Engaged Investor Trustee Forum 21 May 2009 David Collinson Partner Pension Corporation

Engaged Investor Trustee Forum21 May 2009

David CollinsonPartnerPension Corporation

What is pension insurance (buyouts/buy-ins)

Impact of financial turmoil

It’s all about defaults!

Outlook for the future

Copyright © 2008 Pension Corporation LLP. All rights reserved. 3

Insurance in general

Pooling of risks to protect against extreme outcomes

Transfer of first responsibility for a risk

Payment of a premium in exchange for a promise to meet a future claim

Access to solvency capital to ensure that the insurer’s promise is met

Transfer of a profit margin

From an employer/member perspective, a pension fund already meets some of the above features.

The main exception being the capital and profit aspects.


Pension Fund Risk Profile

Pension FundCorporate

Credit Spreads/Defaults

Equity Prices

Inflation Rates

Interest Rates

Longevity

Member Options

Operational Risks

Creditor Risk

Covenant Support

Member

PPF Protection


Buy-in / Buyout – Safe diversified investment or single unsecured loan?

Insurer

Capital Assets

FSCS Protection

Pension FundCorporate

Creditor Risk

Covenant Support

Member

PPF Protection Credit Spreads/Defaults

Equity Prices

Inflation Rates

Interest Rates

Longevity

Member Options

Operational Risks







Insurers

►Capital impact of falling bond values/increased spreads

►Fewer active players quoting in the market

►Lack of availability of inflation hedges

►Pricing benefit of higher credit spreads

►Interesting investment opportunities

►Careful asset due diligence needed to transact

Pension Funds

►Equity exposure may have put insurance out of reach for some funds

►Some insurance processes put on hold

►“New world” for setting technical provisions





Default assumptions

Insurers have already had to grapple with technical provision setting post-September 2008

Many pension funds will need to grapple with this for the 2009 Funding Valuations

Gilts +0.5% or Gilts +60% of AA Spread; Similar in 2006, very different now!

AA spreads +300bps, A spreads +450bps


Default assumptions

Comparison of default assumptions

Insurer Default assumptions 2008

Prudential Equivalent to 80bps pa for the lifetime of the asset portfolio

Aviva Equivalent to 85bps pa for the lifetime of the asset portfolio

L&G 130bps pa for the first 4 years; 30bps pa thereafter

Pension Insurance Corporation

50% of current spread over lifetime of portfolio

Historical evidence

Moody’s Historical Default Data – 86 years of data

Analysis of Moody’s data from 1920-2006 (more recent data not yet available) suggests that:

►average loss from defaults – 9bps

►the most stressed environment was the 1930’s -58bps per annum loss from defaults on average

►the single worst year for defaults was 1938 -170bps loss from defaults

Historical evidence

Worst Decade Ever – Individual default rate in each year

Rating

1931

1932 1933

1934 1935 1936 1937 1938 1939 1940

Aaa0.00

00.00

0 0.0000.00

0 0.000 0.000 0.000 0.000 0.000 0.000

Aa0.00

00.67

0 0.0000.59

9 0.000 0.784 0.000 0.833 0.000 0.000

A0.28

10.87

1 0.2650.34

7 1.333 0.505 0.539 1.700 0.000 0.000

Baa1.03

50.89

2 1.8000.81

1 1.887 0.341 1.093 1.972 0.946 1.316

Ba2.95

95.97

311.11

12.63

2 4.826 1.225 0.649 0.976 0.588 0.410

The following table shows the proportion of companies which defaulted on various grades of corporate bonds during the 1930s.






Key characteristics of developments in 2008

Validation that a solvent buy out market exists

Wide range of providers at start of the year narrowing to only a few serious players at the end

Partial Buy-in / Buyout concept validated

Very aggressive pricing in first 6 months eased to more sustainable levels later in the year

Most deals were for “straightforward” insurance, rather than risk sharing

Security/collateral structures implemented on some buy in deals

“full risk transfer deals” came and went


Buyout market - Outlook

When funding discussions on longevity get difficult, longevity insurance will become attractive - expect deals in this area

Will overall buyout / buy-in volume be at similar level to 2008?

►Opportunistic deals based on price – probably fewer but Plans are gearing up for this

►De-risking deals: Likely to continue, focused on pensioner buy–ins

►Distressed deals: Likely to rise

Disclaimer

This publication has been prepared for general guidance on matters of interest only and are intended for professional/corporate recipients and not for individual/retail customers or pension scheme members and should not be passed on to such without our prior consent, and does not constitute professional advice of any kind. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, Pension Corporation LP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

© 2009 Pension Corporation. All rights reserved. 'Pension Corporation' refers to the Pension Corporation LP and its affiliates each of which is a separate and independent legal entity.

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Engaged Investor Trustee Forum 21 May 2009 David Collinson Partner Pension Corporation