should plan sponsors care about this change? The change from Scale AA to Scale BB is estimated to cause an increase to the liabilities of a typical pension plan by about 2% to 4%, with variation based on plan demographics and provisions. This means that plans will have higher expense and require higher investment returns and/or greater contributions than previously assumed to maintain funded levels. We expect many plan sponsors will adopt the new scale, often with the change first reflected on their December 31, 2012 financial statements. Please contact your pension actuary to see how this change could affect your plan. The March 2012 study confirmed the results of a separate study that was completed in September 2011 by the joint AAA/SOA Payout Annuity Table Team on the valuation of individual annuities. The Payout Annuity Table report confirmed the belief of many insurance company actuaries that Scale AA tended to understate annuity values. Consequently, about half of the impact of Scale BB had already been priced into certain annuity quotes, so the recent Scale BB research might increase average annuity quotes for pension plans by another 1% to 2%. 7

9 To illustrate how this could affect your plan on a very simplified basis, the chart below reflects how the projected benefit obligation (PBO), annuity pricing, and their relative values could change in the future assuming a $100 million liability in Once sponsors update their mortality assumptions to reflect Scale BB, the plan s PBO should move closer to the annuity purchase cost, making annuity purchases more attractive to plan sponsors Plan Sponsor Mortality Projection Scale Scale AA Scale AA Scale BB Insurance Company Mortality Scale Scale AA plus Scale BB Scale BB improvements PBO $100 $100 $104 Retiree Annuity Premium $107 to $110 $108 to $112 $108 to $112 Delta $7 to $10 $8 to $12 $4 to $8 Annuity Premium as % of PBO 107% to 110% 108% to 112% 104% to 108% It should also be noted that SOA is currently performing additional research on the increasing life expectancies of U.S. pension plan participants. The expected release date for this research is late 2013 or early 2014, which adds more uncertainly to estimates of future plan liabilities and makes annuity purchases potentially more attractive now. If you are thinking of settling all or a portion of your plan liability through a partial settlement or plan termination, the cost to purchase annuities could go up as much as 2% in 2012 depending on the timing of the settlement. This estimate will vary depending upon the specifics of your pension plan and when, if they have not already, the insurance companies actually start using the latest SOA research. At least one major insurance company has already fully incorporated the use of improved mortality in their pricing. To get an estimate of the cost to settle all or a potion of your liabilities, please contact your Retirement or Investment Consultant. 8

10 What protection am I buying? The Value of Guaranteed Insulated Separate Accounts To be or not to be, that it is the question! With all deference to Shakespeare, the famous soliloquy from Hamlet is just as applicable to the U.S. annuity buyout market. Now that we have your attention, let s explain the parallel. The Department of Labor s Interpretative Bulletin No (DOL 95-1) asks sponsors to consider various factors to meet their fiduciary responsibilities when purchasing annuities for the purpose of distributing benefits under an employee pension benefit plan. Of the six explicit items the Bulletin promulgates, the fifth factor states that sponsors should consider the structure of the annuity contract and guarantees supporting the annuities such as the use of separate accounts. This would suggest that sponsors have an obligation to assess the value of separate accounts and whether or not it would be beneficial to the plan and its participants. Currently when a sponsor makes a fiduciary assessment on an insurance company, that sponsor has two primary options where to place the annuity contract. Either the sponsor can utilize a separate account or general account annuity structure. Please note that currently, the overwhelming majority of U.S. annuity buyout contracts have been placed in an insurer s general account. Most insurers do not actively provide a guaranteed annuity buyout separate account contract, but will file one based on placement size, client interest and willingness to pay extra for the separate account protections. One insurer actively provides a separate account structure for typical annuity placements and that is Prudential. Separate Account Value Proposition One might wonder why more insurers don t provide this contract structure routinely, especially since it is referenced in DOL This issue goes to the inherent value of a separate account versus a general account. Some insurers might suggest that if they meet all of the financial requirements in DOL 95-1, that the additional separate account cost relative to the benefit for sponsors / beneficiaries is minimal. Although not necessarily apples-to-apples between insurers, the additional cost of the separate account relative to general account might range from 1% to 3%. The extra cost is due to needed liquidity, asset differences, investment leverage, and other factors. However, the elephant in the room is probably less quantitative and more qualitative. There is a general perception that insurers may not need to offer guaranteed separate account annuity buyouts, particularly placements less than a billion dollars, because of a contradictory message it might send to policyholders. The message, although not explicit, could imply that our general account is not financially strong enough so you need to seek the protection of a separate account offering. Perception as many of you know is not necessarily reality. What makes the separate account special and why DOL 95-1 references it, is because it does provide additional protection to plan participants. In the very unlikely event of insurer insolvency, the participants in a guaranteed separate account contract have their assets insulated from the participants in the general account and other creditors. In other words, the assets in the separate account can only be used to pay the obligation of the separate account plan participants. If there are sufficient assets to pay all of the separate account plan participants, then that s great. If there is a deficiency and there are insufficient assets in the separate account, then the separate account plan participants stand side-by-side with the general account participants and the shortfall is paid proportionally from any residual assets in the general account. 9

11 Some would argue that separate account plan participants have the best of both worlds. In other words, if the general account is deficient and the separate account has no shortfall, then the general account participants can not reach into the insulated guaranteed separate account to fund for any general account shortfall. The only exception is if the separate account policyholders are paid in full and there are extra funds available in the guaranteed separate account. Then and only then, can the general account participants use some of those funds. Is it fair or is it not? Now we come to the heart of the issue! There is an argument that some make that the insulated guaranteed separate account plan participants may have an unfair advantage over general account policyholders that could be discriminatory. In fact, Minnesota disallows these types of insulated guaranteed separate accounts because of perceived or real preferential treatment. As a result of these concerns and others, the National Association of Insurance Commissioners (NAIC) established a Separate Account Risk Working Group to study and report back a recommendation on various issues. One specific goal is to determine if there needs to be modifications to these types of separate accounts and determine what type of products should have insulation and which ones should not. At this point we have no reason to believe that insulated guaranteed separate accounts will be disallowed as a viable insurer offering. Insulated guaranteed separate accounts are a long standing viable insurance vehicle. Additionally, some argue that the insulated guaranteed separate account is not inherently discriminatory because the plan sponsor pays more for the extra protection upfront. However, recent activity has created a little bit of uncertainty. Questions that we are analyzing are whether the fees will be worth the protection if changes are made? What risk charges if any does the insulated guaranteed separate account need to pay to compensate the general account for the extra protection? Will there be true insulation in future versions of guaranteed separate accounts? As always we ll continue to monitor the situation and report back to you as the market evolves and as the regulatory bodies continue to study the issue. * * * We will continue to monitor the single premium group annuity market for you. If you have specific questions, please contact your Aon Hewitt or Hewitt EnnisKnupp consultant. 10

12 Contact Information U.S. Team Robin Gantz, Senior Consultant Hewitt EnnisKnupp, an Aon Company Canada Tony Ioanna, Vice President Aon Hewitt Steve Shepherd, Associate Principal Hewitt EnnisKnupp, an Aon Company Jennifer Lawrence, Consultant Hewitt EnnisKnupp, an Aon Company United Kingdom Paul Belok, Principal & Actuary Aon Hewitt +44 (0) Mexico Patricia Barra Aon Hewitt Mexico +52 (55) x2821 About Hewitt EnnisKnupp Hewitt EnnisKnupp, Inc., an Aon company, provides investment consulting services to over 500 clients in the U.S. and abroad with total client assets of over $2 trillion. Our more than 200 investment consulting professionals a result of the merger of Hewitt Investment Group, Ennis, Knupp & Associates, and Aon Investment Consulting advise endowment, foundation, not-for-profit, corporate, and public pension plan clients ranging in size from $3 million to over $740 billion. 11