Getting control back on the vessel some offloading required September 21, 2016

Transcription

1 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 1

2 Agenda 1 De-risking overview 2 Market update Two case studies 2

3 1 De-risking overview Manuel Monteiro, FSA, FCIA, CFA Partner, Mercer

4 Composition of private sector DB plans 1 Defined benefit plans open to new entrants have dropped from 70% in 2007 to 45% in Source: Mercer Pension Database (Canada), Base: 540 plans 4

5 Potential strategies for closed and frozen plans 1 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 APPROXIMATE TIMEFRAME

6 Key steps in establishing a risk management strategy 1 Measure current risk/reward profile Define organization s risk appetite Is current risk profile consistent with risk appetite? Yes No Optimize current strategy Consider alternatives to adjust risk profile Develop transition strategy and implement 6

7 Risk management considerations 1 1 Is the DB plan open, closed or frozen? Upside benefit to taking risk diminishes as size of future accruals decreases 2 Size of plan relative to size of sponsor For large mature plans: Downside risk has a larger impact Upside benefit may be lower (unusable surplus?) Financial strength of plan sponsor Stronger sponsors better able to bear risk 4 Funded position of plan Upside benefit to taking risk diminishes as the funded position improves 5 Who bears the risk? Who reaps the rewards? Risk-shared plans more likely to take risk to keep contributions at a reasonable level 7

8 Sponsors should consider the full suite of risk management tools in developing their strategy Managing Pension Risk 1 Plan strategies Retain Risk Asset strategies Insurance Transfer Risk Individual Plan redesign Change asset mix Annuity buy-in Terminated vested lump sums Letters of credit Optimize growth portfolio Annuity buy-out Retiree lump sums Funding strategies Interest rate hedging Longevity hedging Borrow to fund Alternative asset classes Captives Tail risk protection Dynamic de-risking The focus of this presentation is on these strategies 8

9 2 Market update Manuel Monteiro, FSA, FCIA, CFA Partner, Mercer Heather Wolfe, FIA, FCIA, FSA Managing Director, Client Relationships, Defined Benefit Solutions, Sun Life Financial 9

10 Global risk transfer transactions are significant 2 Cumulative annuities and longevity insurance transacted DB assets 00 U.K. annuities and longevity insurance Total business transacted ($C billion) U.K. annuities Canadian annuities Canadian annuities and longevity insurance U.S. annuities U.K. 2 trillion U.S. $ trillion Canada $1.5 trillion Source: Hymans Robertson, Lane Clark & Peacock LLP, LIMRA and Sun Life estimates and exchange rates at December 1,

11 Canadian annuity market 2 Record Year Record Year Record Year Sources: LIMRA and Mercer Over More than 200 transactions in last of transactions being two years done by ongoing plans 50% x 2 average deal size increasing 11

12 Insurer pricing dynamics 2 INSURER HITS SALES TARGET LEADING TO REDUCED APPETITE PRICE NEW ENTRANT S PREMIUM NORMALISES NEW ENTRANT PRICING LOWER TO ATTRACT BUSINESS INSURER KEEN TO WIN BUSINESS BEFORE IT S YEAR- END INSURER HAS INCREASED APPETITE FOR BUSINESS SEVERAL MONTHS ASSUMING NO CHANGES IN FINANCIAL CONDITIONS 12

13 Annuity transactions challenges for plan sponsors 2 To achieve an exceptional outcome in the annuity transactions market: Plan sponsors must be ready well in advance of seeking to transact Price transparency, unique to their pension plan, must be available Speed in execution in a fast-changing market is essential 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 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 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 1

14 Annuity buy-ins are taking off 2 ANNUITY BUY- IN CAN BE USED TO RIGHT SIZE YOUR PLAN 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 ANNUITY BUY- IN CAN BE USED DURING WIND- UP PROCESS Transfer longevity and investment risk before a wind-up report is approved Convert annuity buy-in to annuity buy-out at any time SINCE 2009 (Approximate) 1 41 ANNUITY BUY- INS IN CANADA $.1 BILLION LIABILITIES 1 Sun Life estimates, as at June 0,

15 What are the barriers to de-risking? 2 Barriers Plan sponsors waiting for interest rates to rise / full funding Current trends Many now changing focus to BENEFIT SECURITY and looking for opportunities to get a GOOD PRICE Regulatory forces (annuity boomerang, solvency funding) B.C., ALBERTA and QUEBEC have removed BOOMERANG; expect others to follow Fear of being a first mover Many plans are taking action but FEW PUBLIC ANNOUNCEMENTS 15

16 Trend: plan sponsors are hedging different combinations of longevity and investment risk 2 Longevity risk Unhedged Hedged Longevity insurance + Traditional Traditional Alternatives Alternatives Longevity insurance + Full LDI Full LDI Group annuities Unhedged Investment risk (discount rate, inflation, credit default, equity) Hedged 16

17 Case Study 1: Bell Canada Pension De-Risking Eleanor Marshall, CPA, CA, CFA Vice-President, Pension & Benefits, BCE and Bell Canada 17

18 About us 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 ~ 6% of BCE market capitalization Actives accruing DC benefits Actives accruing DB service DB Retirees and survivors Plan members 5-year CAGR +1.% % +8.5% 18

19 De-risking context De-risk De-risk Manage De-risk De-risk Key Enterprise Risks: cash flow, balance sheet, benefit security, reputation Objective was to implement a liability driven investment framework to gradually reduce future surplus volatility in a disciplined manner 19

20 De-risking context Impact of a 25bp change in discount rate Impact of a 25bp change in inflation rate Impact of a 1 year change in age 65 life expectancy Impact of a 100bp difference in equity returns Before Hedging Assets After Hedging Assets Interest Rate Risk Equity Risk Inflation Risk Longevity Risk 20

21 De-risking investment framework 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. 21

22 Longevity risk 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 22

23 Longevity insurance 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 Fixed Cash Flow Retirees Pension Payments (1) Pension Fund Insurance company Variable Cash Flow (1) As per the pension plan provisions and not impacted by the longevity insurance Longevity Insurance The Bell plan is buying insurance against members living longer than expected for $5B of liability (about half the retiree liability). 2

24 Longevity insurance $1M example 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 24

25 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 25

26 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 26

27 Implementation considerations 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 27

28 Investor reaction 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,

29 Conclusions 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 29

30 Case Study 2: Combination Annuity Transaction Manuel Monteiro, FSA, FCIA, CFA Partner, Mercer Heather Wolfe, FIA, FCIA, FSA Managing Director, Client Relationships, Defined Benefit Solutions, Sun Life Financial 0

31 There are options for plans with CPI indexing Buy annuities for accrued benefits Amend indexing formula Purchase CPIlinked benefits Leave indexing in plan Replace CPIlinked indexing with flat indexing Transfer inflation risk to insurer Canadian Wheat Board $150 million Combined annuity transaction $50 million 1

32 Inflation has historically been risky 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 15% Historical % increase in CPI 10% 5% 0% % -10% Where will inflation go in the future? 2

33 Limited options for hedging CPI-linked liabilities 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 Canadian RRBs Inflation derivatives Corporate RRBs US TIPS Equities Real estate Perfect correlation to Canadian CPI Hedge efficiency Non-existent market for inflation derivatives for Canadian CPI Only three issues of Canadian corporate RRBs Imperfect correlation to Canadian CPI, introduce C$ / US$ exchange risk Imperfect correlation to Canadian CPI, introduce equity risk, do not hedge interest rates Imperfect correlation to Canadian CPI

34 Cost of inflation protection is currently low The cost of inflation protection can be illustrated as the difference in yield between Canadian nominal return bonds and Canadian real return bonds.00% Implied inflation % Implied CPI 5 Year Historical Average = 1.84% 2.00% 1.50% 1.00% 12/1/ /1/ /1/ /1/201 12/1/ /1/ Calculated using [(1+CANSIM V9062) / (1+ CANSIM V9057) 1] for each year. 4

35 Combined annuity transaction resulted in savings Combine plans with offsetting formulas Material cost savings (perhaps % to 5%) Case study: $50 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 Optimize assets Combining reduced price by over $20 million 5

36 How does a combined annuity deal work? Plan A: indexation formula = 100% CPI, max. % Combine plans to share inflation protection Plan B: indexation formula = CPI % 6

37 Questions 7