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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

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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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