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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
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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
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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?
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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
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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
0
50
100
150
200
250
300
2007 2008 2009 2010 2011 2012 2013 2014 2015
Tota
l bus
ines
s tra
nsac
ted
($C
billi
on)
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 of 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 Y O 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
S I N C E 2 0 0 9 (Approximate)1
3.1 B I L L I O N
LIABILITIES
$
41 A N N U I T Y B U Y - I N S
IN CANADA
1 Sun Life estimates, as at June 30, 2016
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2 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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2 What are the barriers to de-risking?
Long
evity
risk
U
nhed
ged
Hedg
ed
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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2 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
o DB ~ $20.0b and DC ~ $1.0b
Bell DB plan closed since end of 2004
o Other subsidiaries closed before and since
Plan is > 90% funded on solvency basis
o Surplus on going concern basis
Represents ~ 36% of BCE market capitalization
0
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 survivorsPlan members 5-year CAGR
+1.3%
-8.0%
+8.5%
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3 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
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De-risk
De-risk
De-risk
De-risk
Manage
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De-risking context
Interest RateRisk
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 objectives, 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 of 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 of 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 of 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 $150 million
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3 There are options for plans with CPI indexing
• Recently, inflation has been fairly predictable and benign • In the past, inflation has been unpredictable and volatile with prolonged periods of high
inflation • Inflation is out of management’s control and expensive to hedge
-10%
-5%
0%
5%
10%
15%
1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Historical % increase in CPI
Where will inflation go in the future?
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3 Inflation has historically been risky
• Only Canadian real return bonds (RRBs) assure that purchasing power is maintained regardless of the level of inflation • Other asset classes are either unavailable in Canada, or are not well correlated with inflation
Asset class Hedge efficiency
Canadian RRBs Perfect correlation to Canadian CPI
Inflation derivatives Non-existent market for inflation derivatives for Canadian CPI
Corporate RRBs Only three issues of Canadian corporate RRBs
US TIPS Imperfect correlation to Canadian CPI, introduce C$ / 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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3 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 Calculated using [(1+CANSIM V39062) / (1+ CANSIM V39057) – 1] for each year.
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 CPI5 Year Historical Average = 1.84%
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3 Cost of inflation protection is currently low
Combine plans with offsetting 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 over $20 million Optimize assets
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3 Combined annuity transaction resulted in savings
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3 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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