Derisking in Corporate Defined Benefit Pension Plans
April 23, 2013
Christopher DeMeo, FSA, CFA
Head of Investment, Americas
© 2012 Towers Watson. All rights reserved.
An integrated approach to managing pension risk
Manage active liability
risk profile and long-term
plan cost
Manage long-term plan
cost and volatility
Active Benefit
Strategy
Investment
Strategy
Manage size of plan and
overall risk exposure
Legacy
Benefit
Strategy
Funding
Strategy
Assumptions
And Methods
Manage short-term
plan cost and volatility
Manage short-term
issues and cost
recognition timing
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1
Setting objectives is the starting point
Finance
Board of
Trustees
Management
HR
BOARD OF
TRUSTEES
LESS
IMPORTANT
SUMMARY
ASSESSMENT
MORE
IMPORTANT
Cumulative Contributions
Illustrative
Example
Stability of Contributions
Funded Ratio
•
•
•
•
Understand context:
Balance sheet and enterprise risk position
Current plans/liabilities
Desired future state
Stakeholder/committee approach to change
and governance
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Apply Towers Watson’s knowledge and
capabilities:
• Research
• Tools
• Stakeholder education/consensus building
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2
Journey planning
Many paths to plan management
Benefit Strategies
Risk
Frozen / Closed Plan
Offer Bulk Lump
Sum to TV’s
Settle/transfer
Retiree Obligations
Settle/Manage
Remaining
Obligations
Current
allocation
Risk
Asset Strategies
Path D
Alt.
Goal
Current
Path B
Path A
Reduce
equity risk
Path C
Reduce
interest
rate risk
Goal
There are many paths an organization can follow to reach the stated goal
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3
Journey planning
Two key questions
Question 1
How do we gain needed funded status
flexibility?
Question 2
What tactics will be used to reduce risk as
funded status improves?
Time
Less Cash +
Less Time =
Less Risk +
Less Time =
More risk
exposure
needed to
improve
funded status
More cash
required to
improve
funded status
Funded
Status
Flexibility
Lump sum utilization, annuity purchases and
investment derisking are available depending
on financial and non-financial considerations
 Economic
 Accounting
Financial
 Risk/Financial Management
 Plan Complexity and Costs
 Administration and Data Quality
Cash
Risk
 Governance and Compliance
Operational
Less Cash + Less Risk =
 Management Perspective
 Distribution Alternatives
More time until funded status
improves
Philosophical
Balance between funding and investment
strategies to target funded status levels that
allow for desired risk reduction strategies
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 Workforce Implications
 Regulatory/Legal Environment
 Marketplace Capacity/Pricing
Marketplace
 Competitive Considerations
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4
Investment strategy: Building an LDI portfolio
Supporting Objectives
Primary
Also important
Risk-mitigating
Physical Bonds
Return-seeking
Derivative
Instruments
Duration
Credit
Curve/
Convexity
Inflation
Equity
Credit
Illiquidity
Insurance
Skill
Currency
Term
Inflation
Manager selection and monitoring
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Stage 1:
ALM
Stage 2:
Portfolio
Construction
Stage 3:
Risk
Budgeting
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5
Potential stages of LDI fixed income portfolio
Lower
Hedge Allocation
Higher
Hedge Target (% IR Risk)
0%- 30%
30%- 60%
60%-100%
Minimum Allocation to Hedge
Assets
0% - 15%
15%-30%
30%-50%
600 bps
400 bps
200 bps
Benchmark
Market Indices
Liability Cash Flows
Liability Cash Flows
Duration Target
Market Duration
Cash Flow Duration
Key Rate Durations
Managers
(Market Benchmark)
Yes
Maybe
No
Managers (Cashflow
Benchmark)
No
Yes
Yes
No
Needed if also using
market benchmark
mandate
Yes
Tracking Error Expectation
Completion Manager
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6
Sample LDI monitoring
Asset, Liabilities and Funded Status
Change
3/31/2011
Assets
Liabilities
Surplus/(Deficit)
$
$
Funded Ratio
12/31/2010
9/30/2010
Quarter
709 $
905
(196) $
700 $
934
(234) $
651 $
950
(299) $
58 $
(45)
103 $
78%
75%
69%
+3%
YTD
9
(29)
38
+10%
Historical Assets, Liabilities and Funded Ratio
1,000
93%
90%
800
87% 89% 76%
72% 73%
76% 72% 72%
66% 69%
75% 78%
70%
200
60%
0
50%
Return Seeking
Assets Return
Treasury
STRIPS,
18%
800
Cr edit
0
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U.S. Large
Cap
Equity,
24%
40%
30%
20%
U.S. Small
Cap
Equity, 6%
Long
Corporate
Bonds,
27%
Gov't
Assets
+1%
75%
80%
85%
Cash Flow Distribution (Years)
1,000
200
Change in Discount Rate
0%
74%
78%
83%
Funded Ratio (right axis)
Asset Allocation Policy
400
-10%
0%
+10%
-1%
72%
76%
80%
Reflects instantaneous changes to assets and liabilities
and parallel shifts in the yield curve
Dec-07 Mar-08 Jun-08 Sep-08Dec-08 Mar-09 Jun-09 Sep-09Dec-09 Mar-10 Jun-10 Sep-10Dec-10 Mar-11
Retur n
Return
Seekin
Seeking
g
5.4%
5.3%
90%
400
600
Portfolio Yield
Liability Yield
100%
80%
Assets
58%
37%
29%
Sensitivity Analysis
600
Liabilities
Hedge Summary
Interest Rate Hedge %
Credit Hedge %
Curve Hedge %
Liabilities
Deficit
Real
Estate
Equity, 5%
Non-U.S.
Equity,
20%
10%
0%
0-5
5-10
Government
10-20
Credit
20-30
30+
Liabilities
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7
U.S. pension de-risking trends
Plan Design Strategy
Funding & Investment Strategy

71% of Fortune 100 offer only DC plan to new
hires

Continued shift out of equities and into lower risk
fixed income

Of the 29% that continue to offer DB plans to
new hires, 2/3s are account based

Wide-spread adoption of dynamic investment
strategies

During 2012 GM, BoA and Sysco froze their DB
plans to future accruals


Continued shift away from traditional plans; in
2010 38% of F100 offered DB to new hires
Sponsors accelerating funding to increase derisking flexibility (GM & Verizon both made large
contributions and Ford borrowed to fund $1.3B)

AT&T announcement to improve funded status
through company stock contribution
Liability Transfer Strategy
Assumptions & Methods

Bulk lump sum offerings to TVs in 2012
facilitated by falling yields and increases in
PBGC premiums (e.g. Ford – 30k offers, NCR –
23k offers)

Ford, GM and NVE offered lump sums to
retirees; 1st time this has been done in US


Close to $40B in annuity purchases, including
GM ($29B) and Verizon ($7.5B)
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
2012 saw a significant shift towards ‘mark-tomarket’ accounting, with many sponsors
immediately recognizing all gains/losses and
shifting away from smoothed assets to fair value
of assets
Many companies also provide non-GAAP
measure of income to exclude pension
components (e.g. IBM, Boeing)
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8
U.S. 2012 Public Lump Sum Announcements
Announcement
Date
Sponsor
Eligible Population
Offer Made to
Apr, 2012
Ford Motor Company
90,000
Salaried retirees and TVs
June, 2012
General Motors Co.
42,000
Salaried retirees
July, 2012
NCR Corporation
23,000
TVs
Sept, 2012
J.C. Penney
35,000
TVs
Sept, 2012
Sears Holdings
Unknown
Unknown
Sept, 2012
New York Times Company
5,200
TVs
Sept, 2012
Visteon Corporation
~10,000
TVs
Sept, 2012
Archer-Daniels-Midland
Corporation
7,000-7,500
TVs
Sept, 2012
Thomson Reuters
Unknown
TVs
Oct, 2012
Equifax Inc.
3,500
TVs
Oct, 2012
Yum! Brands
Unknown
TVs
Oct, 2012
Baxter International Inc.
16,000
TVs
Oct, 2012
Kimberly-Clark Corporation
10,000
TVs
Dec, 2012
Lockheed Martin
33,000
TVs
Dec, 2012
Ahold USA, Incorporated
Unknown
TVs
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9
2012 Market Activity – Annuity Purchase
DB Annuity Market – Historical Annuity Purchases
2000 – 2012 (estimated)*



*Source: Estimated LIMRA
Discount Rate Spreads Impacting Perceived Premium
Excluding GM and Verizon, 2012
annuity purchase activity was at
highest levels since 2008
Recent transactions have
demonstrated attractive pricing
relative to pension liabilities

Insurer competitiveness

Reduction in credit spreads
Majority of transactions transferred
retiree obligations to insurers

Use of lump sums to settle retiree
obligations prior to purchasing annuities
remains rare

Placements have typically not been tied
to a full plan termination
5.50
5.25
5.00
BOND:Link
RATE:Link 60-90
RATE:Link 40-90
RATE:Link 10-90
4.75
Citigroup Discount Curve
4.50
4.25
4.00
3.75
3.50
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10
Disclaimers
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subsidiary of our parent company, Towers Watson & Co. which along with all affiliates will be referred to in this document as
Towers Watson. In providing the services detailed herein, TWIS may use various resources of Towers Watson. In preparing
this document, we have utilized TWIS either distinct or with Towers Watson as appropriate.
This document was prepared for marketing and general information purposes only and should not be considered a substitute
for specific professional advice. In particular, its contents are not intended by Towers Watson to be construed as the provision
of investment, legal, accounting, tax or other professional advice or recommendations of any kind, or to form the basis of any
investment decision to do or to refrain from doing anything. As such, this document should not be relied upon for investment
or other financial decisions and no such decisions should be taken on the basis of its contents without seeking specific
advice.
This document is based on information available to Towers Watson at the date of issue, and takes no account of subsequent
developments after that date. In addition, past performance is not indicative of future results. In producing this document
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11
Project Overview and Assumptions
Opportunities to Manage Risk
Benefit
Strategy
Funding
Strategy
Effective at managing
active liability risk profile
and long-term plan cost
Effective at managing
short-term plan cost
and volatility
Pension
Risk
Investment
Strategy
Assumptions
and Methods
Effective at managing
long-term plan cost
and volatility
Effective only for
short-term issues
12
Cumulative Contributions
Current Target Allocation
Asset/Liability Frontier - Year 2022
Most Desirable
PV Contributions plus Deficits (PBO) ($M)
50th Percentile
$350
0% AGG DER35
10% AGG DER35
20% AGG DER35
30% AGG DER35
33% AGG DER35 (Target)
40% AGG DER35
$500

Examine cumulative
contributions over the ten-year
projection period, plus any
deficit that still remains

Increasing the fixed income
allocation up to 60% of the
portfolio decreases risk;
beyond that point, risk is
increased and points are
inefficient
50% AGG DER35
60% AGG DER35
70% AGG DER35
80% AGG DER35
$650
90% AGG DER35
100% AGG DER35
$800
$950
$750
$900
$1,050
$1,200
$1,350
$1,500
PV Contributions plus Deficits (PBO) ($M)
95th Percentile
13
Cumulative Contributions
Remove the overlay
Asset/Liability Frontier - Year 2022
Most
PV Contributions plus Deficits (PBO) ($M)
50th Percentile
$350
0% AGG
Desirable
10% AGG
20% AGG
30% AGG
33% AGG
40% AGG
50% AGG
$500
60% AGG
0% AGG DER35
10% AGG DER35
20% AGG DER35
30% AGG DER35
33% AGG DER35 (Target)
40% AGG DER35

A derivative overlay changes
the risk/reward tradeoff with
respect to cumulative
contributions

Removing the overlay
improves efficiency with
respect to cumulative
contributions, improving
both median and worst-case
results
50% AGG DER35
60% AGG DER35
70% AGG
70% AGG DER35
0% AGG DER100
10% AGG DER100
20% AGG DER100
30% AGG DER100
33% AGG DER100
40% AGG DER100
50% AGG DER100
80% AGG
80% AGG DER35
$650
90% AGG
90% AGG DER35
100% AGG
100% AGG DER35
60% AGG DER100
$800
70% AGG DER100
80% AGG DER100
90% AGG DER100
100% AGG DER100
$950
$750
$900
$1,050
$1,200
$1,350
$1,500
PV Contributions plus Deficits (PBO) ($M)
95th Percentile
14
Cumulative Contributions
Move to long bonds; tilt towards long credit
Asset/Liability Frontier - Year 2022
Most Desirable
$350
10% LC Tilt
20% LC Tilt
30% LC Tilt
20% LGC
0% AGG

In order to minimize the liability
spread risk, which is significant
given the level of spreads vs.
interest rates, long corporates
are the preferred instruments
over long gov, long G/C, swaps
and futures

Remove derivative overlay

Move to long bonds

Consider tilting towards long
credit
10% LGC
10% AGG
PV Contributions plus Deficits (PBO) ($M)
50th Percentile
33% LC Tilt
40% LC Tilt
20% AGG
30% LGC
30% AGG
33% LGC
33% AGG
40% LGC 40% AGG
50% LC Tilt
$450
50% LGC
0% AGG DER35
10% AGG DER35
20% AGG DER35
30% AGG DER35
33% AGG DER35
50% AGG
60% LC Tilt
40% AGG DER35
60% LGC
60% AGG
50% AGG DER35
70% LC Tilt
$550
60% AGG DER35
70% AGG
70% LGC
80% LC Tilt
70% AGG DER35
80% AGG
80% LGC
80% AGG DER35
90% LC Tilt
$650
90% AGG
90% LGC
90% AGG DER35
100% LC Tilt
100% AGG
100% AGG DER35
100% LGC
$750
$700
$800
$900
$1,000
$1,100
$1,200
PV Contributions plus Deficits (PBO) ($M)
95th Percentile
15
Cumulative Contributions
Impact of dynamic de-risking
Asset/Liability Frontier - Year 2022
Most Desirable
$390
PV Contributions plus Deficits (PBO) ($M)
50th Percentile
DYN 4%
DYN 2%
30% LC Tilt
DYN 6%
$405
33% LC Tilt

Dynamic de-risking policy
decreases worst-case
contributions throughout the
forecast period

De-risking in 6% fixed
income increments appears
most efficient

DYN 8%
Reduces 95th percentile costs
by $30M while having a
minimal impact on 50th
percentile costs
$420
DYN 10%
40% LC Tilt
$435
$840
$855
$870
$885
$900
PV Contributions plus Deficits (PBO) ($M)
95th Percentile
16
Cumulative Contributions
Summary of Results
PV Contributions plus Deficits (PBO) ($M) - 2022
$1,000
$750
$500
$250
$0
33% AGG DER35
33% AGG
33% LGC
5th-25th percentile
Percentile
5th
25th
50th
75th
95th
33%
AGG
DER35
$98
$303
$480
$670
$994
33% LC Tilt
25th-50th
33%
AGG
$83
$257
$421
$615
$928
50th-75th
33%
LGC
$81
$260
$413
$597
$894
33% LC
Tilt
$76
$254
$405
$589
$888
DYN 6%
75th-95th
DYN 6%
$100
$267
$404
$573
$857
17
PBO Funded Ratio
Summary of Results
Projected Benefit Obligation Funded Ratio - 2023
175%
150%

Removing the derivatives
overlay increases the volatility
of the funded ratio at the end of
the period

However, dynamic de-risking
decreases funded ratio volatility
at the end of the period
125%
100%
75%
33% AGG DER35
33% AGG
33% LGC
5th-25th percentile
Percentile
5th
25th
50th
75th
95th
Prob > 100.0%
33% AGG
DER35
76.3%
90.7%
103.7%
120.7%
157.6%
57.3%
33% LC Tilt
25th-50th
33% AGG
77.0%
92.4%
106.8%
125.6%
166.0%
61.9%
50th-75th
DYN 6%
75th-95th
33% LGC 33% LC Tilt
77.7%
78.1%
92.7%
93.3%
106.0%
106.9%
124.2%
125.5%
163.4%
165.1%
61.5%
62.9%
DYN 6%
82.5%
93.3%
100.0%
106.7%
115.8%
49.9%
18