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Reducing risk in corporate pensions Myles Pink, Paternoster. Faculty of Actuaries 6 December 2006. P A T E R N O S T E R. Pensions Regulator. Securing pension promises “safe haven”. Increasing disclosure obligations. Pension Protection Fund.

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slide1

Reducing risk in corporate pensions

Myles Pink, Paternoster

Faculty of Actuaries

6 December 2006

P A T E R N O S T E R

slide2

Pensions Regulator

Securing pension promises“safe haven”

Increasing disclosure obligations

Pension Protection Fund

Employee / union pressures

Company directors

Defined

benefit pension

plan

Pension

fund

trustees

Concerns about “unsecured creditor” status

Improving longevity

Drivers of change in the defined benefit pension buy-out market

Deficit volatility

slide3

1997: Gordon Brown removes tax relief on dividends

OPB is replaced by OPRA

MFR introduced

2005: The Pensions Regulator replaces OPRA

1988: Nigel Lawson taxes surpluses under SSAP24

How did we get here?

8000

6000

4000

2006: SSF and PPF introduced

2001: FRS 17 disclosures introduced

2000

1990s: Contribution holidays

0

1985

1989

1993

1997

2001

2005

2006

slide4

140

18

8

years

2007

1981

1999

1841

The life expectancy revolution

7.00%

6.00%

Mortality rate for men aged 65-74 in England&Wales

5.00%

4.00%

3.00%

2.00%

1.00%

0.00%

2050

1800

slide5

The pace of change has accelerated dramatically

4.0%

3.5%

Average annual reduction in mortality rates for men in England & Wales aged 65-74 (smoothed)

3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

0.0%

1855

1885

1915

1945

1975

2005

slide6

This is partly due to the emergence of the “cohort effect”

In the UK men and women born in the period 1925-45 have experienced more rapid reductions in mortality rates than generations born either before, or after, this period

slide7

Deaths from heart disease have reduced dramatically

1.8%

1.6%

1.4%

Mortality rate from heart disease for men aged 65-74 in England & Wales

1.2%

1.0%

0.8%

0.6%

0.4%

0.2%

0.0%

1950

1960

1970

1980

1990

2000

we are now seeing mortality improvements in cancers not linked to smoking

30%

Change in

incidence

20%

Change in

mortality

10%

0%

-10%

-20%

-30%

-40%

Age 40-49

Age 50-59

Age 60-69

Age 70-79

We are now seeing mortality improvements in cancers not linked to smoking

Change in breast cancer incidence and mortality over the period 1992-2003 for females in England & Wales

slide9

Projected future improvements for the 1930-34 generation…

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

0.0%

1972

1982

1992

2002

2012

2022

slide10

£-100bn

£-42bn

£-180bn

FTSE 100

FRS17

All UK companies

FRS17

All UK companies

Buyout cost

Increased disclosure requirements

Watson Wyatt

Deloitte

Willetts

Deficit for final salary pension plans

slide11

True economic cost

Pension funds can be managed in deficit

Insurance companies must operate in surplus

Increased disclosure requirements

Pension liabilities

Pension regulation

Insurance regulation

slide12

Pensions regulator

PPF

SPV

Section 75

Changes in pensions regulation

Scheme specific funding

slide13

2000

2000

2001

2001

2002

2002

2003

2003

2004

2004

2005

2005

Past performance – a growing market

3

2

Bulk annuity market volumes (£bn)

1

slide14

900

800

700

600

500

400

300

200

100

2000

2000

2001

2001

2002

2002

2003

2003

2004

2004

2005

2005

Future outlook – an exploding market

LIABILITIES £900 billion

FRS17 deficit £100 billion

Buy-out deficit £300 billion

No. OF SCHEMES 10,000

No OF MEMBERS 15 million

Bulk Annuity Market Volumes (£bn)

2007+

slide15

Paternoster’s proposition

Traditionalbuyout

Low risk

Risk transfer with profit share

Partial/progressiverisk transfer

ALM

Asset returnoptimisation

Managingdeficits

High risk

Increasedcontributions

No action

Low funding

High funding

slide16

Cash payment (net of tax relief)

Assets

Scheme

Sponsoring Company

100% of benefits

Members become annuitants of Paternoster

A pension scheme buy-out

Paternoster

Annuitants

slide17

Partial/ progressive risk transfer

A scheme can be naturally split into the liability cash flows payable to its pensioners and those to its deferred members…

slide18

Partial/ progressive risk transfer

It is also possible to completely remove the liability cash flows of a scheme for a period of time…

slide19

Increased benefits for former Scheme members

£ Y m

£ Z m

£ X m

Paternoster

Escrow account

Sponsoring Company

Payment of benefits +cash commutations

Annuitants

Risk transfer with profit share

£ X m + £ Y m + £ Z m = Total available cash for commuted pensions

the db scheme risk transfer process

Trustees and Pensions Regulator approval

Employees informed

Scheme closed

Assets plus premium paid to Paternoster

Derivatives overlay

Liabilities assumed by Paternoster

Employer triggers termination

Group policy issued

Escrow established

“On risk” events

Contracts novated

“Exchange for physicals”

Data transfer

“clean up”

Escrow release

Trustees wind up scheme

Trustees sign deed of termination

The DB scheme risk transfer process

Buy-out price and structure agreed