Thursday, October 18, 2012

Pension Risk Transfers: A Boon for Insurers?

Olga Kharif and Noah Buhayar of Bloomberg report, Verizon Sends $7.5 Billion in Pension Funds to Prudential:
Verizon Communications Inc. (VZ) is transferring about $7.5 billion in pension obligations, or one- fourth of the total, to Prudential Financial Inc. (PRU) in a drive to remove risk from its balance sheet.

Prudential, the second-largest U.S. life insurer, will take on responsibility for making future annuity payments to certain management retirees of the New York-based telephone company, Verizon said yesterday in a statement.

Verizon is using the agreement to lower risks related to pensions while improving its financial profile. It follows General Motors Co. in paying Prudential to assume the risk that market returns are inadequate or that beneficiaries live longer than expected. Transferring obligations can reduce swings in earnings tied to securities and relieve companies of the need to manage large pools of money.

“What Verizon is doing is what a lot of companies are considering,” John Butler, a senior analyst at Bloomberg Industries, said in an interview. “They are offloading the risk to Prudential.”

The transaction affects U.S. management pension benefits covering about 41,000 current retirees. It excludes current employees and those who retired after Jan. 1, 2010. The pension transfer won’t change the amount of the monthly pension benefit received by affected retirees and surviving beneficiaries, Verizon said.
13 Percent

Prudential Chief Executive Officer John Strangfeld has been expanding through acquisitions and underwriting as he seeks a return on equity of at least 13 percent next year at the Newark, New Jersey-based insurer. He announced a deal last month to take on life insurance obligations from Hartford Financial Services Group Inc. and struck an agreement in June to cut General Motors’s pension obligations by about $26 billion.

“The Verizon transaction is expected to be the second- largest insured annuity settlement in U.S. history, trailing only the GM deal,” Aon Hewitt, the provider of human-resources services owned by London-based insurance broker Aon Plc (AON), said in a statement. Aon Hewitt assisted Verizon in the deal.

The GM agreement may have been a catalyst for more transfers, William Wheeler, president of the Americas at MetLife Inc., the largest U.S. life insurer, said in August.

“That’s causing other corporate treasurers of large, traditional companies with old, traditional pension plans to think hard about what they should be doing,” Wheeler said. “Certainly there’s more conversation now.”

Low interest rates have pressured employers with pension obligations because it is harder for them to generate returns on funds set aside for the liabilities. The Federal Reserve has said it will keep rates near zero at least through the middle of 2015 to stimulate growth in the world’s largest economy.

Insurers are well equipped to take on the contracts because they are used to managing large pools of assets and have experience dealing with risk tied to life expectancies, Prudential has said.

Prudential is focusing on retirement services in the U.S. and Japan after exiting its real-estate relocation and commodities businesses.
I've already discussed GM and Ford's pension jubilee and followed that up with a comment on companies offloading pension risk. I specifically stated:
Obviously, pension transfers to insurers aren't as simple as many companies are led to believe. And while it makes sense from a company to offload pension risk, I worry about the long-term implications of such actions as they will only hurt retirees.

Then there is a question of timing. I'm actually bullish on America for the next five to ten years. I've already discussed the global game changer and how this is leading to a manufacturing renaissance in the United States. Employment growth will pick up strongly over the next few years.

And that leads me to conclude that interest rates will not stay at these historic low levels forever. Yes, Europe has serious challenges it needs to address but they will address them. Many smart investors believe the end of the bond bull market is near.

As rates rise, insurance companies will make a killing in two ways: higher yields and they will be able to sell these pension assets at a nice premium above today's levels.

I wrote that comment back in June, and after Tuesday's presidential debate, I'm still bullish on America but let's get one thing straight, Americans' pensions aren't as big as those of either candidate, which is why both of them ignored the plight of many worried about retiring in dignity and security.   

And these pension risk transfer agreements will be cropping up everywhere as companies shut down defined-benefit plans and offload risk of existing plans to insurance companies who are going to make a killing off these agreements as rates rise and pension assets soar. They pay a low rate on annuities and are going to make a huge spread.

It's money in the bank for insurance companies which is why top funds have been loading up on their shares over the past year. For example, one of  Paulson's best moves was to load up on the Hartford Financial Services Group, Inc. (HIG). He is still the largest holder and has profitted nicely from this position (click on image):


And among the top holders of Prudential (PRU), the insurer receiving pension risk transfers, you will see brand names like JP Morgan Chase, Wellington, and Goldman Sachs. Interestingly, ever since Prudential announced all these pension risk transfer agreements, its shares have been soaring (click on image to enlarge):



No wonder Prudential is "delighted" to take over Verizon's pension obligations:
“We are delighted that Verizon will meet its pension obligations for these retirees by agreeing to purchase monthly guaranteed annuity benefits from Prudential,” said Christine Marcks, president of Prudential Retirement. “This agreement underscores our financial strength, pension management expertise and investment capabilities. We look forward to the opportunity to provide the guaranteed lifetime income these retirees would have received under the Verizon Management Pension Plan, as we have done for millions of Americans since 1928.” 

This agreement, and the many more that will follow, is a cash cow for insurers which is why they're salivating at the prospect of companies 'offloading' pension risk. 

I'm actually amazed at how stupid and careless large corporations have become in managing their pensions. Corporate plans are "de-risking" their pensions into bonds and offloading pension risk at the worst possible time. While bonds have been the asset class of choice this year, equities are quickly gaining favor among global asset managers as central banks pump liquidity into the financial system and investors grow less fearful of the eurozone debt crisis.

Yes folks, it's RISK-ON, which is why smart money is falling off a cliff. Those of you who didn't listen to me and preferred reading the garbage over at Zero Edge, are kicking themselves for not scooping up shares of JP Morgan Chase when the "London Whale" crap hit the newswires (I loaded up on JPM back then; never mess with Greek banksters).

There is still plenty of money to be made in this market and insurance companies are in a sweet spot as they will profit off higher rates and soaring asset prices. And I'm not just talking about equities. Some of these corporate plans (like GM) heavily invested in alternatives like private equity, hedge funds and real estate. Investors are betting big on global real estate, and insurers will profit handsomely off these private assets too.

Of course, Verizon (VZ) doesn't really care about pensions. The company just posted a 16 percent increase in quarterly profit, helped by higher revenue in its wireless business after it raised data prices and started selling the latest Apple iPhone. Their shareholders are very happy as shares have soared over the past two years and they keep clipping a 4.7% dividend yield in the process. 

But the landscape for corporate pension plans is changing and the people who are going to suffer the most are future retirees who will not have peace of mind that comes with a defined-benefit plan. If they're lucky, their 401(k)s will do fine but these savings plans are no substitute for defined-benefit plans. 

Below, Roger Crandall, chief executive officer of Massachusetts Mutual Life Insurance Co., talks about changing demographics in the U.S. and MassMutual's resulting strategy. He speaks with Pimm Fox on Bloomberg Television's "Taking Stock." Smart guy, listen to his comments on alignment of interests.