Bristol-Myers (BMY) - Get Report and Motorola Solutions (MSI) - Get Report bought this "single premium group annuity contract" late last month, with Bristol-Myers putting $1.4 billion and Motorola Solutions $4.2 billion into a Prudential product that turns pension obligations into an annuity.
There are two factors at work here. The population bulge known as the Baby Boomers has started hitting retirement age at a time big companies want to reduce or get rid of their pension obligations. Among the other big insurers in this market are MetLife (MET) - Get Report and American International Group (AIG) - Get Report .
Insurers are gambling in two ways. First, through taking on the risk through the annuity they hope to get better returns on the pension funds than the companies that held them. Second, they hope the retirees covered by these pensions will die sooner or on schedule (according to the actuarial charts) before the cash set aside for the annuities runs dry.
Bigger investment returns make these contracts more profitable for the life insurers while market jitters make them worse.
The Bristol-Myers and Motorola Solutions contracts are the biggest sold by Prudential since General Motors (GM) - Get Report and Verizon (VZ) - Get Report signed with the Newark, N.J., company in 2012. The GM contract was worth about $25 billion and the Verizon one around $8 billion, said Scott Gaul, senior vice president and head of distribution for Prudential's pension risk transfer business.
As Standard & Poor's wrote after the GM pension deal was signed, "As life expectancy continues to improve in the U.S., the risk that someone could outlive their financial resources is increasing."
Gaul noted that Prudential has been in this business since 1928, and for life insurers it offsets risks. When you buy a life insurance policy, the insurer "loses" the bet when you die. With this product the obligation to pay ends at your death. The two bets balance out.
This does not have to be an all-or-nothing deal for pension funds. Bristol-Myers, for instance, is keeping $3.6 billion of its $5 billion in pension liabilities, as well as the money devoted to backing that risk. Gaul said that in July Prudential signed a deal with British Telecom (BT) in which it handles only the "longevity risk," with BT continuing to manage the funds.
The "return risk" BT is keeping hit its peak during the last two recessions, in 2001 and 2008, Gaul explained, when many pension funds were considered to be underfunded because they had lost money on investments.
For companies with defined pension plans this is "de-risking," or reducing the risks inherent in offering a pension. In the Motorola Solutions deal Prudential took on $3.1 billion in obligations, covering 30,000 retirees, and the company said it will offer lump sum payouts to 32,000 other workers, reducing its pension obligations by $4.2 billion. Retirees taking the lump sums, meanwhile, could then be solicited by insurers selling annuity products, which charge 3% to 4% for managing the risks on the open market.
News of the latest deals hasn't helped Prudential in a down market. The stock presently sells at about $87, down close to 6% for the year. That loss has come since Sept. 19 when the shares hit their high for the year of about $93. Prudential's current dividend of 53 cents a share, up from 40 cents in 2013, currently represents a 2.45% yield, slightly below that of a U.S. 10-year note.
At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
TheStreet Ratings team rates PRUDENTIAL FINANCIAL INC as a Buy with a ratings score of A-. TheStreet Ratings Team has this to say about their recommendation:
"We rate PRUDENTIAL FINANCIAL INC (PRU) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its revenue growth, compelling growth in net income, good cash flow from operations, increase in stock price during the past year and impressive record of earnings per share growth. We feel these strengths outweigh the fact that the company shows low profit margins."
You can view the full analysis from the report here: PRU Ratings Report