Ever since General Motors and Verizon Communications offloaded a combined $33 billion in pension obligations to Prudential Financial in 2012, pension-market observers have been speculating when an anticipated boom in such deals might occur.
There are several indications that an explosion of similar transactions may come sooner than later, but earlier predictions in that direction proved to be erroneous. “There have been more false starts in the pension-derisking space than any starter gun could handle,” says Matt Herrmann, leader of the retirement risk management group at Towers Watson. “With each new mega-deal, people think it’s the start of the wave. At some point in time, they’re going to be right. But predicting when that wave will hit has been a big challenge.”
As happened with the GM and Verizon deals, Motorola will purchase annuities from Prudential to cover the current value of a portion of its future plan liabilities. The company will also transfer to the financial firm $3.1 billion worth of bonds and other assets held by its pension fund. Such deals become more feasible when a plan holds a large percentage of the assets needed to pay off its future obligations. In this case, Motorola’s plan was at least 100% funded.
Prudential, which will be responsible for the obligations, takes on the risk that their value will rise in the future.
The Motorola deal is only the third in which a plan sponsor has purchased annuities to cover more than $1 billion in pension liabilities. A far more common derisking strategy is offering voluntary, lump-sum buyouts to plan participants. Motorola is also doing that; it says the combined strategies will shave its pension liabilities to $4.2 billion. That’s half the current tab of $8.4 billion.
Why have so few companies taken the annuity approach? For one thing, their balance sheets could take a hit. “Most plan sponsors want to get out of the pension business, but they want to do it responsibly,” says Herrmann. “Is now the right time economically? Right now a company is paying a lot to offload liabilities, because the present value of the future pension payments is being discounted with a very low [interest] rate.”
Motorola, with already enough plan assets to pay off the present value of the future liabilities it’s handing to Prudential, obviously felt the economics were in its favor, though neither party replied to requests for comment by press time. In a statement, Motorola CFO Gino Bonanotte said, “We have substantially reduced the funding volatility associated with our pension plans while protecting benefits for retirees. Our retirees’ benefits are not changing, just who provides them.”
The deal may well be a good one for Prudential too, Herrmann points out, because of its “knowledge differential, economies of scale, operational factors and investment prowess. Prudential invests hundreds of billions of dollars in fixed income, and it’s phenomenally good at matching assets with liabilities — arguably better than most if not all plan sponsors.”
Besides companies’ innate desire to exit pension plans, other factors point to the possibility that a wave of annuity deals between plan sponsors and insurers may be imminent. For one, as of June 30, investments in the average company’s pension plan were enough to cover 86% of future obligations, up from 78% at the end of 2011, the Wall Street Journal reported, citing J.P. Morgan Asset Management. The higher funding ratios have been driven by stock-market gains and a slow, incremental rise in interest rates.
Also, notes Herrmann, the cost of operating plans is rising, people are living longer and plan sponsors are paying more in premiums to the government to maintain the Pension Benefit Guaranty Corp. “It may not be critical to take action now, but we’re seeing a heightened focus on understanding what set of conditions would prompt you to act. It’s an ‘If not now, when?’ question.”