Insurance companies have created an entire industry based upon risk, and except for American International Group, Inc. (NYSE:AIG) during the financial crisis, it has worked out pretty well. So, it’s not a stretch to imagine a large life insurer like Canada’s Sun Life Financial (NYSE:SLF) assuming the pension liability for the Canadian Wheat Board’s defined benefit plan in a recent $147 million deal, the first such accord in Canada’s history.
A U.S.-born trend
Sun Life may be a trailblazer to the north, but it first developed an interest in this type of transaction after U.S. insurer Prudential Financial Inc (NYSE:PRU) snagged itself two such pension pacts last year. The first, with General Motors Company (NYSE:GM) , involved the transfer of pension obligations for 110,000 salaried workers by General Motors Company (NYSE:GM) to Prudential Financial Inc (NYSE:PRU) for approximately $25 billion. Earlier in the year, General Motors Company (NYSE:GM) had estimated that it would hand over about $26 billion in retirement obligations to Prudential Financial Inc (NYSE:PRU).
Shortly after inking the General Motors Company (NYSE:GM) deal, Prudential Financial Inc (NYSE:PRU) acquired $7.5 billion in pension liability for 41,000 managers from Verizon Communications Inc. (NYSE:VZ). Though the amount represents only around 25% of the telecommunications giant’s entire pension obligations, it still removes a significant amount of risk from the company’s balance sheet.
Peace of mind, for a fee
The transaction transfers pension obligations from a company to an insurer through the purchase of a group annuity contract. For a lump sum, the insurance company takes on the responsibility of current and future retiree payments, thus freeing the client from having to worry about — and try to plan for — future pension-related costs.
For insurers, it’s a great fit. As Prudential Financial Inc (NYSE:PRU) commented at the time of the Verizon Communications Inc. (NYSE:VZ) contract, insurers are used to managing lots of money, as well as risk. Monthly, yearly, or lump sum payments are constantly pouring in, and likely won’t have to be paid out again for a long time, if ever. Insurance companies invest these sums, and this produces income — which will be climbing higher right along with rising interest rates.
This is the beauty of the insurance model, and its charm has attracted investing greats like Warren Buffett, who may have pioneered this latest trend through his own company, Berkshire Hathaway Inc. (NYSE:BRK.A). In 2010, Berkshire took on AIG’s asbestos liability for a hefty fee, and did the same for Cna Financial Corp (NYSE:CNA) the following year. There’s little doubt that Buffett added to his wealth by wisely investing the $3.65 billion he received in those two deals.
An executive at the Canadian Wheat Board described the contract as “win-win,” and it seems certain that Sun Life would agree. An analyst in Toronto told the Financial Post that this particular type of business deal is becoming more popular, and may increase as interest rates rise. If so, Sun Life will be there, ready to help.
The article Shifting Risk: Insurers Take a Gamble on Pensions originally appeared on Fool.com.
Fool contributor Amanda Alix has no position in any stocks mentioned. The Motley Fool recommends American International Group, Berkshire Hathaway Inc. (NYSE:BRK.A), and General Motors Company (NYSE:GM). The Motley Fool owns shares of American International Group and Berkshire Hathaway Inc. (NYSE:BRK.A) and has the following options: Long Jan 2014 $25 Calls on American International Group.
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