Innovative LDI Strategy. Matt Zumbach, Director Investments, Aon
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1 Innovative LDI Strategy Matt Zumbach, Director Investments, Aon
2 Aon U.S. Funded Status History Key Dates : Plan becomes underfunded due to the Internet Bubble : Pension plan was Closed and Frozen 2008: Financial Crisis hits causing the market to crash and interest rates to decline 2009: Liability Driven Investing (LDI) strategy implemented to eliminate funded status roller coaster 2013: Bull market rally and rising interest rate environment 2014: New mortality tables & falling interest rates
3 LDI Stage 1: Glidepath Design ( ) Glidepath Design: How much income, balance sheet and cash flow statement risk is Aon willing to accept? Funded status volatility Annual earnings targets Credit ratings Alternative uses of cash 75% Aon U.S. Glidepath 20% 10% Risk trade offs Funded status volatility Extra cash contributions Longer recovery period 25% Planning team Corporate Treasury Aon Hewitt Consultants Aon Hewitt Actuaries Capital Planning Team Investment Committee 0% < - 85% 85% % 95%- -105% 105%-110% 110%+ Funded Status Fixed Income Allocation Growth Assets
4 Liability/Asset Value LDI Stage 2: Glidepath Implementation (2009) Glidepath Implementation: Corporate bond exposure Hired an intermediate duration corporate bond manager Separate account - visibility into the underlying investments Long duration government/credit exposure Target the long end of the corporate credit and government curve Increase Aon s asset duration profile Interest rate derivatives Swaps / Swaptions Purchased 15Y, 20Y, and 30Y Receiver Swaptions Financed with 15Y, 20Y, and 30Y out-ofthe money Payer Swaptions $200 $180 $160 $140 $120 $100 $80 $60 $40 $20 $0 Cash Flow Profile U.S. Qualified Plan Term (yrs) Notional PV FI Assets Int Rate Deriv Notional
5 LDI Stage 3: Maintaining Investment Returns (2009-Today) Maintaining Investment Returns: Reduce interest rate risk Higher allocation to fixed income assets 1 120% Equity Linked Note Index Decreased the overall expected investment return Increase equity risk Developed an Equity Linked Note structure Sold out-of-the-money calls and puts to purchase ATM calls (spent a premium) Levered equity exposure to increase the overall expected returns Total investment risk Overall risk to funded status, cash contributions, and pension expense declined Maintained target investment return of 8.8% with less volatility Cumulative Investment Return () () () () (20%) 110% 20% 10% -- (10%) (10%) (20%) () () () -- 10% Sell the upside 20% Cumulative Total Return Index Return Buy ATM Leverage 110% () Equity Bench ELN
6 LDI Stage 4: Redefining Asset Allocation (2013-Today) Redefining Asset Allocation (Back to Basics): Aon U.S. Glidepath Old method Specific target allocations for Growth vs. Matching assets based on funded status Growth and Matching treated as separate portfolios Risk generally defined as overall investment volatility Old Method 75% 25% 0% 10% 20% < - 85% 85% % 95%- -105% 105%-110% 110%+ Funded Status Fixed Income Allocation Growth Assets New methodology Specific target for overall risk based on funded status Growth and matching portfolios combined to measure overall risk Risk is defined as funded status volatility New Method
7 Liability/Asset Value Liability/Asset Value LDI Stage 5: Completion Mandate (2014-Today) Completion Mandate: General fixed income mandates Low cost option for simple corporate and government bonds Combination of separate accounts and Delegated Consulting Fund Completion mandate Manage interest rate curve exposure Attempt to equally hedge liability duration across the curve Completion mandates become increasingly important as plans become better funded and more hedged $200 $180 $160 $140 $120 $100 $80 $60 $40 $20 $0 $200 $180 $160 $140 $120 $100 $80 $60 $40 $20 $0 Cash Flow Profile Stage 2 LDI Term (yrs) Notional PV FI Assets Int Rate Deriv Notional Cash Flow Profile Theoretical Completion Mandate Term (yrs) Notional PV FI Assets Int Rate Deriv Notional
8 Funded Status Global Funded Status Volatility As a result of de-risking initiatives Aon s funded status volatility has been substantially less than other companies in the S&P 500. Global Pension Funding Status 95% 93% 85% 85% 89% 89% 86% 88% 85% 88% 91% 89% 91% 89% 75% 77% 79% 78% 78% 75% 82% 78% 81% 81% 79% 82% 82% 77% 81% 65% Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Source: Aon Hewitt Pension Risk Tracker Funded Status of Plans in S&P 500 Aon
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