HEALTH WEALTH CAREER DEFINED BENEFIT TOP AREAS OF FOCUS FOR 2016 Jay Love DB Investments Leader, US Matt McDaniel DB Risk Leader, US Richard McEvoy Head of Financial Strategy Group, US
TODAY S SPEAKERS RICHARD McEVOY Head of Financial Strategy Group, US JAY LOVE DB Investments Leader, US MATT McDANIEL DB Risk Leader, US MERCER 2016 1
CONTEXT: CONTINUED VOLATILITY HEADING INTO 2016 EQUITY LEVEL 160% 150% 140% 130% 120% 110% 100% INTEREST RATES & MARKET VOLATILITY 1/22/2016 5.5 5.0 4.5 4.0 3.5 YIELD (%) 100% 95% 90% 85% 80% 75% 70% Funded ratios reach five-year high (94%) in late 2013 Funded ratios down to 74% in early 2015 Estimated Funded ratio of 79% on 1/22/2016 Funded ratio of 82% at the end of 2015 90% 3.0 12/31/2012 12/31/2013 12/31/2014 12/31/2015 65% 12/31/2012 12/31/2013 12/31/2014 12/31/2015 S&P 500 Long AA Yield ASSETS LIABILITIES 01 RISING RATES 05 PBGC PREMIUMS UP TO $600/PERSON 02 DIVERGENT MONETARY POLICY 03 S&P DOWN ~ 8% IN JANUARY 04 SLOWING GROWTH AND RECESSION RISK MERCER 2016 2 06 UNDERFUNDING PBGC TAX OF 4% PER YEAR 07 INCREASING MORTALITY COSTS 08 REGULATORY RISKS
STRATEGY AND IMPLEMENTATION TAKING A HOLISTIC APPROACH THERE ARE MANY DIFFERENT JOURNEYS, THE OPEN PLAN: STEADY AS SHE GOES THE CLOSED PLAN: COURSE CORRECTION THE FROZEN PLAN: DESTINATION AHEAD BUT THE KEY ELEMENTS ARE THE SAME. CHARTING THE JOURNEY MANAGING RISK OPTIMIZING IMPLEMENTATION ENGAGE EMPLOYEES MERCER 2016 3
GLIDE PATH STRATEGY Glidepath adjusts portfolio position to plan status Range of expected funded ratio in one year Growth Allocation Interest Rate Risk Funded Status Risk Expected Return Contribution Volatility Ending Funded Ratio 130% 120% 110% 100% 90% 80% 70% 5th 25th 75th 95th 60% Funded Ratio Stable State/ Termination Feasible 50% Starting Funded Ratio Sample Plan 80% 85% 90% 95% 100% 105% 110% Growth Allocation 70% 65% 60% 55% 45% 35% 20% MERCER 2016 4
BE OPPORTUNISTIC AND STRATEGIC 12.5% Long Term Expected Return 10.0% 7.5% 5.0% Equity Risk Premium: 4.5% 2.5% 0.0% US Equity US Treas 10Y US Treas 30Y Expected equity return is estimated based on earnings yield plus a Normalized P/E ratio with a 20 Year Reversion to average P/E ratio. Expected bond return is an estimate and assumes interest rates revert to Mercer s equilibrium assumptions over 10 years. MERCER 2016 5
MANAGE GROWTH AND INTEREST RATE RISK More Growth and More Duration Interest Rate Risk 50% Growth Asset Risk 50% Increasing Return Sources of Funded Status Risk* Increasing Funded Status Risk * Sample Plan, Total Funded Status Volatility 12.5%, 90% funded, 14 year liability duration, Asset Allocation: 60% World Equity 40% Long Gov t Credit MERCER 2016 6
ASSET MANAGEMENT THEMES FOR 2016 Expect more volatility and larger sell-offs Opportunities for dynamic strategies and de-risking Prudence around leverage and collateral REDUCED MARKET LIQUIDITY A MATURING CREDIT CYCLE Tilt growth assets towards less equity-sensitive assets Merit in holding some dry powder Prepare for opportunities in distressed debt Seek valuable sources of alpha Consider absolute return and similar flexible strategies TILT FROM BETA TO ALPHA THINK LONG TERM Plan for slow rise in rates Use your illiquidity budget Risk is not a number: consider a broader perspective on risk MERCER 2016 7
RISK TRANSFER ANNUITY BUYOUTS $ Billions 35 35 14 12 10 8 6 Annuity Buyout Deal Volume 1995 2015 35.9 8.5 12 (est) 2012: GM and Verizon deals 2014: Motorola and BMS 4 2 3.8 2015: Kimberly Clark, Philips and JC Penney 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 OUTLOOK FOR 2016 More insurers involved in sizable deals Operational capacity concerns Deferred lives more difficult to annuitize Emerging strategies to break up settlements Small benefit settlements more compelling MERCER 2016 8
RISK TRANSFER LUMP SUMS $80,000 $70,000 $60,000 $50,000 $40,000 $30,000 $20,000 + 18% Expected IRS update to mortality tables in 2017 could make 2016 the last attractive opportunity to pay out lump sums. $10,000 $0 2014 2015 2016 2017 (est) Lump Sum Amount (current mortality assumption) Potential mortality update Lump sum costs have been increasing and are set to increase again in 2017 Sample participant: age 45 in 2014 with $1000/month benefit Note: 2017 lump sums based on current interest rate levels, with 8% load assumed at 1/1/2017 for 417(e) mortality change MERCER 2016 9
LIABILITY MANAGEMENT THEMES FOR 2016 Market continues to grow and evolve Opportunity for defining population to maximize savings Pricing idiosyncrasies drive need for monitoring ANNUITY BUYOUTS LUMP SUM CASHOUTS Continued theme from 2012 2015 Final opportunity before statutory mortality update Opportunity to achieve lump sums economics for active populations Need to think through implications on cash, accounting, and administration SPINOFF TERMINATION BORROW TO FUND DEFICIT PBGC premium increases make underfunded pension liabilities very expensive Could facilitate full plan termination MERCER 2016 10
RECAP THERE ARE MANY DIFFERENT JOURNEYS, THE OPEN PLAN: STEADY AS SHE GOES THE CLOSED PLAN: COURSE CORRECTION THE FROZEN PLAN: DESTINATION AHEAD BUT THE KEY ELEMENTS ARE THE SAME. CHARTING THE JOURNEY MANAGING RISK OPTIMIZING IMPLEMENTATION ENGAGE EMPLOYEES MERCER 2016 11
QUESTIONS? RICHARD McEVOY Head of Financial Strategy Group, US JAY LOVE DB Investments Leader, US MATT McDANIEL DB Risk Leader, US 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. 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. MERCER 2016 12
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