PENSION LONGEVITY RISK MERCER LEAD ADVISOR ON FIRST EVER CANADIAN PENSION LONGEVITY INSURANCE TRANSACTION

Transcription

1 PENSION LONGEVITY RISK MERCER LEAD ADVISOR ON FIRST EVER CANADIAN PENSION LONGEVITY INSURANCE TRANSACTION MARCH 2015 Paul Forestell, FSA, FCIA Benoit Hudon, FSA, FCIA Manuel Monteiro, FSA, FCIA

2 Today s speakers Paul Forestell Senior Partner and Retirement Business Leader for Canada Benoit Hudon Partner and Canada Retirement Innovation Leader Manuel Monteiro Partner and Leader of the Financial Strategy Group MERCER March

3 Agenda LONGEVITY RISK Where are we coming from and magnitude of risk. LONGEVITY TRANSACTIONS A look at historical transactions and where Canada may be heading. STRATEGIC CONSIDERATIONS Where does longevity fit and how to approach the issue? CLOSING REMARKS Where to take it from here? MERCER March

4 Holistic risk management Sponsors should consider the full suite of risk management tools Understand Pension Risk Retain Risk Transfer Risk Plan strategies Asset strategies Insurance Target State 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 These strategies help in managing longevity risk MERCER March

5 Pension Risk Transfer Transactions The volume is increasing despite falling interest rates MERCER March

6 LONGEVITY RISK 5

7 Improving life expectancy increases the cost of DB pension plans Everyone knows this story about DB pension plans % Interest rates + = Equity markets A roller coaster ride But does this tell the whole story? Each additional year of life expectancy increases pension liabilities by 2-4% MERCER March

8 Liabilities are very sensitive to changes in mortality How is the insurance industry looking at your pension liabilities? Life expectancy is higher than estimated by pension actuaries (1 to 2 years higher) Pension liabilities should generally be increased by 2% to 8% Increase in liability 1 15% 10% 5% 0% Are Canadians underestimating pension liabilities? CPM-B (0.8% long term rate) UK Current View (1.5% long term rate) UK Emerging View (2.0% long term rate) Catastrophic Longevity (4.5% long term rate) MERCER 1. Liabilities are calculated using a discount rate of 4.0% and base mortality of CPM2014 Private. March

9 Quantifying longevity risk Pension liabilities under various longevity scenarios -3% +11% Optimistic Current Best-Estimate Pessimistic Optimistic : no future mortality improvements Pessimistic : e.g., cure against cancer MERCER March

10 The issue of improved life expectancy Some questions remain unanswered Good News Life expectancy is improving faster than expected Bad News We don t know: Will this last? How fast will the life expectancy improve? For how long? Will everyone benefit to the same extent? What will it cost? How much capacity can the market provide? MERCER March

11 Size of longevity risk Can leading Canadian life insurance companies absorb it? Market Value of Assets for DB Pension Plans Source: Statistics Canada (2013) $1,199B 1 year of life expectancy $35B to $40B Market Capitalization Manulife $39B Great-West Lifeco $32B Sun Life $24B Source: Yahoo Finance (Oct 28, 2014) MERCER March

12 The Canadian market is attractive and capacity is increasing Many foreign banks and reinsurers have appetite for Canadian pensions and more MERCER March

13 LONGEVITY TRANSACTIONS 12

14 What is a longevity swap? 2 Fixed payments that the plan pays the counterparty (e.g. 105% of best estimate ) Expected cash flow Fixed leg of longevity swap Potential cash flow range 1 Best estimate cashflows agreed to with the counterparty 3 The third party is exposed to fluctuations in future mortality and longevity experience and its payments may exceed the fixed payments it receives Note: may be more or less than current best estimate MERCER March

15 Overall structure of longevity swap Plan longevity swap Reinsurance arrangements Monthly pension payment paid until life deceased Monthly cash flow paid for fixed term Monthly cash flow paid for fixed term Reinsurer(s) Pensioners Plan Counterparty Reinsurer(s) Monthly cash flow paid until life deceased Monthly cash flow paid until life deceased Cost depends on existing assumptions Cost could potentially be paid for by an increase in growth asset allocation Insurer, bank or captive Carries out admin functions Intermediation fee and operational costs Typically reinsures majority of longevity risk Global reinsurer(s) with offsetting mortality risk Can benefit from capital efficiency from entering into longevity swap Takes majority of the longevity risk MERCER 14 March 2015

16 Key characteristics of a longevity swap From plan sponsor perspective Risk transfer: complete transfer of longevity risk Cash flows: No cash outlay (assets stay in pension plan) Fixed cash flows determined at onset Credit risk: collateral mechanism mitigates risk From pensioner perspective Seamless Pension plan maintains relationship with pensioners and continues to make benefit payments Benefits remain unaltered MERCER March

17 Historical longevity transactions Over $100B cumulative longevity swap transactions since largest pension longevity transactions $31B $10B $6B $6B $5B July 2014 March 2014 Nov Feb Feb Exchange rate: $1 = 0.52 First pension longevity transaction outside of UK MERCER March

18 Longevity swaps made-in-canada Counterparty risk Insurance company vs. bank Locally registered vs. foreign entity operating in Canada as a branch Reinsurance Structure OSFI regulations and policy Insurance Pension Collateral vs. ongoing cash resets Ongoing monitoring and mark-to-market MERCER March

19 Captives can also be used to insure longevity or investment risk, or both Single premium Single premium + fee ABC Pension Plan Captive Insurance Company Monthly pensions Monthly pensions ABC Retirees Advantages Access to surplus, if any Global asset management strategy Disadvantages Fronting fee Complexity Impact on governance Additional monitoring May attract additional tax Parental guarantee may be required Note: Above chart is an illustration of one of the possible structures. Other structures exist based on risk management objectives. MERCER March

20 STRATEGIC CONSIDERATIONS 19

21 Holistic risk management Sponsors should consider the full suite of risk management tools Understand Pension Risk Retain Risk Transfer Risk Plan strategies Asset strategies Insurance Target State 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 MERCER March

22 Strategic considerations Appetite for risk Funded status of pension plan Economic outlook OCI / Capital P&L expense Required cash contributions Generally more options available as funded status improves Will low interest rate environment continue to prevail and is this truly a consideration? Counterparty risk MERCER March

23 CLOSING REMARKS 22

24 Longevity patterns vary by industry Mercer industry tables Reflecting type of work performed in each activity sector Full credibility Hundreds of thousands lives = Significantly more credible than experience included in the CIA studies or any individual plan study Taking control Provides strong basis for discussions with regulators, auditors, or other stakeholders Results currently available for the following industries Pulp & Paper Mining Financial Sector Universities Generally substandard longevity Generally longer life expectancy MERCER March

25 Managing pension risks Mercer s proven track record and expertise Risk Management Expertise Hundreds of transactions completed in Canada Deep understanding of Canadian longevity Bringing global expertise to address local needs - Mercer was involved in the vast majority of large and complex transactions around the globe Consulting in a global risk management framework, considering all available options MERCER March

26 Questions Paul Forestell Benoit Hudon Manuel Monteiro QUESTIONS Please type your questions in the Q&A section of the toolbar and we will do our best to answer as many questions as we have time for. To submit a question while in full screen mode, use the Q&A button, on the floating panel, on the top of your screen. CLICK HERE TO ASK A QUESTION TO ALL PANELISTS FEEDBACK Please take the time to fill out the feedback form at the end of this webcast so we can continue to improve. The feedback form will pop-up in a new window when the session ends. View past recordings and sign up for upcoming webcasts MERCER March

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