Two more large corporate names have opted for transferring pension-related liabilities and their associated risk to a third party, in each case pursuing structures that illustrate how the market is evolving.
The Prudential Insurance Company of America has been the leader in terms of taking on the pension obligations and risk of the largest multinational companies, and in early October it announced transactions for J.C. Penney and the US subsidiary of Royal Philips. In a first, the precise size of the retailer’s transfer and the specific plan participants involved will not be determined until the closing nears in December. That will greatly reduce the risk post-transaction funded status of unanticipated market volatility changing the values of plan assets and liabilities—a growing concern recently after several years of relatively low volatility.
“We can monitor any changes and ultimately size the transaction much closer to the execution date, enabling the company to have more certainty and maintain their objective of a target-funded and potentially over-funded plan,” said Scott Kaplan, head of pension risk transfer for Prudential Retirement’s pension and structured solutions business.
Financial market volatility has picked up significantly recent months. The Chicago Board Options Exchange’s Volatility S&P 500 (VIX) option, which measures equity market volatility, leaped to more than 40 in late August after rarely exceeding 20 since the start of 2012.
In addition, waiting provides certainty on the rate at which J.C. Penney employees take up lump-sum payouts rather than the annuity.
“The payout may end up being below the carrying value of the liability on their books, so if more people take the lump-sum payouts it could enhance the funded status of the plan,” Mr. Kaplan said.
J.C. Penney is transferring the pension obligations related to its retired employees who are currently receiving pension payments, reducing its pension liabilities by between 25 percent and 30 percent. The pension obligations related to current employees who are still accruing pension benefits and former employees who have not yet started to receive benefits will remain with the company, although those, too, can be a part of pension risk transfer transactions.
Most companies decide to transfer all or part of the pension fund liabilities to Prudential and other insurers, including MetLife, to reduce the risk of the pension fund’s funded status deteriorating, whether because of market disruptions or developments such as the Society of Actuaries changing its longevity tables earlier this year. Prudential has captured most of the big-name companies, including Bristol-Myers Squibb, General Motors and Kimberly-Clark.
Managing longevity risk as well as risks pertaining to credit and making annuity payments are core competencies of life the insurers. Companies pay a one-time premium to insurers to take on the pension obligations of these plans that by now are typically closed and no longer used to attract or retain professional talent. Mr. Kaplan noted that investors tend to look favorably on companies reducing those risks, and for treasury such transfers lessen cash flow uncertainties.
“Greater certainty around cash flows make more cash flow available to the company’s core business,” Mr. Kaplan said.
The Philips transfer is anticipated to reduce its pension-related liabilities by approximately $1.1 billion. Mr. Kaplan said the transfer was split among three carriers, a unique aspect of the deal which follows a pension risk transfer transaction earlier this year for Kimberly-Clark that Prudential split with Massachusetts Mutual Life Insurance Company. In the Philips deal, a OneAmerica subsidiary will be issuing annuities to plan participants who have not yet retired by mid-2015, while Prudential and Legal & General’s U.S. subsidiary will divide the current retirees, with Prudential as the annuity administrator. The total transfer will cover about 17,000 former U.S. employees and their beneficiaries.
“The whole notion of a split transaction may be an emerging trend that started with Kimberly-Clark,” Mr. Kaplan said.