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Execution of a Successful Pension Risk Transfer Transaction June 22, 2017

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PANEL

Moderator Marcia Kelson Jones Day Partner ERISA Counsel Kevin Noble Jones Day Partner Transactional Counsel George Flemma Jones Day Of Counsel Insurance Company Glenn O’Brien Prudential Financial Managing Director, Institutional Investments Actuary, Administration, Marketplace Ari Jacobs Aon Hewitt Senior Partner 3

CAST OF CHARACTERS

• Plan actuary

‒ Performs accounting and funding calculations ‒ Develops mortality and demographic studies

• Asset Managers

‒ Implements asset-in-kind strategy ‒ Implements hedging strategy as needed

• Investment Banker

‒ Leads fundraising if cash needed ‒ Works with credit rating agencies as needed

• Independent Fiduciary

‒ Represents interests of plan participants

• Outside counsel

‒ ERISA issues ‒ Transactional issues

• Plan administration

‒ Communications to plan participants

• Bidding Insurance Companies

‒ Slate of potential insurers

• Trustee

‒ Transfers assets to pay premium

• Internal Resources

‒ Primary: Treasury, Legal ‒ Also: Accounting, Finance, Communications, Investor Relations

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PENSION RISK MANAGEMENT Why De-Risk

• Volatility of pension exposure
• Outsized pension liability; legacy
• bligation; stock price impact
• Rising PBGC premiums
• Mortality table adjustments
• Focus on core business, not pension

management

Methods of De-Risking

• Limit Future Liability – Hard or Soft

Freeze

• Management of Assets within Plan

‒ Liability Driven Investment (LDI) – asset/liability matching ‒ Annuity Buy-in – Mostly in U.K. ‒ Longevity Swap – U.K.

• Elimination of Some or All Liability

‒ Lump-Sum Window ‒ Pension Risk Transfers

• Lift Out or Spin/Term
• Full Termination

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243 237 180 150 194 247 235 293 339 493 $2.7 $2.3 $0.8 $0.7 $0.9 $3.8 $8.6 $13.4 $14.1 $0B $2B $4B $6B $8B $10B $12B $14B $16B 50 100 150 200 250 300 350 400 450 500 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Total Premium Transaction Count

$35.3

Verizon and GM deals signal shift to larger transactions

PENSION RISK TRANSFER ANNUITY TRANSACTIONS BY YEAR

95 deals for $1.4B in first quarter 2017 compared to 82 deals for $1.1B in first quarter 2016

Source: Year-end 2016, as reported in insurer responses to Aon Hewitt Investment Consulting’s survey of the most significant U.S. insurers

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Insurers Included American General MassMutual Minnesota Life (Securian) OneAmerica Principal United of Omaha Banner (L&G) MetLife New York Life Pacific Life Prudential Voya (not bidding)

Source: Year-end 2016, as reported in insurer responses to Aon Hewitt Investment Consulting’s survey of the most significant U.S. insurers

PENSION RISK TRANSFER ANNUITY TRANSACTIONS BY INSURER DURING 2016

20 19 69 5 18 18 115 6 180 33 5 2 $5,055 $2,020 $1,916 $1,776 $820 $517 $502 $447 $426 $363 $196 $75 $0M $1,000M $2,000M $3,000M $4,000M $5,000M $6,000M 25 50 75 100 125 150 175 200 Insurer 1 Insurer 2 Insurer 3 Insurer 4 Insurer 5 Insurer 6 Insurer 7 Insurer 8 Insurer 9 Insurer 10 Insurer 11 Insurer 12

Total Premium Transaction Count

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JUMBO PENSION RISK TRANSFER TRANSACTION

Chronological Order of Process:

• 1. Pre-Transaction Planning
• 2. Structuring
• 3. Bid Process
• 4. Transactional Tasks
• 5. Group Annuity Contract Issuance

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PRE-TRANSACTION PLANNING INITIAL STEPS

• Analyze Financial Impact

‒ Settlement Accounting ‒ Funding Requirements (i.e., is “Top-up Payment” needed?)

• Coordinate plan investment strategy – LDI glide path
• Establish Realistic Timeline
• High-level quote / test of the market
• Evaluate population scenarios

‒ Potential union considerations

• Data Integrity

‒ Complete participant information is critical!

• Birthdates, gender, beneficiaries, unique benefit issues
• Beneficiary information is thorniest issue

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STRUCTURING TWO PRIMARY APPROACHES FOR JUMBO DE-RISKING

Spin/Term

• Clear Legal Precedent

‒ Spin-off actives and DVs into new, mirror plan ‒ Terminate old plan consisting of retirees only ‒ Clear regulatory process

• Likely top-up payment will be

required

• Independent Fiduciary

*Spin/Term potentially more problematic with collectively-bargained units, but Lift-Out not completely free of union issues

Lift-Out

• Legally permissible, but less

affirmative precedent

‒ Amend plan to require irrevocable annuity for specifically defined group ‒ Comparable benefit notices

• Voluntary top-up payment to

maintain funding level

• Independent Fiduciary
• More common due to lower cost;

less complexity

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STRUCTURING INDICATIVE TIMELINE MINIMUMS FOR JUMBO TRANSACTION

Spin/Term

• Day 0: Complete preparation
• Day 0: Spin-off Date (IRS filing of spin-off

due 30 days before this date)

• Day 0: Sign Definitive Purchase

Agreement with insurer

• Day 1: Issue NOIT & NOPBs (required

notice of termination and individualized benefit notices)

• Day 2: File with PBGC
• Day 63: Exit PBGC 60-day review period
• Day 64: Close on annuity contract
• Day 63 + 180 days: Complete all mortality

and data true-ups

Lift-Out

• Day 0: Complete preparation
• Day 0: Sign Definitive Purchase

Agreement with insurer

• Day 1: Notify participants of retiree lift out

purchase, and individualized retiree benefit notices (comparable to those in spin-term); SEC 8-K (if applicable)

• 45+ day interim period that mimics notice

period in spin/term

• Day 46: Close on annuity contract
• Day 46 + 6 months: Complete all mortality

and data true-ups

*Specifics of timeline dependent on structure of deal

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STRUCTURING BOTH APPROACHES END PARTICIPANT STATUS

• Impact on plan participants is the same under either scenario
• Provision in a terminating plan

‒ In a standard termination, annuity contracts must be available. ERISA § 4041(b)(3).

• Provision in an ongoing plan

‒ In ongoing plans, an individual ceases to be a participant when the entire benefit rights of an individual are (1) fully guaranteed by an insurer, (2) enforceable by the sole choice of the individual against the insurer, and (3) a certificate is issued to the individual. 29 C.F.R. § 2510.3-3(d)(2). ‒ PBGC rule for premium purposes is similar. 29 C.F.R. § 4006.6(b)(2). ‒ Code rules do not treat distribution of an annuity contract as a cutback. 26 C.F.R. § 1.411(d)-4, Q/A-2(a)(3)(ii)(A) (source of payments is not a protected

• ptional form of benefit).

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STRUCTURING FIDUCIARY AND SETTLOR ACTS

• Decision to terminate or amend a plan is a settlor act to which fiduciary

duties do not attach.

‒ In termination context, because a plan covers more than just the target population, a pre-termination spin-off of active participants, etc., is necessary. Code “permanence” rule suggests that actives, and not the population to be annuitized, should be spun. 26 C.F.R. § 1.401-1(b)(2). ‒ In an ongoing plan, careful attention should be given to how the amendment is structured and to eliminate discretion as to certain annuitization decisions, like the population to be annuitized.

• Implementation of a settlor act implicates fiduciary duties.

‒ In connection with an annuity contract purchase, the most important fiduciary act is the selection of the insurer or insurers to provide the annuity. See 29 C.F.R. § 2509.95-1 (Labor Department interpretive bulletin on the selection of annuity providers). ‒ Other items, like the terms of the annuity contract and communications surrounding the decision, also implicate fiduciary duties.

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STRUCTURING EXECUTIVE LIFE AFTERMATH

• In the 1980s, a large number of spin-off/terminations occurred in order

to obtain reversions of assets from over-funded plans.

• In the wake of the Executive Life Insurance Company failure in 1991,

some courts denied standing to former participants who had ELIC

• annuities. See Kayes v. Pac. Lumber Co., 51 F.3d 1449, 1455 (9th Cir.

1995).

• Congress amended ERISA to add a cause of action for former plan

participants to bring suit for fiduciary breaches in connection with the purchase of an annuity contract. ERISA § 502(a)(9).

‒ Some courts have allowed such suits outside the section 502(a)(9) context. See Bussian v. RJR Nabisco, Inc., 223 F.3d 286 (5th Cir. 2000); Calobrace v.

• Am. Nat’l Can Co., 1995 U.S. Dist. LEXIS 13244 (N.D. Ill. Sept. 8, 1995).
• The Labor Department also issued an interpretive bulletin regarding its

views of the fiduciary duties attendant to an annuity provider selection. 29 C.F.R. § 2509.95-1.

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STRUCTURING DOL IB 95-1

• DOL IB 95-1 states that “fiduciaries choosing an annuity provider for the

purpose of making a benefit distribution must take steps calculated to

• btain the safest annuity available.” However, it recognizes that “a

fiduciary may conclude . . . that more than one annuity provider is able to offer the safest annuity available.”

• Requires an “objective, thorough, and analytical search” and DOL

expects that most fiduciaries would need to hire a qualified expert

• DOL lists six facts, which are generally viewed as a minimum threshold,

but two factors to call out:

‒ General vs. Separate Account ‒ Extent of State Guaranty Association protection

• Some courts have found that the standard focuses too much on the

quality of the insurer selected and too little on the conduct of the plan fiduciary in reaching its decision. See Bussian v. RJR Nabisco, Inc., 223 F.3d 286 (5th Cir. 2000).

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STRUCTURING ROLE OF AN INDEPENDENT FIDUCIARY

• There is at least the appearance of a conflict of interest for sponsor-

related entities to select insurer, heightened in lift-out transactions

‒ In high conflict situations, can form special plan committee to hire IF

• Role of IF

‒ Determine whether DOL IB 95-1 and ERISA is satisfied; directs trustee ‒ Retains its own insurance advisor and counsel

• Role of corporate sponsor when there is an IF

‒ Can focus on cost, corporate interests

• Tripartite Negotiations

‒ IF represents retirees

• Negotiates certain terms, structure of annuity contract

‒ Plan sponsor negotiates annuity and asset pricing issues free from conflicts ‒ Insurance Company represents its interests

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STRUCTURING TRANSACTION CHOREOGRAPHY WITH INDEPENDENT FIDUCIARY

• Initial corporate analysis
• Independent Fiduciary engaged
• Independent Fiduciary due diligence

‒ Parallel track to corporate due diligence

• Board gives approval; delegates authority to implement
• Plan amendment to mandate purchase
• Independent Fiduciary follows plan amendment, selects insurance

company, and directs plan trustee to pay premium

‒ Existing investment managers prepare cash and/or assets to be transferred

• Group Annuity Contract issued
• Amendment period; Independent Fiduciary directs plan trustee to pay

any additional premium

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STRUCTURING MARKETPLACE, CONSERVATIVE STRUCTURING, TENSION

• Marketplace divergence for lift-outs over / under $1 Billion

‒ Assets in-kind more likely over $1B; bespoke transactions less likely under $1B

• Plan termination is subject to regulatory requirements, including content

and timing requirements regarding notice to participants

• Lift-out is not subject to express regulation

‒ Implementation is subject to fiduciary requirements ‒ Plan term rules could be seen as expectation for ending plan relationship

• From participant standpoint, plan is terminating as to them

‒ Funding level for remaining plan; Plaintiffs bar fuming over standing

• Tension

‒ Legal and execution desire to get complete deal in place before payment ‒ Insurer engagement given available resources and multiple transactions in marketplace

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STRUCTURING MINIMIZATION OF RISKS

• “Cut the cord”

‒ Analyze and minimize all potential risks ‒ Ounce of prevention is worth a pound of cure

• Objective is to de-risk; not trade funding volatility risk for tail risks

‒ Plaintiffs bar actively looking for next source of litigation (Verizon)

• Annuity market was historically slow / disjointed (from corporate view)

‒ Primarily plan terminations; mostly deferred vesteds; insurers had all leverage and sponsors rarely pushed back; scant purchase agreements were the norm

• Still today, regulatory approval may delay annuity contract issuance

‒ Essentially transferring assets for a promise ‒ That promise needs to be documented with precision!

• Jumbo transactions present unique qualitative issues in addition to size

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STRUCTURING “ROLL FORWARD” TO MIMIC TERMINATION REQUIREMENTS

Spin/Term

• Day 0: Complete preparation
• Day 0: Spin-off Date (IRS filing of spin-off

due 30 days before this date)

• Day 0: Sign Definitive Purchase Agreement

with insurer

• Day 1: Issue NOIT & NOPBs (required

notice of termination and individualized benefit notices)

• Day 2: File with PBGC
• Day 63: Exit PBGC 60-day review period
• Day 64: Close on annuity contract
• Day 63 + 180 days: Complete all mortality

and data true-ups

Lift-Out

• Day 0: Complete preparation
• Day 0: Sign Definitive Purchase

Agreement with insurer

• Day 1: Notify participants of retiree lift
• ut purchase, and individualized retiree

benefit notices (comparable to those in spin-term); SEC 8-K (if applicable)

• 45+ day interim period that mimics

notice period in spin/term

• Day 46: Close on annuity contract
• Day 46 + 6 months: Complete all mortality

and data true-ups

*Specifics of timeline dependent on structure of deal

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STRUCTURING LEE & PUNDT, ET. AL. V. VERIZON

• Verizon announces lift-out in October 2012; w/ IF, w/ roll-forward
• Participants sue; TRO/PI denied Dec. 7, transaction closes Dec. 10
• Independent Fiduciary not sued; 8-k reflects $2.5B top-up payment (not pled)
• Case proceeds with two classes:

‒ Transferee class (Lee): various theories challenging lift-out concept

• Dismissed on 12(b)(6); Affirmed by Fifth Circuit – settlor decisions, no other facts pled

sufficient to state a violation (e.g., no facts pled on why premium was excessive)

‒ Non-transferee class (Pundt): cost unreasonable; depleted remaining assets

• Dismissed for lack of constitutional standing; Affirmed by Fifth Circuit; Cert petitioned

in S.Ct.; S.Ct. remands in light of intervening S.Ct. decision on Article III standing

• September 2016: Fifth Circuit re-affirms prior decision

– Injury based on a statutory violation must constitute a “risk of real harm”; no such risk here

• March 2017: Cert denied by S.Ct.

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STRUCTURING CURRENT TRENDS

• Lift-outs or full plan termination; spin/term is rare
• Sub $1 Billion market more active today
• Low monthly dollar amount transactions

‒ E.g., only cover retirees receiving under $150/month. ‒ Eliminates administrative and PBGC costs

• Analyze economic liability rather than only GAAP PBO
• Roll forward / lift-out waiting period only in biggest deals
• Annuity contract may be prepared post-purchase
• Standard or minimally revised insurer purchase agreements
• Pension rights activists still active; IRS agrees to prohibit lump sums to

pay-status retirees in 2015

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BID PROCESS

• Send out Request for Quotes / RFPs to insurer universe

‒ Conducted by third party advisor (investment banker or plan actuary) ‒ Requests insurer specimen documents (e.g., Group Annuity Contract) ‒ Some insurers may decline due to size or population ‒ Execute NDAs with insurers before releasing identifying information

• May request different structures

‒ General vs. separate account ‒ Split transactions

• Multiple rounds of bids

‒ A few weeks between bid rounds ‒ Other work streams occurring between bid rounds; weekly calls ‒ Negotiate with multiple insurers at once

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TRANSACTIONAL TASKS REVIEW PERIOD / ROLL-FORWARD

• Choreography for under $1B with no review period

‒ Traditionally, bids come in by noon; expire at 4pm. ‒ Sponsor reviews bids at noon; amends plan to require purchase ‒ IF selects insurer by 4pm and directs plan trustee to pay premium

• Effort to mimic notice timing requirements and PBGC review period,

even though no PBGC review occurs in lift-out

‒ Follows termination requirements, opportunity to correct data errors ‒ Verizon example

• Review period requires price to be rolled forward

‒ Roll forward introduces complexity in tracking price ‒ Top-up calculation / in-kind assets require attention

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TRANSACTIONAL TASKS DEFINITIVE PURCHASE AGREEMENT

• Better model for large, discretionary retiree de-risking is one based on

the M&A / Asset Purchase model

‒ Reps and Warranties from all parties ‒ Clear covenants regarding transaction implementation and timing ‒ Roll-forward pricing terms detailed with abundant precision

• Deals can become very complex
• Forcing both sides to describe expectations with precision uncovers,

and settles, potential issues that could arise later

• Meets expectations of Board and senior leadership that process was

conducted in a manner befitting a multi-billion dollar transaction

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TRANSACTIONAL TASKS OTHER TASKS

• “Death, Bonds, and Interest Rates”

‒ Premium heavily dependent on mortality and interest rates ‒ Asset-based funding mechanics: Insurers interested in high-quality bonds ‒ Roll-forward price hedging; funding ratio effect, top-up contribution

• Trust amendments

‒ IF directs, so may need to be amended

• Group Annuity Contract

‒ Must be approved by state regulators ‒ Separate account requires plan or operations, which must also be approved

• Prohibited Transaction considerations

‒ Determine if insurer is an ERISA party in interest, and determine exemption

• Outside Financing

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TRANSACTIONAL TASKS BOARD COMMUNICATIONS AND RESOLUTIONS

• Every Board unique and has own protocols

‒ Good boards are diverse; some members interested in details, others not ‒ Activist investors require active engagement

• Keep Board informed before and during transaction, explain benefits:

‒ Balance sheet impact / settlement at attractive cost, ‒ Impact on future contributions / income statement, ‒ Retiree and employee protections

• Board needs to authorize management to

‒ Enter into the definitive purchase agreement, etc.

• Usually comes with strings, e.g., no more than XXX% above GAAP PBO

‒ Make necessary plan document amendments

• Clarify authority to hire / delegate authority to IF
• Mandate annuity purchase with no discretion (pure settlor decision)

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TRANSACTIONAL TASKS OUTSIDE COMMUNICATIONS

• Affected participants

‒ Look to plan termination requirements: NOPB, NOIT, etc.

• Non-affected participants

‒ Consider how transaction may be viewed by remaining plan participants

• Investing Public (8-k filing)
• Analysts
• Press
• Regulatory agencies

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GROUP ANNUITY CONTRACT ISSUANCE

• Bring-down letters regarding covenants, still 95-1 compliant
• Close: Transfer premium, sign group annuity contract

‒ What if annuity contract is not ready?

• First insurer payment subject to negotiation, may still be 1-2 months off
• Mortality discovery

‒ Mortality takes a few months to be reported / discovered ‒ Results in premium refund back to the plan

• “True-up” amendments for discovered data errors and mortality

‒ ~6 month true-up period is normal

• Annuity certificate issuance

‒ Important because of regulation regarding participant status

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CONTACT INFORMATION

Marcia Kelson Jones Day Partner 500 Grant Street, Suite 4500 Pittsburgh, PA 15219 (T) 1.412.394.9563 mkelson@jonesday.com Kevin Noble Jones Day Partner 51 Louisiana Ave., N.W. Washington, D.C. 20001 (T) 1.202.879.3882 krnoble@jonesday.com George Flemma Jones Day Of Counsel 250 Vesey Street New York, NY 10281 (T) 1.212.326.3772 717 Texas, Suite 3300 Houston, TX 77002 (T) 1.832.239.3772 gflemma@jonesday.com Glenn O’Brien Prudential Financial Managing Director, Institutional Investments 1540 Broadway New York, NY 10036 (T) 1.917.339.4418 glenn.o’brien@prudential.com Ari Jacobs Aon Hewitt Senior Partner 45 Glover Avenue Norwalk, CT 06850 (T) 1.203.523.8472 ari.jacobs.2@aonhewitt.com

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