Pension Investment Strategy and Pension Risk Transfer. Adapted for Mid-Atlantic Actuarial Club Annual Meeting September 11, 2014

Transcription

1 Pension Investment Strategy and Pension Risk Transfer Adapted for Mid-Atlantic Actuarial Club Annual Meeting September 11, 2014

2 Derisking costs Cost as % of ongoing liability* ACTIVE VESTED RETIREE TYPICALPLAN TERMINATED Ongoing liability (ABO) Annuities paid from plan Group annuity Lump sums n/a Plan termination * Prior to RP 2014/MP 2014 adoption

3 Termination immunization illustrations Immunization vs. termination for well funded frozen pension plans Look at 3 fully funded plans Typical, Mature, and Young Baseline liability of $500M using a PBO or PPA full yield curve measurement ($ Millions) PLANS Typical Mature Young Active Liability $166.7 $100.0 $400.0 Terminated Vested Liability $166.7 $100.0 $50.0 Retiree Liability $166.7 $300.0 $50.0 Total Liability $500.0 $500.0 $500.0

4 Variables impacting cost Immunization cost factors Termination cost factors Bond underperformance relative to the liability Administrative expenses Offering lump sums Group annuity costs Lump sum acceptance rates Early retirement benefits and plan features Lump sum offer to retirees

5 Termination - immunization results* Immunization and termination have similar costs Deciding factors may be qualitative ($ Millions) PLANS Typical Mature Young Baseline Immunization Liability Baseline Termination Liability Termination/Immunizati on Ratio $537.6 $536.9 $540.0 $532.8 $537.4 $ % 100.1% 98.2% Lower cost alternative Neutral Neutral Termination * Prior to RP 2014/MP 2014 adoption

6 True cost of pension plan example $ Millions (21) 400 Ongoing ABO + Net yield difference + Expenses Lump sum savings Immunization Liability Assumptions: Liability is 40% active, 40% retiree, and 20% terminated vested. 75% of active and terminated vested participants take a lump sum. Ongoing liability, lump sum benefits, and group annuity all use the same mortality assumption.

7 Plan termination cost example $ Millions (32) (6) Assumptions: Liability is 40% active, 40% retiree, and 20% terminated vested. 75% of active and terminated vested participants take a lump sum. Ongoing liability, lump sum benefits, and group annuity all use the same mortality assumption.

8 Immunization Termination comparison example* Immunization Termination Ongoing ABO Net yield differential Expenses 6 6 Lump sum savings (21) (32) Insurer investments (6) Plan provisions 3 Capital/profit 12 Total liability * Based on RP 2014/MP 2014 mortality for all purposes

9 The drivers of uncertainty/volatility (risk) 20% Plan design and other 40% Investing in equities 40% Interest rate sensitivity Traditional DB plan with 60% 70% invested in equities; fixed income in broad market bonds

10 Investment objectives Traditional asset only Liability driven Minimize volatility around return objective Assets and liabilities move together

11 Pension investment derisking Changes in funded ratio change plan objectives and the asset mix 80% Funded 95% Funded 110% Funded Stocks Long bonds Extended bonds Intermediate bonds Higher return to improve funded status Lower risk to maintain funded status

12 Immunization things to think about Portfolio construction Performance reporting Investment policy statements Investment committees Pension accounting

13 Long corporates vs. pension plan C a s h F l o w Liability duration = 14.2 Portfolio duration = 12.6 Yield = 4.5%. Net Yield = 3.7% 0% Treasury Pension cash flow Bond fund cash flow Year of Payment

14 Long corp + STRIPS vs. pension C a s h F l o w Liability duration = 14.2 Portfolio duration = 13.4 Yield = 4.1% Net Yield = 3.4% 40% Treasury Pension cash flow Bond fund cash flow Year of Payment

15 Long corp + long STRIPS vs. pension C a s h F l o w Liability duration = 14.2 Portfolio duration = 14.2 Yield = 4.4% Net Yield = 3.6% 15% Treasury Pension cash flow Bond fund cash flow Year of Payment

16 Net Yield Portfolio 1 100% long corporate Portfolio 2 add targeted STRIPS Portfolio 3 add long STRIPS Corporate yield 4.52% 4.52% 4.52% Add Treasuries (0.46%) (0.10%) Investment costs (0.20%) (0.30%) (0.25%) Downgrades/defaults (0.65%) (0.39%) (0.56%) Net yield 3.67% 3.37% 3.61%

17 u1 Credit headwind illustration Matching corporate bonds don t keep up with liability Bonds A & B make up liability universe Market sees more credit risk in Bond B Bond B is downgraded out of liability universe Y i e l d 6.0% 5.0% Bond A Bond B Bond A Bond B yield increases Bond A Bond B Discount rate = 5.0% Discount rate = 5.5% Assets: lose value Liability: decreases Discount rate = 5.0% Assets: no change in value Liability: increases

18 Slide 17 u1 unms 7/20/2012 Investment General\Pension Finance update SME: Nathan Zahm (Kyle Morrison) Updates: Q (some slides -- Nathan to decide) unms, 7/20/2012

19 Portfolio summary Portfolio 1 100% long corporate Portfolio 2 add targeted STRIPS Portfolio 3 add long STRIPS Hedge ratio 88% 94% 100% Curve match OK Good OK Basis mismatch no Treasuries 40% Treasury 15% Treasury Gross Yield 4.52% 4.06% 4.42% Net Yield 3.67% 3.37% 3.61% Which one do you like?

20 Portfolio construction issues Modeling performance Stochastic A-L modeling not very helpful How to calculate tracking error ex-ante? Do credit spreads revert to mean? Which liability/discount rate? Splitting portfolio amongst managers Keeping it simple for investment committees

21 Liability measurement alternatives The yield curve used to measure the liability is important AA downgrades Jan 12 Feb 12 Mar 12 Apr 12 May 12 Jun 12 Jul 12 Aug 12 Sep 12 Oct 12 Nov 12 Dec 12 AA Curve 6A Curve PPA Curve Source: Vanguard

22 Performance reporting Assets Liabilities Beginning of period Contributions/accruals 0 0 Benefit payments Investment return Equity 0 0 Interest accrual Interest rate change Total return End of Period A simple overview is helpful

23 Performance reporting Is tracking error outside anticipated range? Compare ex-post hedge ratio to ex-ante hedge ratio What about negative numbers? Assessing individual manager performance What mismatches are arising from Level of rates Shape of the yield curve Basis mismatch Credit spreads Other noise (demographics, data)

24 Investment Policy Statement Some concepts and objectives must change Diversified Return in excess of benchmark Strategic asset allocation Long-term Balanced Performance measurement Rebalancing Must maintain fiduciary focus!

25 Investment committee Manager selection criteria Economic forecasts Return vs. benchmark return Peer group return comparisons Evaluation of manager performance Expected return Is the typical investment committee process relevant for overseeing immunization strategies?

26 Typical Accounting Paradigm: short-term Current yield on hypothetical corporate bond portfolio 5.20% Yield sacrifice (Treasury exposure) 0.20% Downgrade adjustment 0.60% Investment management cost 0.30% Net yield 4.10% Annualized impact of interest rate rise over 2 years 2.00% Expected 2 year return 2.10% Discount rate EROA

27 Typical Accounting Paradigm: long-term Yield on hypothetical corporate bond portfolio 5.20% Yield sacrifice (Treasury exposure) 0.20% Long term downgrade adjustment 0.60% Investment management cost 0.30% Net yield 4.10% Annualized impact of interest rate rise over 30 years +0.20% Expected long term return 4.30% Discount rate EROA

28 Rational Accounting Paradigm Yield on hypothetical corporate bond portfolio 5.20% Yield sacrifice (Treasury exposure) 0.20% Long term downgrade adjustment 0.60% Investment management cost 0.30% Net yield 4.10% Discount rate EROA

29 Immunization summary It s a whole new world!