Rate Cuts Unlikely to Affect PRT Market in Short Term

The pension risk transfer market boomed in 2023 and so far in 2024 due to a record level in funded status across corporate pension plans, as plan sponsors sought to offload their pension liabilities in record numbers.

Now that interest rates are newly on the downswing, PRTs allow funds to lock in their gains and continue to enjoy the benefits of previous higher rates.

Those higher interest rates were a major driver in creating funding surpluses. According to Aon’s funded status tracker, corporate plans in the S&P 500 stood at 100.6% funded as of September 2. Other funded status trackers saw funded ratios of corporate plans reaching even higher: 108% (Mercer), 109.5% (LGIM America) and 114.9% (Insight Investment) at the end of July.

“We’ve seen a lot of funded status gains due to higher rates,” says Ciaran Carr, head of client solutions for North America at Insight Investment. “Pension plans that have de-risked into more fixed income” have hedged against interest rate risk and have locked in gains. So, he notes, “they’re in a better position to be protected.” Plans that did not do a PRT “will remain subjected to rates declining from here.” 

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With the Fed announcing a 50-bps cut to the fed funds rate, the pension risk transfer market, having thrived as a result of elevated rates, is unlikely to be affected in the short term. That is because pension funds, as long-term investors, are mainly exposed to long-term rates, which are unlikely to drop much, despite the projected slide in short-term rates.

“Pension funds are more sensitive to longer-term interest rates, rather than the level of fed fuds, and we expect as rate cuts occur [that] the yield curve will likely steepen, with little downward impact on longer interest rates,” says Scott Garrett, head of U.S. pensions at Schroders.

A spokesperson for PRT provider Legal & General Retirement America said the company does not anticipate any short-term changes in the rate transfer market as a result of rate cuts.

“We don’t anticipate any short-term changes due to rate cuts, as markets have generally reflected those,” the spokesperson said. “On the longer term, sponsors are now better funded and likely better hedged, so we would not necessarily expect any significant impact.” 

The timing of transfers is a factor in PRT pricing. The PRT market has exhibited “seasonality” in recent years, with PRT transactions executed earlier in the calendar year tending to produce better PRT pricing for plan sponsors, according to Brian Donohue, a partner in October Three Consulting. “Which is to say that it may be difficult to generate insurer interest and attractive pricing toward the end of 2024, as insurers fill their books for the year.” 

What Funds Should Do

Schroders’ Garrett says the changing interest rate environment is likely to increase volatility and add challenges for pension asset allocators.

“We believe the more interesting impact on the pension fund allocations will be the need to diversify risks, given the lower level of risk premium, greater idiosyncratic risk and the greater likelihood of higher volatility as central bank policies diverge, particularly given the large overweight to corporate beta through bonds and equities and loans,” Garrett says. 

Justin Demino, head of solution design for North America at Insight Investment, said his firm views interest rate risk as an uncompensated risk.

“We think that taking interest rate risk off the table to the extent that it’s affordable by a pension plan is a prudent decision. Think about hedging interest rate risk with physical bonds, with completion overlay, both at an aggregate level to 100% interest rate hedge ratio if affordable.” 