GM-Prudential annuity deal seen setting off race to gain piece of DB derisking action

A new day is seen dawning in pension derisking as a result of General Motors Co.'s purchase of a multibillion-dollar group annuity contract to cover future benefit obligations of retirees in its U.S. salaried defined benefit plan.

And it's a day for which insurance companies have spent years planning, in hopes a company with a large pension plan would make this move.

Sources said pension executives at large plans have looked into pension buyouts in recent years, but were hesitant to become the first. Compounding the indecision is the fact that a low funded status coupled with low interest rates makes it a costly proposition.

“I think that this transaction defines a new era in pension derisking in the U.S.,” said Dylan Tyson, Woodbury, N.J.-based senior vice president and head of pension risk transfer at Prudential Financial Inc., which struck the deal with Detroit-based GM on June 1. “People will look back and say this is what ignited a trend in pension derisking.”

Detroit-based GM is purchasing a group annuity contract for its 118,000 retirees in its $33 billion U.S. salaried DB plan. The pension buyout will reduce the automaker's pension obligations by $26 billion. Some 42,000 of those retirees have an option to accept a lump-sum benefit by July 20 instead. GM has a total of $94 billion in U.S. DB assets and $107 billion in liabilities.

(Separately, GM will terminate its current salaried pension plan and replace it with a new defined benefit plan for active U.S. salaried employees and those who retired after Dec. 1 with the same provisions as the terminated plan.)

“This is by an order of magnitude, the single largest (pension buyout) transaction both in the U.S. market and globally,” said Ramy Tadros, New York-based partner and head of the Americas insurance practice at Oliver Wyman Group.

“What makes this a real landmark is the sheer size of it. They are the first ones to go through this and test the market reaction to a move like this.”

Oliver Wyman advised on the deal. State Street Corp., as independent fiduciary to GM's pension plan, hired Oliver Wyman and Mercer LLC to help with due diligence on potential insurers and the structure of the annuity contract.

The “unambiguously positive” market reaction GM received should be a catalyst for more plans to take a serious look at the buyout option, Mr. Tadros said. GM's stock price surged to $23.15 from $21.60 immediately following the announcement, closing June 1 at $22. GM stock closed at $22.05 on June 8.

“By far, the biggest hurdle is the investor and market perception,” Mr. Tadros said.

The issue is whether plans have the required cash or debt to pay the funding gap and insurance premium, since insurance companies will require the cost of 110% to 115% of the current liabilities, he added.

“I wouldn't be surprised if another jumbo deal is announced in the next 12 months,” Mr. Tadros said. He declined to name any possibilities.

Robert Collie, chief research strategist, Americas institutional, at Russell Investments Inc., Seattle, said he long had expected pension buyouts to become a “big part of the pension market” because companies eventually would want to cut plans loose.

“The insurance industry has been ready for this for years,” Mr. Collie said. “This is a real shot for that market and may generate a lot of activity.”

Metropolitan Life Insurance Co. has been actively preparing for this time since the Pension Protection Act was passed in 2006, said Cynthia Mallett, Boston-based vice president product and market strategies, corporate benefit funding.

“We have a very healthy pipeline of activity and we've seen that pick up over the last year,” said Ms. Mallett.

MetLife manages $36.3 billion in pension risk transfer assets, Ms. Mallett said. Prudential managed $27.8 billion in such assets before the GM deal, Mr. Tyson said..

Mr. Collie expects more insurers to enter the pension buyout business because the potential market is too big to ignore, he said.

ING Investment Management, for example, is seriously considering entering the market and should decide in the next few months, said Seth Finkelstein, New York-based senior vice president, client portfolio manager and head of investment services.

“Other insurance companies not currently in the business are probably going through the same thing we are,” he said.

As for which pension plans should do pension buyouts, “it makes a lot more sense for frozen plans where the liabilities aren't growing,” said Scott Campion, New York-based senior manager in the Americas insurance practice at Oliver Wyman.

GM's salaried plan was frozen in 2006, affecting employees hired before 2001. Dan Ammann, senior vice president and chief financial officer, said in a conference call on June 1 that the pension buyout is a continuation of its objective to desrisk the pension plans while strengthening the company's balance sheets.

Russell's Mr. Collie said the GM-Prudential deal is significant for two reasons — the size of the transaction, and the fact that the move includes the lump sum offer. GM followed Ford Motor Co. as the second large plan to offer lump sums to current retirees.

Lump sums for terminated vested employees have been around for some time, but extending the offer to retirees is a new development, Mr. Collie said.

Ford, which is offering lump-sum payments to 90,000 salaried retirees and former employees beginning in August, decided against the buyout route for its $39.4 billion U.S. pension plans to preserve capital.

“We looked at a number of options and we are comfortable with where we are,” Jay Cooney, Ford spokesman, said in an e-mail. “We decided not to offload our pension obligations because it takes a lot of cash to accomplish and our focus is on growing the business, increasing dividends and strengthening the company. We are already allocating money to derisk the pension obligation and by mid-decade, our pension plans will be fully funded.”

According to Aon PLC, an insurance broker as well as a consulting firm, no pension buyout has exceeded $1 billion since the 1980s. And, Prudential's Mr. Tyson said there has been more interest in pension buyouts during the past year than in the last three to five years combined.

Mr. Tyson said plan executives are looking to get rid of longevity and volatility risk and Prudential is keying in on businesses that do not see their pension funds as a core or sustainable advantage for their business.

GM has been a pioneer in pension derisking, MetLife's Ms. Mallett said. It was one of the first plans to employ LDI, it aggressively moved out of equities in recent years, and has the cash flow to kick in about $4 billion to cover the funding gap.

Like at GM, executives at most corporate pension funds are likely to use a combination or progression of derisking strategies before reaching the buyout stage, she said. Ms. Mallett expects pension buyouts to produce a “sustained level of activity over the next five years.”

The number of companies that will complete pension buyouts depends on the pension fund's funded status and on cash flow. In many cases, the decision comes down to the size of the plan relative to the business, said Oliver Wyman's Mr. Campion.

A plan with a large contingent of retirees but a smaller active workforce might consider the move, he said.

GM's U.S. salaried DB plan is 92% funded and GM has about $32 billion in cash.

Most corporate defined benefit plans are vastly underfundedcompared to GM, making it a costly proposition to transfer or get rid of pension liabilities.

“You're going to start seeing a lot more plans take these terminal routes,” but it will still be cost-prohibitive for most, Mr. Finkelstein said. “At the end of the day, we believe it is the intention of a large number of pension plans to get to this stage, and the question is when.”