CN Pension Plan
Managing Pension Risks: How We Work and Why
CIA Pension Seminar - April 16, 2007
Caroline Drouin
1
Table of Contents

Background
– CN Pension Plan
– CN Railroad
–

3
Railroad Industry
Managing Pension Risks
– Plan Design
11
–
Plan Governance
– Funding / Accounting Policy
– Investment Policy

Summary
20
2
Background - CN Pension Plan
Demography

Covers 16,200 active members at January 1, 2006

CN Pension Plan is large and very mature with 2.6 pensioners for
every active member

Pays monthly pensions to 42,500 pensioners at January 1, 2006

Retirees represent roughly 70% of the plan population and their
liabilities are roughly 60% of the total plan liabilities
 Same rules apply to union and management employees
within CN Pension Plan
 New management employees hired from 2006 join DC Plan
3
Comparison to Other Class I Railroads
PBO divided by service cost, fiscal year end 2004-2006
120 x
110 x
100 x
90 x
80 x
70 x
60 x
50 x
40 x
30 x
20 x
10 x
0x
2004
2005
10th - 25t h
25th - 50th
50th - 75th
2006
75th - 90th
CN
Source: Mercer Human Resource Consulting
44
Background - CN Pension Plan
Financial Summary

Financial position as of January 1, 2006
– Going Concern
▫ Assets (AV)
$11.8B
▫ Liabilities
$11.6B
▫ Surplus
$0.2B
– Solvency
▫ Assets (MV)
$14.1B
▫ Liabilities
$13.7B
▫ Surplus
$0.4B
– Accounting
▫ Assets (MV)
$14.1B
▫ Liabilities
$13.4B
▫ Surplus

$0.7B
2006 Contributions
– CN
$85M
– Employee
$50M
2006 Pension Expense
-- CN
$50M
5
Background – CN Pension Plan
Comparison to other Canadian Public Companies
Funding
Going
Concern
Proportion of plans in deficit
Funding
Solvency
Accounting
59%
75 %
78%
117%
128%
122%
90%
81%
82%
 All plans
101%
92%
90%
CN
102%
103%
105%
Average ratio of assets to liabilities
 Plans in surplus
 Plans in deficit

Based on most recent actuarial valuations (145 pension plans)
Source: Mercer Pension Database
6
Background - CN Railroad
Precision Railroading
 Engaged in the rail and related transportation business
 20,300 miles of track spanning across North America
 2006 Financial Highlights
– Total revenues :
$7.716 B
– Operating income:
$3.030 B
– Operating ratio:
– Total Assets:
– Free cash flow:
60.7 %
$24.004 B
$1.343 B
7
Background - CN Railroad
Managing Business and Financial Risks

CN faces normal business risks similar to any other transportation
company. Those risks are understood and expected by investors
–
Freight revenues come from 7 commodity groups representing
a diversified and balance portfolio of goods
–
This combined with our geographic diversity positions CN well
to face economic fluctuations

CN also faces financial risks that can be mitigated in order to reduce
variability of financial results

Interest Rate Risk
–
Pension Liability / Corporate Debt = $14B / $5.6B
–
Pension Liability / Company Assets = $14B / $24B
8
Background - Railroad Industry
 In the US, CN competes against 6 major class 1 railroads
 US Railroad employees participate in the US Railroad Retirement
Board
–
Uneven playing field  US railroads do not report comparable
pension liabilities or obligations on their books
–
At $14B, CN pension liabilities are comparable to CN corporate
liabilities
–
Pension liabilities are approximately 10 times the level of our US
peers
Explaining differences in pension systems & obligations
to CN investors is a communication challenge
9
Comparison to Other Class I Railroads
PBO as a percentage of corporate liabilities, fiscal year 2004-2006
12 0.0 %
10 0.0 %
8 0.0 %
6 0.0 %
4 0.0 %
2 0.0 %
10th - 25th
25th - 50t h
50th - 75th
2 00 6
2 004
2 00 5
0.0 %
75th - 90th
CN
Source: Mercer Human Resource Consulting
10
10
CN’s Risk Management Approach
11
Managing Pension Risks
Funding
Business
Objectives
Investment
Governance
Benefits
Managed
Plan Costs
Accounting
12
Managing Pension Risks
Benefits - Risk Reducing Design

Plan has unique & innovative experience gain (loss) sharing features
that tie pension improvements to Plan capacity to pay
– 50/50 Investment experience sharing with actives and pensioners
– 50/50 mortality experience sharing with pensioners


Escalation Account (EA) was created in 1989 for pensioners
Improvement Accounts (IAs) were created in 1998 for both active
unionized and non-unionized employees
13
Managing Pension Risks
Benefits - Risk Reducing Design

Gain/ Loss sharing approach has worked well …

60% indexation paid every year

Benefits have been improved significantly since 1997 and Plan is in
top quartile of Canadian private pension plans

At the same time, EA/IAs absorb part of the loss during the "rainy
days“  Risk sharing with members
Pension improvements are discussed at the pension committee
level
Preserves financial integrity of the plan & minimizes risk for plan
members and for CN
14
Managing Pension Risks
Adopting and Adhering Good Governance Practices


Role and structure of CN Pension Committee revamped in 1998

Quarterly meetings

Composed of senior union leaders, company officials and retiree
representatives

Oversees the administration of the Plan rules and can recommend plan
improvements
CN Board of Directors Sub Committees

Human Resources and Compensation Committee (HRCC)

Audit Committee

Investment Committee

Finance Committee
15
Managing Pension Risks
Funding / Accounting Policy
 Practice of filing actuarial valuations annually
 Employer contributions continued to be paid even when Plan was in
surplus position
– Cash Contribution / Free Cash Flow: $85M / $1,343M
 Pension expense under control
– Expense as % of operating income is low compared to other
class I Railroads
 Comprehensive review of valuation basis conducted every 5-year in
addition to annual review of economic assumptions
Self imposed discipline in order to better manage future
demands for cash contributions
16
Comparison to other Canadian Public companies
Cash Contribution/Free Cash Flow
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
-50%
All Companies
Transportation & Environmental Services
Canadian National Railway Company
Quartiles
Median
Source: © Watson Wyatt's Pension Finance Indicator Database
17
Managing Pension Risks
Funding/Accounting Policy – Actuarial Basis
 Gradual reduction in funding discount rate from 1999 (7.5%) to 2006
(6.5%) to reflect decline in long-term interest rates
 CN pensioner mortality experience shows significant mortality
improvement  Introduced generational mortality table to anticipate
future improvement in mortality
 Conservative asset method: Five-year smoothing of realized and
unrealized gains/losses is used to calculate actuarial value of assets
for funding and accounting purposes
Market value on 31.12.2005:
Actuarial value on 31.12.2005:
Difference:
$14,094M
$11,794M
$ 2,300M
Proactive and conservative approach
in setting actuarial assumptions
18
Managing Pension Risks
Investment Policy
 CN’s conservative policies on design (risk sharing features) and funding,
combined with a good governance structure allows it to sustain volatility
associated with an active investment policy
 60% Equity / 40% Fixed Income
 Strategic investments in attractive, diversified asset classes have
added substantial value
Fund achieved annualized return of 11.1% over the last 36 years
 Allows higher expected returns over the long-term
 Within active investment policy, risk reducing measures are also
implemented
– Diversification, etc.
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Summary

Plan is large and very mature; small changes in assets and liabilities
have material impact on pension costs

Financial risk is mitigated through prudent financial management by
adopting conservative benefit and funding policies combined with a
robust governance structure

Fund’s long-term ownership oriented philosophy has been an integral
part of its success
This has helped offset the impact of the reduction in long-term
interest rates

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