Global Institutional Annuity Market Update Liability De-Risking / Plan Terminations Year-End 2012 Hewitt EnnisKnupp, An Aon Company 2013 Aon Corporation Brief Description: This newsletter reviews the international annuity market in the second half of 2012, capacity concerns in the domestic market and how PBGC Coverage compares to State Guaranty Association coverage.
Year-End International Market Update United States In the second half of 2012, there were 72 group annuity placements worth a total of about $34 billion in premium, as reported to us by the insurance companies surveyed below. There were 40 placements worth a total of about $600 million in the third quarter, and 32 placements worth about $34 billion in the fourth quarter. GM executed a large deal for its retirees by initially offering a lump sum and then annuitizing the remainder. On the heels of the GM deal, Verizon annuitized its retirees. These deals were revolutionary in their size, scope and complexity and should be the impetus for other large transactions in the future. Both deals closed in the fourth quarter. The aggregate number of placements in the second half of 2012 was less than in the second half of 2011, but the amount of premium placed was more than double, even excluding GM and Verizon. The vast majority of premium in the third quarter of 2012 was placed with Principal Life. The fourth quarter was led by Prudential, again due to Verizon and GM. 2012 overall was a great year, with the 247 placements being the highest total in the last eight years. Even excluding GM and Verizon, the remaining total premium of $2.3 billion placed in 2012 was the second highest in the last eight years. 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 10 insurance companies (11 companies from 2005 to 2009) 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. $40 $7 Total Premium $35.3 Insurance companies currently surveyed include: American General 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 Total Premium (billions) $6 $5 $4 $3 $2 $1 $0.6 $1.8 $2.7 $2.3 $0.8 $0.7 $0.9 $0 Year 1
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 2012 Prudential Annuity placement inquiries have been on the rise, 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. We anticipate an increase in placements over the next 12 to 24 months. 2
Annuity purchase rates continued to fall over the second half of 2012, though there was a slight uptick in December. Immediate rates fell over 30 basis points from June 30 th to December 31 st, while deferred rates fell just about 30 basis points over the same period. The chart below illustrates annuity pricing and market interest rates since January 2007. Note: Rates are derived from a Hewitt EnnisKnupp survey completed monthly by eleven insurance companies active in the marketplace. (3/31/2012 and forward excludes one of these insurers which is currently on bidding hiatus.) 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 only held open for a couple of hours on the day they are published. 3
Immediate Annuity Rates Deferred Annuity Rates Rates as of: Low High Low High 12/31/2012 2.44% 2.74% 3.04% 3.42% 11/30/2012 2.36% 2.66% 2.98% 3.36% 10/31/2012 2.43% 2.73% 3.02% 3.40% 9/30/2012 2.51% 2.81% 3.05% 3.43% 8/31/2012 2.55% 2.85% 3.15% 3.53% 7/31/2012 2.57% 2.87% 3.14% 3.52% 6/30/2012 2.79% 3.05% 3.35% 3.73% 5/31/2012 2.67% 2.90% 3.26% 3.64% 4/30/2012 2.77% 3.07% 3.42% 3.80% 3/31/2012 2.94% 3.24% 3.65% 4.03% 2/29/2012 2.88% 3.18% 3.55% 3.93% 1/31/2012 2.90% 3.20% 3.51% 3.89% 12/31/2011 2.97% 3.27% 3.45% 3.83% 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. Our Aon Hewitt Pension Risk Tracker is recalibrated each year to reflect updated fiscal year-end disclosures. The fourth quarter data below reflects the latest recalibration, which incorporates actual pension disclosures through February, 2012. In the fourth quarter of 2012, we saw continued improvement in pension plan funded status. The recalibrated aggregate funded ratio of pension plans in the S&P 500 Index at the end of the third quarter was 75.7%. This ratio increased moderately to 77.2% over the fourth quarter. The increase was driven by a 1.0% decrease in pension liabilities, primarily due to an increase in corporate bond yields. Also, tenyear treasury rates were up by 0.13% over the quarter, while credit spreads narrowed modestly by 0.02%, resulting in an up-tick in the 10-year corporate bond yield to 3.78% at the end of the quarter. For the full year 2012, the aggregate S&P 500 funded ratio declined by about 1.2%. The 10-year treasury yield declined by 11 basis points, from 1.89% to 1.78%. Aa credit spreads shrunk from 263 to 200 basis points. With the decline in 10-year treasury yields, corporate Aa yields fell by 74 basis points from 4.52% to 3.78% over the last year. is resulted in the S&P 500 pension deficit rising from $374 billion to $435 billion over the last twelve months. The sizeable increase in pension liabilities overshadowed a good performance from pension assets. 4
Canada Total group annuity premiums placed with the major Canadian insurance companies were $308 million for the first quarter and $118 million for the second quarter. The third quarter of 2012 closed at $200 million, for a total of $626 million. Based on the experience in the past two years, the fourth quarter generally has competitive pricing, considering that the total amount of annuities sold in the Canadian market since the start of the year is about half of the amount sold in 2011 and that insurers may have performing assets available to support competitive quotes by the end of 2012. As communicated in the last Market Update, the Canadian Institute of Actuaries (CIA) revised their discount rate guidance for estimating the cost of purchasing non-indexed group annuities for hypothetical wind-ups and solvency valuations in August 2012. This discount rate guidance for estimating annuity pricing for non-indexed pensions, which uses Government of Canada long-term bond yields (GoC) plus a 90 basis point (bps) margin at the valuation date, was revised by a decrease of 10 bps, to reflect an 80 bps margin over the GoC bonds. Further, on December 4, 2012, the CIA revised their discount rate guidance for estimating annuity pricing for non-indexed pensions by an additional decrease of 10 bps, to reflect a 70 bps margin over the GoC bonds to valuations with effective dates on and after September 30, 2012, up to December 30, 2012. GoC bond yields closed at 222 bps as of September 30, 2012 and were at around 230 bps at the end of December 2012. Finally, as part of market progress updates in Canada, the insurance company leading in annuity placements announced in August 2012 the completion of an annuity buy-in purchase worth over $20 million to protect a plan sponsor's Canadian DB plan against investment and longevity risks during a wind-up. Additionally, in November 2012, this same insurer also completed the first conversion of an annuity buy-in to an annuity buy-out contract in Canada for a plan sponsor. For more information, please contact Tony Ioanna at +1.514.982.5189. 5
United Kingdom There were 45 cases written in the UK in the third quarter for a total of 1,069 million, which was double the value written in the first quarter. Business in the first three quarters of 2012 surpassed the first three quarters of 2011, despite the fall in market yields from July 2011 onwards. Legal & General (L&G) was the leader by far in terms of the number of second and third quarter placements. The leader in the first quarter, Pension Insurance Corporation (PIC), wrote the largest value in the second quarter and a close second in the third quarter. Prudential, MetLife and Aviva wrote the remainder of deals in the second and third quarters, with Canada Life writing two deals. Lucida announced on November 14 th that it would close its insurance book to new business. Canada Life announced that it is not currently interested in bulk annuities. Aviva has decided not to quote on large bulk deals. These companies join Paternoster, AEGON and AIG, which previously exited the market. The remaining insurers are showing signs of becoming increasingly selective about the cases on which they will quote. The effective date of Solvency II, the new solvency regime for European Insurance Companies, has been pushed back to 2016. The UK is ahead of the game, since its existing requirements are closer to the new Solvency II requirements than other EU countries. For companies with a big block of annuities, any impact on existing investment and reserving strategies is critical to understanding how profits can be realized from the book going forward. For more information, please contact Paul Belok at +44 (0) 20 7086 8089. 6
Mexico In Mexico, pension plan topics are relatively new. As mentioned in previous issues, the retirement savings culture is not common. However, the Mexican government is making efforts to promote it since the Social Security Law change in 1997. 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 are as follow: Premiums Figures in US (000s) Period ending 2010 2011 2012 Mar $276,450 $288,034 $336,527 Jun $591,354 $555,705 $650,583 Sept $884,334 $877,212 $1,010,902 Dec $1,219,116 $1,211,473 $0 Exchange Rate: $1 USD = 13 Mexican pesos Every year more Pension Plans are implemented. While the transition generation of Social Security is decreasing and the new generation is increasing, the annuity market and retirement savings culture will acquire greater importance in Mexico. For more information, please contact Patricia Barra at +52 (55) 5340.2800 x2821. 7
Capacity Problems? Maybe. Just Not What You Think! After the bevy of 2012 annuity transactions, there was one constant refrain heard from every plan sponsor considering an annuity settlement: Are you confident there is still enough capacity to get my deal done? The good news is asset and capital capacity were more than sufficient to transact the largest annuity buyout deal flow in decades. Insurance companies told us early in the year that they had adequate capacity to implement deals and executed GM and Verizon, in addition to many large, midsize and smaller transactions. Going into 2013, we know that insurance companies can underwrite and fund deals. The real question is: which insurers will quote on which deals? Current Marketplace According to the 2012 ACLI Insurer Data Fact Book, there are 895 life insurance companies in the U.S. market. These companies combined have about $5.5 trillion in assets. Out of those 895 insurance companies, there are only about 10 which explicitly say they are in the annuity buyout marketplace. These companies are among the largest and strongest U.S. insurers and all have infrastructures and underwriting capabilities to effectively price and administer these deals. These market participants all believe the buyout market will be even more attractive because of expected larger deal flow - after the GM and Verizon transactions. The U.S. annuity buyout market has generally been a $2 to $3 billion market in annual placements. This is minute compared to the total insurance industry or US corporate defined benefit assets. Over the past few years, particularly after the 2008 capital market dislocations, the annual buyout market was even more anemic than usual. Influential annuity buyout carriers like Travelers, which was purchased by MetLife in 2005, and Hartford, which exited the institutional retirement business in 2008, created greater market provider contraction. New Paradigm? With the emergence of jumbo deals, insurance companies are revisiting their quoting policies. Although one can quibble around the margins, we see four distinct market sizes: small, mid, large and jumbo. Small deals would be considered transactions less than $10 million. Mid-market would be deals that are between $10 and $100 million. Large deals would be considered deals between $100 million and $1 billion. And finally, jumbo deals would be any transaction over $1 billion. It is clear that jumbo transactions involve a tremendous amount of insurer resources (M&A-like), capital commitment and intellectual capacity. Annuity Deal Size Small Mid Large Jumbo Definitions Transactions less than $10 million Transactions between $10 million and $100 million Transactions between $100 million and $1 billion Transactions over $1 billion In the last few months, towards year-end where companies are their busiest, we noticed that quoting selectivity increased among insurers. In addition, a few market participants took a quoting hiatus for internal business reasons. Again, plan sponsors began wondering how many insurers would bid on their placements. 8
Implications for the Market It is very possible that 2013 will see less competition for some placements in certain market segments. We think a different subgroup of insurers will play in the jumbo market versus those that play in the small market. We also think the vast majority of insurers will continue to play in the mid to large market segments. However, the question remains, Should plan sponsors be concerned about bringing annuity transactions to market? Our answer is that prudence is appropriate but not concern. We expect that other insurers not currently in the market will begin to fill the void. Insurance companies should find the annuity buyout business attractive for many reasons. First, many insurance companies are de-risking their balance sheets and moving away from volatile products such as the extreme benefit guarantees within retail variable annuities. Annuity buyouts also provide good, long term liabilities for insurers with very limited to no liquidity risk. Next, the annuity buyout liability provides a complementary risk to life insurance exposure. Finally, many insurance companies can leverage existing business structures and processes. Annuity buyouts, particularly retiree buyouts, are similar in concept to retail Single Premium Immediate Annuity (SPIA) deals. The primary difference is that the annuity buyout business is more of an institutional offering geared towards plan sponsors. An insurer s baseline SPIA infrastructure can be leveraged greatly for a much lower barrier to entry. Finally, Department of Labor, Interpretative Bulletin 95-1 (DOL IB 95-1) fiduciary guidance does not impose a safe harbor requirement on the number of insurers needed for adequate due diligence. The standard merely requires that a thorough and objective analytical search be performed by an expert to find a Safest Available Annuity Provider. The bottom line is if fewer insurers are willing to bid in a particular market segment, then more vigilance is needed to ensure sponsors are getting the best deal for the plan and its participants. This is a very important trend for U.S. plan sponsors to observe as we enter into 2013. 9
PBGC Coverage vs. State Guaranty Associations As U.S. pension plan sponsors contemplate plan termination or partial settlements with an insurance company, it is important to consider how the benefit protection changes upon settlement. The monthly benefit and annuity form promised under the pension plan will remain the same; however, the mechanisms that safeguard the benefit upon company bankruptcy or insurer insolvency are very different. These differences are discussed below. PBGC Coverage The Pension Benefit Guaranty Corporation ( PBGC ) is a federal agency responsible for insuring certain qualified defined benefit pensions should a company become unable to continue operating the plan. The PBGC is funded by: 1) insurance premiums paid by companies that maintain qualified defined benefit plans, 2) pension plans assets it takes over as trustee along with recoveries from the companies formerly responsible for those plans, and 3) the investment earnings on those assets. If the PBGC takes over a pension plan, the PBGC insurance program generally pays retirees the same amount previously paid by the pension plan, up to the limits set by law. It does so in the same form of benefit, but potentially adjusted to reflect the plan s funded status and priority categories. One of the participant categories is retirees, which guarantees current retirees their full benefits before other plan participants. Most participants receive the same benefit as under their pension plan; however, benefits are not payable as lump sums and the benefits payable also depend on the amount of assets the PBGC receives from the plan and the plan sponsor. The PBGC releases an annual table of monthly benefit amounts it will guarantee. These amounts are based on the participant s age when the PBGC assumes the liability, which is generally as of the plan termination date or the date the plan sponsor enters bankruptcy. The limits for 2013 ranged from about $2,100 a month for a 55-year-old to $7,900 per month for a 70-year-old. The yearly limits are indexed annually for inflation; however, once the PBGC assumes payment of a benefit, the maximum amount payable is fixed. State Guaranty Associations The insurance commissioners of all states, including Washington, DC and Puerto Rico, have established guaranty funds to protect policyholders in their jurisdictions. These funds are meant to safeguard some classes of policyholders in the event of nonperformance by an insurance company. It is very unlikely, in our opinion, to have a total insolvency of a large, well diversified and well capitalized insurance company. This is in part due to regulatory safeguards, including mandated Risk-Based Capital levels, statutory reserve standards and cashflow testing methods, as well as other rigorous requirements. However, in the event a state determines that an insurer is insolvent, the mechanism used to protect policyholders is the state guaranty association. In general, the coverage limit for annuities is between $100,000 and $500,000 per individual (present value of annuity benefits) and varies by state. The success of state guaranty funds has been apparent in the past, but the evidence is not substantial because total insurer insolvencies have been rare, even during the last economic downturn. Nevertheless, it has been our experience that in almost all instances, annuitants have continued to receive benefits in full and on time in the event of an insurer s seizure by its regulators. 10
Insurance companies are prohibited by law from advertising this coverage to entice prospective buyers. However, if asked, an insurer can direct clients to the National Organization of Life & Health Insurance Guaranty Associations (NOLHGA). The website is www.nolhga.com. Also, note that even before the guaranty fund coverage has been needed in the past, other insurance companies often purchased parts or all of a failing company s liabilities, and fully assumed all ongoing payment obligations. Comparison Comparing PBGC and state coverage is in many ways like comparing apples and oranges. This difficulty is due to the many differences, including: Likelihood of triggering coverage Size of claim after paying benefits from any existing assets Individual participant factors, including state of residence and benefit form It is important to understand both the economic and non-economic tradeoffs between the two types of protections. Some items to consider include: Regulatory jurisdiction Is it government guaranteed? Source of funds and premiums Credit underlying each system Funded status of organization Coverage levels Insurance triggers Claims payable when PBGC Federally regulated No Self-funded by corporate pension sponsors; not Federally funded The general credit rating of the sponsoring company and the financial wherewithal of the PBGC Current reported deficit of $34 billion Varies based on age For 2013, for age 65: $4,789.77 per month straight-life Company bankruptcy and PBGC review Plan assets are insufficient and PBGC takes over as trustee to the plan State Guaranty State regulated; all 50 states plus Puerto Rico and Washington, DC No Assessment of insurers licensed in the state in which the insolvent insurer is domiciled The financial strength rating of the selected insurer(s) and the general financial strength of the insurance industry Guaranty fund is unfunded until an insolvency triggers required funding Varies by state, but not typically by age Present value limit ranges from $100,000 to $500,000 depending on each state Insurer declared insolvent after corrective supervision and rehabilitation process Remaining insurer assets are insufficient 11
Many plan sponsors have hired Hewitt EnnisKnupp to assist them in analyzing and understanding the economics around the protections of the PBGC vs. State Guaranty Associations based on their specific pension plan demographics. It would be prudent for most plans sponsors to seek outside expertise unless they have the in-house expertise to help them understand these options. 12
Contact Information U.S. Team Robin Gantz, Senior Consultant Hewitt EnnisKnupp, an Aon Company +1.949.823.8533 robin.gantz@aonhewitt.com Canada Tony Ioanna, Associate Partner Aon Hewitt +1.514.982.5189 tony.ioanna@aonhewitt.com Steve Shepherd, Associate Partner Hewitt EnnisKnupp, an Aon Company +1.203.523.8164 steve.shepherd@aonhewitt.com Jennifer Lawrence, Consultant Hewitt EnnisKnupp, an Aon Company +1.610.834.2271 jennifer.lawrence@aonhewitt.com United Kingdom Paul Belok, Partner Aon Hewitt +44 (0) 20 7086.8089 paul.belok@aonhewitt.com Mexico Patricia Barra Aon Hewitt Mexico +52 (55) 5340.2800x2821 patricia.barra@aonhewitt.com 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. 13