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De-risk the Defined Benefit Pensions
– Collaboration of all stakeholders
Defined benefit pension is a top issue for management
FINANCIAL CRISIS
INCREASING
REGULATION
NEED FOR GREATER
CONTROL AND
UNDERSTANDING
3
3
Pension risks are important and need to be managed
jointly
REGULATION
INTEREST RATE
FINANCIAL MARKET
DESIGN
REPUTATION
INFLATION
LONGEVITY
CURRENCY
OPERATION
4
Opportunity for HR and Finance to work together
Operational
risk
People
risk
Compliance
risk
COMMON OBJECTIVE
HR to design
the benefits
Retain
Attract
Motivate
Finance to fund
the benefits
Cost
Effectiveness
Efficiency
Financial
risk
Market
risk
Strategic 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
design changes to reduce
future exposures
Finance driven investment
solutions acquired to manage
the investment risk
exposures
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
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De-risking Trends
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De-risking Trends
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De-risking Trends
Freeze /
Close
Plan
Cash out /
Transfer
Deferred
Participants
Extend
Bond
Duration
Increase
Bond
Allocation
Traditional Investment
Solutions
Buy-in Bulk
Annuities
Buy-out /
Settle
Schemes
Traditional Insurance
Solutions
Collaboration
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De-risking Trends
Pension Annuity
Pension Captive
Pension Plan
Pension Plan
Annuity
premium
Annuity
premium
Annuity
payment
Annuity
payment
Insurance Company
Reinsurance
premium
Insurance Company
Reinsurance
payment
XYZ Captive
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Collaborative Approach
Current
Plan
Current
allocation
Freeze /
close plans
Cash-out
Deferreds
Captive
Solution
Insurance
Buy-in/out
Current
Extend
Bond
Duration
Increase
Bond
Allocation
Hedged
Portfolio
De-risk
Capabilities
Risk
Management
Experience
and Expertise
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Global
Coverage
DERISKING OF PENSION FUNDS
FOCUS ON IRELAND
Managing DB Risk
Recent financial
turbulence
Changes to
pension
regulations
Marketplace
focus on
managing DB
risk
Increased
shareholder
scrutiny
Further closure
of DB accrual
Wider
accessibility of
hedging
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%
197%
207%
SMURFIT
KAPPA
250%
BANK OF
IRELAND
300%
220%
200%
59%
62%
IRISH
CONTINENTAL
GROUP
100%
F.B.D
150%
88%
109%
127%
INDEPENDENT
NEWS &
MEDIA
GREENCORE
GROUP
FYFFES
TOTAL
PRODUCE
0%
UTV MEDIA
50%
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
63
78
50
8
0
< €1m
•
€1m - €5m
€5m - €10m
€10m €50m
€50m €100m
Source: Pensions Board Defined Benefit Survey 2010
€100m €1bn
> €1bn
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
Strategy
Investment
Strategy
Governance
Benefit
Policy
Employer
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%
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
Benefit Policy
• Closures to future accrual
Already
implemented
more than 12
months ago,
6%
Implemented in last
12 months or in
process of, 13%
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
4.5
3.8
23.5
21.5
18.5
1.0
8.7
0.8
8.0
2.3
9.1
90.0
80.0
70.0
4.2
24.9
4.3
33.2
2.8
3.8
60.0
5.9
4.4
50.0
40.0
30.0
63.0
66.3
65.2
64.3
52.2
20.0
10.0
0.0
End 2003
End 2005
Equities
•
End 2007
Property
Other
End 2009
Bonds
End 2011
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
Annuity Price €
270,000
250,000
230,000
210,000
190,000
170,000
Mar-12
Sep-11
Mar-11
Sep-10
Mar-10
Sep-09
Mar-09
Sep-08
Mar-08
Sep-07
Mar-07
Sep-06
Mar-06
Sep-05
Mar-05
Sep-04
Mar-04
Sep-03
Mar-03
Sep-02
150,000
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 /
sovereign
annuities
Non-cash
funding
Balanced
solution
reflecting
objectives of all
stakeholders
Liability Driven
Investment
strategies
Diversify sources
of investment
return