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Your Pension Check May Soon Be Coming From an Insurance Company

The Wall Street Journal. logo The Wall Street Journal. 3/12/2017 Leslie Scism

© Libby March for The Wall Street Journal

Millions of retirees are expecting to get a company pension check for the rest of their lives. Increasingly, the name on it is likely to be an insurance company.

The reason is a growing business called pension-risk transfer, in which employers with old-fashioned pension plans, such as General Motors Co., cut deals with insurers to take responsibility for retirees’ monthly benefit.

The movement is expected over time to transform the management of pensions for employers, which can slash their exposure to the volatility of the stock and bond markets, as well as for the insurance industry, which gains a source of growth at a time when some traditional businesses are slipping.

For retirees, it can be unsettling to learn an old employer no longer is responsible for their pension, and they may face additional risk from a switch to a different safety-net system. Others consider their benefits just as safe, or even safer, in the hands of a highly rated insurer with expertise in longevity calculations.

Now the prospect of higher U.S. interest rates is providing another spur to the little-known business of transferring pension risk. Under the complex math used to calculate liabilities, higher rates generally make it less expensive for employers to offload pension obligations.

“If interest rates go up…there definitely will be a lot [of employers] lining up to do this,” said Robin Diamonte, chief investment officer of United Technologies Corp. The Connecticut manufacturer signed a $775 million deal in October to transfer about 35,000 pension-plan participants to the care of Prudential Financial Inc.

William Nelson, who worked as a mechanic for Kimberly-Clark Corp. in Texas, “didn’t like the idea whatsoever” when he learned in 2015 his former employer was moving responsibility for him and 21,000 other pensioners to Prudential and Massachusetts Mutual Life Insurance Co.

“I think if you make an agreement, you shouldn’t back out of it and put a third party in there to do it,” said Mr. Nelson, 60 years old. Kimberly-Clark declined to comment.

Among his concerns, Mr. Nelson worried the insurance companies might someday not have the money to pay. More recently, however, he said he had a good experience with Prudential’s call center and now is more satisfied.

Prudential has emerged as the leader in U.S. pension-risk transfer. The insurance giant, which traces its roots to the Widows and Orphans Friendly Society in 1873, has signed 10 jumbo deals through which it has assumed nearly $45 billion of corporate pension obligations, involving more than 320,000 people.

Other insurers pitching pension-risk transfer include MetLife and the U.S. unit of British giant Legal & General. Some smaller insurers have gotten in on the action, teaming up to have sufficient capital to make credible bids. Despite the spread of 401(k) plans, about 22,000 traditional plans sponsored by single, private-sector employers remain in the U.S., covering 30 million people.

Prudential, based in Newark, N.J., initially grew interested in this business in 2006. It was a time when some employers were freezing traditional pension plans because of costs and investment volatility, while Congress was simultaneously debating an update of pension law.

Phil Waldeck, a Prudential executive and self-described pension nerd, was glued to C-Span the day Congress voted to tighten rules for pension-plan funding. In the details, he saw opportunity.

His team built upon an existing, low-profile business called pension closeouts, in which insurers assumed the liabilities of organizations that wanted to shut down their entire pension plan. Prudential had done one such deal in 1928 with the Cleveland Public Library. It still sends checks to two former librarians, aged 100 and 103.

In the closeout transactions, a company paid an insurer cash to take over the entire pension responsibility. The closeouts typically involved private companies or organizations and involved liabilities of no more than tens of millions of dollars.

Hoping to do much larger deals, Mr. Waldeck started building a team of actuaries, lawyers and investment professionals. The larger transactions would differ in some ways. They generally would involve only retirees, where liability can be estimated with greater precision, unlike pension closeouts, which include active workers.

And employers, instead of paying the insurance company cash, would hand over assets accumulated to back the pensions, along with an amount charged by the insurer for doing the deal. In the biggest deals, insurers typically would isolate these assets in separate accounts.

Mr. Waldeck anticipated that growing numbers of large, publicly traded companies would be interested, having seen their pension-plan assets crater when the tech-stock bubble burst a few years earlier.

While he was building his team, the 2008 financial crisis interfered. The stock plunge left many corporate pension plans with deep funding gaps. The gaps widened further when the crisis kicked off a Federal Reserve campaign of ultralow interest rates, which required a recalculation of liabilities. In industry lingo, when interest rates are lower, the present value of the monthly payments owed in the future is higher.

Prudential didn’t want to take over any pension liabilities that weren’t fully funded. So, many companies interested in handing off obligations would first have to pour more assets into their plans.

Employers fretted about how shareholders would react to the costs involved. An employer doing a pension-risk transfer would have to hand over not only assets backing the obligations but a substantial additional amount as the insurer’s price, typically a mid-single-digit percentage of the liabilities.

Among employers, “no one wanted to be the first elephant through the door, because you didn’t know if you were going to be shot by your shareholders at the other side,” said Michael Moloney, a partner with Oliver Wyman, a consultancy that advises on large pension transactions.

Despite the hurdles, GM and Prudential agreed on a pension-risk deal in 2012 in which the car maker provided Prudential with a total of $25.1 billion for a “group annuity,” as the deals are technically called, according to a GM regulatory filing. Prudential received fixed-income securities as payment.

​The transaction was part of a broader set of changes to GM’s pension plan, and the company has told analysts its net cost was around 107% of the obligations it shed. At that percentage, the math suggests GM would have paid Prudential more than $1.6 billion above its liabilities. GM declined to provide a specific figure.

Prudential earns interest on the bonds it takes possession of, using the interest and eventually the principal to pay pension checks. For additional profit, it sometimes trades out of bonds received from an employer and invests in similar-quality but higher-yielding loans that Prudential’s investment-management unit makes directly to companies.

If retirees live far longer than the insurer expected when doing the deal, it may have to tap other financial resources; if they live less long, its profit may be greater.

State regulators require insurers to set aside capital to back the transactions in case their estimates are way off, usually cushions of 5% to 10% of a pension-risk deal’s size.

Most of insurers’ profit is expected to come from negotiating deal prices large enough to cover future monthly checks and leave a tidy sum for the insurer once those obligations have been fulfilled. Counting this, the bond interest and its efforts to trade into higher-yielding loans, Prudential aims to earn a 12% to 13% long-term return on the capital tied up in pension-risk deals, it has told investors.

The deal Prudential did with GM didn’t relieve the auto maker of all of its pension liability, by any means. At the time, this totaled $134 billion, counting active workers, in the U.S. and abroad. Still, a GM executive said on an investor call, the transaction let GM chip away at its image as “a very large pension plan with a car company attached.”

When giant risk transfers such as this one first took off in 2012, some workers resisted. Verizon’s $8.4 billion agreement with Prudential that year ran into legal challenges—claims of harm both from some of the retirees being transferred and from some of those whose pension obligations stayed with Verizon.

A retiree representing those whose obligations stayed at Verizon said the company had harmed them by paying the entire deal price, including the amount for Prudential’s potential profit, out of pension-plan assets.

The plaintiffs suing on behalf of the 41,000 transferred pensioners said they were harmed because they no longer had protection from the Pension Benefit Guaranty Corp. In pension-risk deals, this federal backstop is replaced by state-based associations funded by the insurance industry, which offer varying levels of protection.

“These pension deals are beautiful for insurance companies, but they’re asking us to take on additional risk with no compensation, no consideration,” Thomas Guarino, a 65-year-old former manager for Verizon in New England, said in an interview.

Citing the switch in safety nets, Mr. Guarino said “some kind of bonus” ought to be paid to transferred pensioners to make up for the risk, especially in light of big problems some insurers had during the 2008 financial crisis.

The loss of a federal backstop didn’t bother Nevada resident Edward Fowler, an 80-year-old who retired as a manager at a Verizon predecessor company.

“Who’s in worse shape, Prudential or the federal government?” Mr. Fowler said he asked other retirees at their coffee klatch in Gardnerville, Nev. He said he was “more worried about our government going bankrupt than Prudential.”

A judge in federal court in Dallas ruled in Verizon’s favor. The decision remains in effect after an appeal and further proceedings, but plaintiffs have a pending petition seeking Supreme Court review. Verizon said it acted properly.

For Prudential, an important step in developing large pension-risk transactions was figuring out how to transfer thousands of securities directly from employer pension plans, rather than receiving cash. A transfer would cut trading costs and the risk of bond prices changing radically as the insurer poured hundreds of millions of dollars into the market.

Employers that transfer pension risk often must first adjust their mix of assets backing the obligations. For employers, asset mixes often include stocks, but insurers generally want only bonds.

And just the right bonds. In the 2012 GM deal, the auto maker spent months rejiggering its fixed-income portfolio to match credit ratings, industries, maturities and other particulars specified by Prudential.

Employers that transfer pension risk to insurers increasingly involve two of them, in part to ease retiree worry of an insurance-company failure. A U.S. unit of Royal Philips of the Netherlands used three.

To price their bids, insurers ask for demographic data on the retirees. They want birth dates, genders, ZIP Codes and kind of work performed, on a names-withheld basis.

Insurers must beware of longevity miscalculations, said Scott Robinson, a manager at Moody’s Investors Service. “Retirees living longer than an insurer assumes in pricing can eat into expected returns and even cause big losses.”

Between 1970 and 2015, the average U.S. male’s remaining life expectancy at 65 increased to 21.7 years from 15.7 years, according to the Society of Actuaries.

Prudential limits its exposure to life-extending advances by focusing on retirees rather than active workers. The average age of those in its deals is about 72.

“A cure for cancer is a potential shock to our longevity modeling but…has a smaller impact than one might expect” on older people, said Mr. Waldeck. “It takes time for medical advances” to filter through the health-care system.


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