Eleanor Marshall , CPA, CA, CFA Vice-President, Pension & - - PowerPoint PPT Presentation

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Getting control back on the vessel – some offloading required

September 21, 2016

Eleanor Marshall, CPA, CA, CFA

Vice-President, Pension & Benefits, BCE and Bell Canada

Heather Wolfe, FIA, FCIA, FSA

Managing Director, Client Relationships, Defined Benefit Solutions, Sun Life Financial

Manuel Monteiro, FSA, FCIA, CFA

Partner, Mercer

2 3 Market update Two case studies 1 De-risking overview

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Agenda

De-risking overview

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Manuel Monteiro, FSA, FCIA, CFA

Partner, Mercer

Source: Mercer Pension Database (Canada), Base: 540 plans

Defined benefit plans open to new entrants have dropped from 70% in 2007 to 45% in 2015.

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Composition of private sector DB plans

2020 – 2040 2090 + 2015 – 2020 2040 – 2055

A P P R O X I M A T E T I M E F R A M E SETTLE AS SOON AS POSSIBLE MAINTAIN PLAN UNTIL ACTIVE DB MEMBERSHIP FALLS BELOW A THRESHOLD MAINTAIN PLAN UNTIL LAST ACTIVE DB MEMBER RETIRES MAINTAIN PLAN UNTIL LAST ACTIVE DB MEMBER DIES

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Potential strategies for closed and frozen plans

1 Measure current risk/reward profile Is current risk profile consistent with risk appetite? Define organization’s risk appetite Optimize current strategy Consider alternatives to adjust risk profile Yes No Develop transition strategy and implement

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Key steps in establishing a risk management strategy

Stronger sponsors better able to bear risk Upside benefit to taking risk diminishes as the funded position improves Risk-shared plans more likely to take risk to keep contributions at a reasonable level Upside benefit to taking risk diminishes as size of future accruals decreases Is the DB plan open, closed or frozen? For large mature plans:

• Downside risk has a larger impact
• Upside benefit may be lower (unusable surplus?)

Size of plan relative to size of sponsor Financial strength of plan sponsor Funded position of plan Who bears the risk? Who reaps the rewards?

1 2 3 4 5

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Risk management – considerations

Insurance Individual Plan strategies Asset strategies

Managing Pension Risk Transfer Risk Retain Risk

Terminated vested lump sums Retiree lump sums Captives Longevity hedging Annuity buy-out Annuity buy-in Change asset mix Optimize growth portfolio Interest rate hedging Alternative asset classes Tail risk protection Dynamic de-risking Plan redesign Letters of credit Funding strategies Borrow to fund

The focus of this presentation is on these strategies 1

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Sponsors should consider the full suite of risk management tools in developing their strategy

Market update

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Manuel Monteiro, FSA, FCIA, CFA

Partner, Mercer

Heather Wolfe, FIA, FCIA, FSA

Managing Director, Client Relationships, Defined Benefit Solutions, Sun Life Financial

250 125 14 19 98

50 100 150 200 250 300 2007 2008 2009 2010 2011 2012 2013 2014 2015

Total business transacted ($C billion) U.K. annuities and longevity insurance U.K. annuities Canadian annuities Canadian annuities and longevity insurance U.S. annuities

Source: Hymans Robertson, Lane Clark & Peacock LLP, LIMRA and Sun Life estimates and exchange rates at December 31, 2015.

Cumulative annuities and longevity insurance transacted U.K.

£2 trillion

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DB assets U.S.

$3 trillion

Canada

$1.5 trillion

Global risk transfer transactions are significant

Sources: LIMRA and Mercer

transactions in last two years

200

• f transactions being

done by ongoing plans

50%

average deal size increasing

x 2

Record Year

Record Year

Record Year

More than

Over

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Canadian annuity market

N E W E N T R A N T P R I C I N G L O W E R T O A T T R A C T B U S I N E S S I N S U R E R H A S I N C R E A S E D A P P E T I T E F O R B U S I N E S S I N S U R E R H I T S S A L E S T A R G E T L E A D I N G T O R E D U C E D A P P E T I T E I N S U R E R K E E N T O W I N B U S I N E S S B E F O R E I T ’ S Y E A R - E N D N E W E N T R A N T ’ S P R E M I U M “ N O R M A L I S E S ”

P R I C E

S E V E R A L M O N T H S ASSUMING NO CHANGES IN FINANCIAL CONDITIONS

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Insurer pricing dynamics

To achieve an exceptional outcome in the annuity transactions market:

Speed in execution in a fast-changing market is essential

• Insurers can prepare for binding

quote in advance (less time needed to prepare submission)

• Plans that are ready to transact will

secure desired pricing before prices move

• Participant data and documents

should be prepared in advance

• Insurer due diligence must be

carried out

Plan sponsors must be ready well in advance of seeking to transact

• Data and plan specifications shared

with insurers

• Decision-making process primed

and decision makers ready to act quickly

• Portfolio hedging, liquidation, and

rebalancing actions identified and prepared for

Price transparency, unique to their pension plan, must be available

• Obtained over a suitable monitoring

period to provide insights into price drivers

• Monitoring identifies opportunities
• Deal triggers set in advance alert

sponsors to attractive pricing

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Annuity transactions – challenges for plan sponsors

A N N U I T Y B U Y - I N C A N B E U S E D T O R I G H T S I Z E YO U R P L A N

• May provide a higher yield than an index bond portfolio

with duration of your liabilities

• No top-up contribution required for under funded plans
• No settlement accounting impact (confirm with your

auditor)

• Longevity and investment risk transferred to insurer

A N N U I T Y B U Y - I N C A N B E U S E D D U R I N G W I N D - U P P R O C E S S

• Transfer longevity and investment risk before a wind-up

report is approved

• Convert annuity buy-in to annuity buy-out at any time

SINCE 2009

(Approximate)1

3.1

BILLION

LIABILITIES

$

41

ANNUITY BUY-INS

IN CANADA

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Annuity buy-ins are taking off

Many now changing focus to BENEFIT SECURITY and looking for opportunities to get a GOOD PRICE B.C., ALBERTA and QUEBEC have removed BOOMERANG; expect others to follow Many plans are taking action but FEW PUBLIC ANNOUNCEMENTS

Plan sponsors waiting for interest rates to rise / full funding Regulatory forces (annuity boomerang, solvency funding) Fear of being a “first mover”

Barriers Current trends

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What are the barriers to de-risking?

Longevity risk

Unhedged Hedged

Investment risk

(discount rate, inflation, credit default, equity)

Unhedged Hedged Group annuities Traditional Longevity insurance + Traditional Longevity insurance + Full LDI Alternatives Full LDI Alternatives

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Trend: plan sponsors are hedging different combinations of longevity and investment risk

Case Study 1: Bell Canada Pension De-Risking

Eleanor Marshall, CPA, CA, CFA

Vice-President, Pension & Benefits, BCE and Bell Canada

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Canada’s largest communications company

• One of Canada’s largest private sector pension

sponsors with plan assets ~ $21.0b

• DB ~ $20.0b and DC ~ $1.0b
• Bell DB plan closed since end of 2004
• Other subsidiaries closed before and since
• Plan is > 90% funded on solvency basis
• Surplus on going concern basis
• Represents ~ 36% of BCE market capitalization

20 40 60 80 100 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Actives accruing DC benefits Actives accruing DB service DB Retirees and survivors

Plan members 5-year CAGR +1.3%

• 8.0%

+8.5%

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About us

Objective was to implement a liability driven investment framework to gradually reduce future surplus volatility in a disciplined manner

Key Enterprise Risks: cash flow, balance sheet, benefit security, reputation

3 De-risk De-risk De-risk De-risk Manage

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De-risking context

Interest Rate Risk Equity Risk Inflation Risk Longevity Risk

Before Hedging Assets After Hedging Assets

Impact of a 25bp change in discount rate Impact of a 100bp difference in equity returns Impact of a 25bp change in inflation rate Impact of a 1 year change in age 65 life expectancy

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De-risking context

• The investment framework has been implemented to

de-risk the pension plan assets over time in a disciplined fashion

• The framework is built around the solvency ratio in line

with the objective to reduce contribution volatility

• Assets are moved from the Return Generating Portfolio

to the Low Risk Portfolio as the solvency position improves

• Moves toward a targeted level of equity risk for the “end

game” scenario of all retirees, 105% funded De-risking strategy is not static – it must adjust to changing plan characteristics, risk management

• bjectives, cost constraints, capital market views.

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De-risking investment framework

Observations

• Life expectancy beyond age 65 has been

increasing on an absolute basis and at an increasing rate

− Current life expectancy beyond age 65 is ~19

years (or 84 years at death)

• During the 80’s, life expectancy increased by

~1.0 years

• During the 90’s, life expectancy increased by

~1.5 years

• From 2002 to 2012, life expectancy increased

by ~2 years

Increase in life expectancy after age 65 comes mainly from improvements in medical science, reduction in smoking and healthier lifestyles

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Longevity risk

Longevity vs mortality risks

• Pension plans are subject to longevity risk, meaning increase in pension payments if pensioners live longer

than expected

• Life insurance companies are mainly subject to mortality risk, meaning there is a cost if insured dies earlier

than expected

• Agreements can be reached when both parties enter into an agreement that mitigates their risk

Illustration of longevity insurance

(1) As per the pension plan provisions and not

impacted by the longevity insurance

Retirees Pension Fund Insurance company

Fixed Cash Flow Variable Cash Flow Pension Payments (1)

Longevity Insurance

The Bell plan is buying insurance against members living longer than expected for $5B of liability (about half the retiree liability).

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Longevity insurance

• Pension Plan

payments are fixed and known from day 1

• Present value of

Fixed Pension Plan payments is $1M under all scenarios

• Net present value
• f exchanged cash

flows is minimal under Scenario 1

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Longevity insurance $1M example

• Present value of

Pension Plan payments remains unchanged (same as Scenario 1)

• Net present value
• f exchanged cash

flows is $70K payable from Pension Plan to Insurance Company

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Longevity insurance $1M example

• Present value of

Pension Plan payments remains unchanged (same as Scenario 1)

• Net present value
• f exchanged cash

flows is $70K payable from Insurance Company to Pension Plan

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Longevity insurance $1M example

The apparent simplicity of the resulting agreement belies the effort put into its implementation

• Requires education and buy-in to de-risking strategy at executive and board level
• Lengthy implementation process – 2 years start to finish; partially due to being first in Canada
• A multi-disciplinary team including actuarial, legal, corporate finance, investment and accounting

expertise from internal and external advisors – from Canada, UK and US

• Due diligence on both sides, plus the trustee
• A large and diverse retiree population has its advantages and disadvantages
• Requires new processes for ongoing administration, valuation
• External stakeholders – regulators, auditors and investors
• Pensioner stakeholders:

“One doesn’t often come across true ‘win-win’ scenarios, but I think this qualifies.”

Bob Farmer President – Canadian Federation of Pensioners

The Bell / Sun Life agreement demonstrates that large scale risk transfer transactions can be accomplished in Canada

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Implementation considerations

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Transaction recognized as positive indication that management was continuing to address pension risks Over the long term, the arrangement will help reduce cost volatility with respect to benefit payments to retirees. We believe the arrangement is slightly positive for BCE, because longevity risk is becoming more important as the population ages and lives longer. - Maher Yaghi, March 6, 2015 It will have minimal impact on BCE’s pension solvency position. However, it will reduce cost volatility over the long term with respect to benefit payments to retirees. The arrangement effectively transfers the risk of pensioners living longer than expected to Sun Life…In this way, the risk that the Bell pension plan's actual liabilities exceed expected liabilities is transferred to Sun Life. – Jeff Fan, March 3, 2015

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Investor reaction

Board level de-risking conversations

• What does the ‘end game’ look like for our DB plan – immunization, wind-up, long-term sustainability?
• How is pension risk affecting the success of our core business – distraction, threat, capital allocation?
• What is the reward for taking this risk?
• How does de-risking affect our stakeholders?
• What risks are we competent at managing and what risks should be outsourced?
• What are the risk transfer options available to our plan?

Bell’s commitment to pension risk management makes us a better communications company

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Conclusions

Case Study 2: Combination Annuity Transaction

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Manuel Monteiro, FSA, FCIA, CFA

Partner, Mercer

Heather Wolfe, FIA, FCIA, FSA

Managing Director, Client Relationships, Defined Benefit Solutions, Sun Life Financial

Buy annuities for accrued benefits

Leave indexing in plan

Amend indexing formula

Replace CPI- linked indexing with flat indexing

Purchase CPI- linked benefits

Transfer inflation risk to insurer Combined annuity transaction $530 million Canadian Wheat Board $150 million

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There are options for plans with CPI indexing

• Recently, inflation has been fairly predictable and benign
• In the past, inflation has been unpredictable and volatile with prolonged periods of high

inflation

• Inflation is out of management’s control and expensive to hedge
• 10%
• 5%

0% 5% 10% 15% 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Historical % increase in CPI Where will inflation go in the future?

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Inflation has historically been risky

• Only Canadian real return bonds (RRBs) assure that purchasing power is maintained

regardless of the level of inflation

• Other asset classes are either unavailable in Canada, or are not well correlated with inflation

Asset class Hedge efficiency

Canadian RRBs Perfect correlation to Canadian CPI Inflation derivatives Non-existent market for inflation derivatives for Canadian CPI Corporate RRBs Only three issues of Canadian corporate RRBs US TIPS Imperfect correlation to Canadian CPI, introduce C$ / US$ exchange risk Equities Imperfect correlation to Canadian CPI, introduce equity risk, do not hedge interest rates Real estate Imperfect correlation to Canadian CPI

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Limited options for hedging CPI-linked liabilities

The cost of inflation protection can be illustrated as the difference in yield between Canadian nominal return bonds and Canadian real return bonds

1.00% 1.50% 2.00% 2.50% 3.00%

12/31/2010 12/31/2011 12/31/2012 12/31/2013 12/31/2014 12/31/2015

Implied inflation1

Implied CPI 5 Year Historical Average = 1.84%

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Cost of inflation protection is currently low

Combine plans with

• ffsetting

formulas Material cost savings (perhaps 3% to 5%)

Case study: $530 million combined annuity deal

• Two unrelated Canadian pension plans with significant liabilities
• Pensions are CPI-linked, inflation formulas are different and complementary
• Combining different formulas allowed us to optimize asset strategy

Purchase annuities at same time Combining reduced price by

• ver $20 million

Optimize assets

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Combined annuity transaction resulted in savings

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How does a combined annuity deal work?

Plan A: indexation formula = 100% CPI, max. 3% Plan B: indexation formula = CPI – 3 % Combine plans to share inflation protection

Questions

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