Collaboration of all stakeholders Defined benefit pension is a top - - PowerPoint PPT Presentation

De-risk the Defined Benefit Pensions – Collaboration of all stakeholders

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FINANCIAL CRISIS INCREASING REGULATION NEED FOR GREATER CONTROL AND UNDERSTANDING

Defined benefit pension is a top issue for management

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Pension risks are important and need to be managed jointly

INFLATION CURRENCY FINANCIAL MARKET LONGEVITY REPUTATION REGULATION DESIGN OPERATION INTEREST RATE

Opportunity for HR and Finance to work together

HR to design the benefits Retain Attract Motivate Finance to fund the benefits Cost Effectiveness Efficiency Operational risk People risk Compliance risk Financial risk Market risk Strategic risk

COMMON OBJECTIVE

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Pension de-risking process is dynamic

Finance, Risk Management and HR need to utilize a spectrum of solutions to de-risk the risk exposure of corporate defined benefit pension benefits

Design Solutions

HR driven pension plan design changes to reduce future exposures

Investment Solutions

Finance driven investment solutions acquired to manage the investment risk exposures

Insurance Solutions

Risk management and finance driven insurance solutions utilised to mitigate the longevity or entire risk exposures

• Pension plan redesigned to

reduce future accruals of risk exposures

• Freeze / close pension plans

to reduce / eliminate future accruals

• Cash out participants to

reduce the already accrued risk exposure

• Increase fixed income

allocation to reduce interest rate risk exposure

• Increase fixed income

duration to better hedge interest rate exposure

• Utilising derivatives to fully

hedge the interest rate risk

• Purchase pension bulk annuities as

buy-out / buy-in contracts to transfer risk exposures

• Utilising company’s captive

insurance company to centralize pension financing

• Utilising longevity swaps /

insurance to mitigate longevity risk

De-risking Trends

1/4/ 201 2 7

De-risking Trends

1/4/ 201 2 8

12/ 5/2 011 9

Freeze / Close Plan Extend Bond Duration Increase Bond Allocation Buy-in Bulk Annuities Buy-out / Settle Schemes

Traditional Insurance Solutions Traditional Investment Solutions

De-risking Trends

Collaboration

Cash out / Transfer Deferred Participants

De-risking Trends

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Pension Annuity Pension Captive

Annuity payment

Pension Plan

Annuity premium

Insurance Company

Annuity payment

Pension Plan

Annuity premium

Insurance Company

Reinsurance payment Reinsurance premium

XYZ Captive

Current Plan Insurance Buy-in/out Current allocation Extend Bond Duration Hedged Portfolio

Current

De-risk Cash-out Deferreds Freeze / close plans Increase Bond Allocation

Collaborative Approach

Captive Solution

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Capabilities

Risk Management Global Coverage Experience and Expertise

DERISKING OF PENSION FUNDS FOCUS ON IRELAND

Changes to pension regulations Increased shareholder scrutiny Wider accessibility of hedging investments Further closure

• f DB accrual

Recent financial turbulence Marketplace focus on managing DB risk

Managing DB Risk

Pension Risk & Irish Corporates

• ISEQ companies had pension scheme deficits of c. €4bn at end 2011
• Pension risk is a material issue for many Irish plcs

Selected ISEQ Companies - Pension Liabilities exceeding 50%

• f Market Cap

59% 62% 88% 109% 127% 197% 207% 220% 332% 0% 50% 100% 150% 200% 250% 300% 350% F.B.D IRISH CONTINENTAL GROUP UTV MEDIA TOTAL PRODUCE FYFFES BANK OF IRELAND SMURFIT KAPPA GREENCORE GROUP INDEPENDENT NEWS & MEDIA

Size of Irish Pension Schemes

• Source: Pensions Board Defined Benefit Survey 2010

Schemes by Minimum Funding Standard Liability - Extrapolated to 31/12/2010 133 285 186 254 63 78 8 50 100 150 200 250 300 < €1m €1m - €5m €5m - €10m €10m - €50m €50m - €100m €100m - €1bn > €1bn

• Over 85% of pension schemes had liabilities of €50m or less at end 2010

Irish Pension Legislation & Regulations

• New regulations & guidance recently released
• Introduced need for schemes to hold a “Risk

Reserve”

– Will likely encourage a move from equities to EU sovereign bonds

• Sovereign annuity concept also introduced
• Lack of Debt on Employer for schemes

winding up in deficit

Governance Benefit Policy Employer Covenant Investment Strategy Funding Strategy

Pension Risk Factors to Consider

• Initial area of focus for managing DB risk
• Range of actions taken by pension scheme

sponsors, including but not limited to:

– Closure to new entrants – Reduce future service benefits (e.g. CARE) – Cease future accrual – Reduce past service benefits (Section 50)

Benefit Policy

• Closures to new entrants

Benefit Policy

No, 10% Considering - but unlikely, 6% Considering - likely, 8%

Implemented in last 12 months or in process of, 12%

Already implemented more than 12 months ago,

64%

• Source: Irish Association of Pension Funds Short Survey 2011

• Closures to future accrual

Benefit Policy

• Source: Irish Association of Pension Funds Short Survey 2011

No, 57% Considering - but unlikely, 16% Considering - likely, 8%

Implemented in last 12 months or in process of, 13%

Already implemented more than 12 months ago,

6%

• Traditionally involved Employer paying a contribution

rate that varied with scheme’s funding position

• Many now paying maximum affordable contribution
• Other funding options therefore being considered

– Contingent Assets – Unsecured Employer Undertakings

• To cover new Risk Reserve requirement

– Special Purpose Vehicles

• Using Company assets to generate cashflow stream

Funding Strategy

Why take investment risk?

• Trustees’ Perspective:

– Excess return can improve the funding level – High investment return can improve member benefits (e.g. provide discretionary benefits)

• Company Perspective:

– Higher investment returns can reduce contributions – Leads to lower P&L accounting charge

• Although accounting rule changes remove this incentive

from 2013 onwards

Investment Strategy

• Move towards lower risk assets in recent years

Investment Strategy

Asset Allocation

63.0 65.2 66.3 64.3 52.2 8.7 8.0 9.1 3.8 4.4 1.0 0.8 2.3 2.8 5.9 23.5 21.5 18.5 24.9 33.2 3.8 4.5 3.8 4.2 4.3 0.0 10.0 20.0 30.0 40.0 50.0 60.0 70.0 80.0 90.0 100.0 End 2003 End 2005 End 2007 End 2009 End 2011 Equities Property Other Bonds Cash

• Source: Irish Association of Pension Funds Asset Allocation / Investment Surveys

Pension Risk Risk Transfer

• Various ways of transferring risks associated

with operating a pension scheme to the members / insurers

– Paying transfer values (standard or enhanced) – Annuity purchase (deferred or immediate)

• Annuity purchase most common method,

although still mostly used on scheme wind-up

Risk Transfer Annuity Purchase

Historical Annuity Pricing

150,000 170,000 190,000 210,000 230,000 250,000 270,000 290,000 Sep-02 Mar-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Date Annuity Price €

* Graph shows the cost of buying a pension of €10,000p.a. for a male aged 55, with a five year guarantee and an attaching 50% reversionary annuity (husbands assumed to be 3 years older than wives)

• Traditional annuity pricing near all-time highs

Pension Risk Focus on Sovereign Annuities

• Sovereign annuity concept recently launched in the

Irish market

• Schemes have option of buying sovereign annuities

– Priced off Irish bond yields – Leading to a material reduction in the value of pensioner liabilities (c. 20% - 30%)

• BUT…
• A default / restructure of Irish sovereign debt is

borne by annuity holder

Traditional / sovereign annuities Liability Driven Investment strategies Diversify sources

• f investment

return Non-cash funding Benefit management Balanced solution reflecting

• bjectives of all

stakeholders

Derisking of Pension Funds - Options