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

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

Defined benefit pension is a top issue for management FINANCIAL CRISIS INCREASING NEED FOR GREATER REGULATION CONTROL AND UNDERSTANDING 3 3

Pension risks are important and need to be managed jointly REGULATION LONGEVITY INTEREST RATE FINANCIAL MARKET CURRENCY DESIGN INFLATION REPUTATION OPERATION 4

Opportunity for HR and Finance to work together COMMON OBJECTIVE Operational Financial risk risk HR to design Finance to fund the benefits the benefits Market People Retain Cost risk Attract Effectiveness risk Motivate Efficiency Compliance Strategic risk risk

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 Investment Solutions Insurance Solutions HR driven pension plan Finance driven investment Risk management and design changes to reduce solutions acquired to manage finance driven insurance future exposures the investment risk solutions utilised to mitigate exposures the longevity or entire risk exposures • • • Pension plan redesigned to Increase fixed income Purchase pension bulk annuities as reduce future accruals of risk allocation to reduce interest buy-out / buy-in contracts to exposures rate risk exposure transfer risk exposures • • • Utilising company’s captive Freeze / close pension plans Increase fixed income to reduce / eliminate future duration to better hedge insurance company to centralize accruals interest rate exposure pension financing • • • Cash out participants to Utilising derivatives to fully Utilising longevity swaps / reduce the already accrued hedge the interest rate risk insurance to mitigate longevity risk risk exposure 6

De-risking Trends 1/4/ 201 2 7

De-risking Trends 1/4/ 201 2 8

De-risking Trends Cash out / Freeze / Increase Extend Buy-out / Buy-in Bulk Transfer Close Bond Bond Settle Annuities Deferred Plan Allocation Duration Schemes Participants Traditional Investment Traditional Insurance Solutions Solutions Collaboration 12/ 5/2 011 9

De-risking Trends Pension Annuity Pension Captive Pension Plan Pension Plan Annuity Annuity premium payment Annuity Annuity payment premium Insurance Company Reinsurance Reinsurance premium payment Insurance Company XYZ Captive 1/4/ 201 2 10

Collaborative Approach Freeze / Cash-out Captive Insurance Current Plan close plans Deferreds Solution Buy-in/out Current Current allocation Extend Bond Duration Increase Bond Allocation Hedged Portfolio De-risk

Capabilities Risk Management Experience Global and Expertise Coverage 12

DERISKING OF PENSION FUNDS FOCUS ON IRELAND

Managing DB Risk Recent financial turbulence Changes to Further closure pension of DB accrual regulations Marketplace focus on managing DB risk Wider Increased accessibility of shareholder hedging scrutiny investments

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

Size of Irish Pension Schemes • Over 85% of pension schemes had liabilities of € 50m or less at end 2010 Schemes by Minimum Funding Standard Liability - Extrapolated to 31/12/2010 285 300 254 250 186 200 150 133 100 78 63 50 8 0 < €1m €1m - €5m €5m - €10m €10m - €50m - €100m - > €1bn €50m €100m €1bn • Source: Pensions Board Defined Benefit Survey 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

Pension Risk Factors to Consider Funding Investment Strategy Strategy Governance Benefit Employer Policy Covenant

Benefit Policy • 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 No, 10% Considering - but unlikely, 6% Considering - likely, 8% Already implemented Implemented in last more than 12 12 months or in months ago, process of, 12% 64% • Source: Irish Association of Pension Funds Short Survey 2011

Benefit Policy • Closures to future accrual Already implemented Implemented in last more than 12 12 months or in months ago, process of, 13% 6% Considering - likely, 8% No, 57% Considering - but unlikely, 16% • Source: Irish Association of Pension Funds Short Survey 2011

Funding Strategy • 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

Investment 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 Asset Allocation 100.0 3.8 3.8 4.2 4.5 4.3 90.0 18.5 23.5 21.5 24.9 80.0 33.2 2.3 0.8 1.0 9.1 70.0 2.8 8.0 8.7 3.8 60.0 5.9 4.4 50.0 40.0 66.3 65.2 64.3 63.0 30.0 52.2 20.0 10.0 0.0 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 • Traditional annuity pricing near all-time highs Historical Annuity Pricing 290,000 270,000 250,000 Annuity Price € 230,000 210,000 190,000 170,000 150,000 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 * 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)

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

Derisking of Pension Funds - Options Benefit management Traditional / Non-cash sovereign Balanced funding annuities solution reflecting objectives of all stakeholders Liability Driven Diversify sources Investment of investment strategies return