Last week, Prudential Financial (
) announced agreements with Bergmann Associates and LiveOps to
manage their retirement plans. Prudential will assume
responsibility for Bergmann Associates' $33 million retirement plan
for 330 participants and LiveOps' $13 million retirement plan. The
deal is a part of Prudential's effort to expand its retirement
division through institutional agreements. Last year, the insurer
signed pension risk transfer agreements with General Motors (
) and Verizon (
Research from Mercer shows that there is still a $138 billion
deficit in the funding levels of pension plans sponsored by S&P
1,500 companies, even though the funded ratio (assets divided by
liabilities) has improved to a five year high of 93%. During the
third quarter conference call, Prudential's management indicated
the potential for additional deals, particularly with mid and large
cap companies. We believe that the company can achieve bottom line
growth in the coming years, but will have to carefully manage
margins on this incremental business.
Our $80 price estimate for Prudential Financial's stock is in
line with the current market price.
See our full analysis of Prudential here
Investment Returns Will Be Crucial
At the end of the September quarter, Prudential reported
record-high retirement account values of $312.5 billion, about 32
billion of which came from the transfer agreements signed last
year. Adjusted operating earnings for the division through the
first nine months of 2013 were up nearly 80% over the prior year.
However, after including net investment losses and investment
losses on trading account assets supporting insurance liabilities,
the operating income was actually down 60%.
Returns from investments remain crucial for Prudential.
Excluding investment income, the expense-to-income ratio for the
retirement division was around 108% last year, indicating that the
company would be running on losses if it was not generating
sufficient returns from its investments. More than 75% of the
company's assets are invested in fixed maturity securities like
government and corporate bonds. The yields from these investments
have been low in the last few years due to the quantitative easing
program and low short-term interest rates set by the Fed. The
10-year Treasury bond yield, which can be used as a benchmark for
bond yields, was around 5% before the financial crisis, but fell to
around 1.5% in 2012. As a result, Prudential's yield from
fixed-maturities fell from 5% in 2008 to 3% in 2012.
This had a direct impact on the operating margin for the
retirement division, which fell from 20% in 2009 to 4% last year.
Bond yields have been increasing this year on speculation that the
Fed will soon start tapering the QE3 program. The 10-year Treasury
bond yield is now close to 3%. Prudential's yield from fixed
maturities was around 3.75% for the last quarter. We expect a
gradual increase in the company's operating margin in the coming
years, but there is a 20% upside to our price estimate, should
Prudential realize pre-recession margins within the next three
years. This will not only require a macroeconomic recovery, but
also strong execution on the part of management.
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