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

3

3

FINANCIAL CRISIS INCREASING REGULATION

NEED FOR GREATER CONTROL AND UNDERSTANDING

Defined benefit pension is a top issue for management

4

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

RetainAttractMotivate

Finance to fund the benefits

Cost EffectivenessEfficiency

Operational risk

People risk

Compliance risk

Financial risk

Market risk

Strategic risk

COMMON OBJECTIVE

6

Pension de-risking process is dynamicFinance, 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

27

De-risking Trends

1/4/201

28

12/5/2011

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

1/4/201

210

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

Currentallocation

Extend Bond

Duration

Hedged Portfolio

Current

De-risk

Cash-out Deferreds

Freeze / close plans

Increase Bond

Allocation

Collaborative ApproachCaptive Solution

12

Capabilities

DERISKING OF PENSION FUNDSFOCUS ON IRELAND

Changes to pension

regulations

Increased shareholder

scrutiny

Wider accessibility of

hedging investments

Further closure of 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% of Market Cap

59% 62%88%

109%127%

197% 207% 220%

332%

0%

50%

100%

150%

200%

250%

300%

350%

F.B

.D

IRIS

HC

ON

TIN

EN

TA

LG

RO

UP

UT

V M

ED

IA

TO

TA

LP

RO

DU

CE

FY

FF

ES

BA

NK

OF

IRE

LA

ND

SM

UR

FIT

KA

PP

A

GR

EE

NC

OR

EG

RO

UP

IND

EP

EN

DE

NT

NE

WS

&M

ED

IA

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

6378

8

0

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

FundingStrategy

Pension RiskFactors 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 64.352.2

8.7 8.0 9.13.8

4.4

1.0 0.82.3

2.8

5.9

23.5 21.5 18.524.9

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 RiskRisk 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 TransferAnnuity Purchase

Historical Annuity Pricing

150,000

170,000

190,000

210,000

230,000

250,000

270,000

290,000

Sep-0

2

Mar-

03

Sep-0

3

Mar-

04

Sep-0

4

Mar-

05

Sep-0

5

Mar-

06

Sep-0

6

Mar-

07

Sep-0

7

Mar-

08

Sep-0

8

Mar-

09

Sep-0

9

Mar-

10

Sep-1

0

Mar-

11

Sep-1

1

Mar-

12

Date

An

nu

ity P

rice €

* 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 RiskFocus 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 of investment

return

Non-cash funding

Benefit management

Balanced solution

reflecting objectives of all

stakeholders

Derisking of Pension Funds - Options