Verizon Communications Inc., New York, purchased an annuity contract with Prudential Insurance Co. of America for about 25% of its pension liabilities just when demand in the high-quality corporate bond market is starting to supplant supply in a low interest-rate environment.
Early adopters of pension buyouts should not have a problem in finding quality liability-matching fixed-income investments, but problems could develop as more companies follow the lead of Verizon and General Motors Co., said Robert Collie, chief research strategist, Americas institutional, at Russell Investments, Seattle.
Only those companies with strong enough balance sheets to make the large contribution necessary to fully fund the liabilities they are transferring are looking at pension buyouts, Mr. Collie said.
Many corporate plans already are employing some kind of liability-driven investing strategy in the long credit market, causing an imbalance with supply and demand, said Travis Bagley, director of transition management at Russell. The use of buyouts by purchasing annuities is only going to increase that imbalance.
The long bond market is “not limitless in terms of capacity, and we see an increased interest in more deals and a continued lack of supply to facilitate it in the bond market,” Mr. Bagley said.
The Barclays Long A and AA credit indexes have a market value of about $680 billion; the GM and Verizon annuity contracts will take up about 5% of that, Mr. Bagley said.
Moody's Investors Service Inc. said in a credit outlook report that the Verizon transaction was credit negative for Prudential as it “increases the insurer's risk concentrations, further exposing it to the challenges of estimating longevity risk, managing a long-duration portfolio and investing any portion of the proceeds not provided through existing investments in a low-yield environment.”
Prudential also is providing GM's annuity contract, and Moody's said that transaction also is credit negative because it represents more than 5% of Pru's general account holdings. Prudential officials said they had been building up their business for years in anticipation of a big deal like GM, and thus were confident the company has sufficient capacity.
The trend of pension derisking “is very real and will continue,” said Ari Jacobs, senior partner and global retirement solutions leader at Aon Hewitt, Norwalk, Conn., which served as lead adviser for Verizon along with Morgan Stanley.
As transactions like these take place, there will also be a shift in the way the assets are managed, Mr. Jacobs said. Whereas a typical pension plan has more than 50% invested in equities, insurance companies will mostly invest the assets in high-quality corporate bonds to match liabilities. Prudential and MetLife are the two largest players in the buyout market, but Mr. Jacobs said other insurance companies have the capacity to handle these large deals and are building teams to compete.