Pension Plans of the Future - SHARE€¦ · © Aon Consulting Inc. 2009 – All Rights Reserved Pension Plans of the Future Strategic Risk Management for Long-Term Sustainability

© Aon Consulting Inc. 2009 – All Rights Reserved

Pension Plans of the Future

Strategic Risk Management forLong-Term Sustainability

SHARE 2009 BC Pension ForumDecember 10, 2009

Rosalind GilbertAon Consulting, [email protected]

© Aon Consulting Inc. 2009 – All Rights Reserved2

Introduction

Ê Plan "type" less important than strategic design of features and ongoing management / monitoring

Ê Attain long-term plan sustainability through strategic design and monitoring

Ê Be aware of risks and challenges to sustainability

Ê Plan management proactive not reactive


Risk: Failing to meet Stakeholder Expectations

Ê Failing to meet the benefit obligations

Ê Requiring unacceptable increases to sponsor and member contributions

Ê Poor performance, both absolute and relative to other plans

Trustees should consider all three risk measures when overseeing the plan …

… but assign priorities


FundingContributions

+ =

Financial Risks Operational Risks

Integrated View of Pension Risk

Investment Return

+

Benefits

AdministrativeExpenses

LiabilitiesÊAssumptions vs experienceÊFunding marginsÊActuarial methodsÊCurrent svc cost vs conts

AssetsÊMarket / economyÊAsset / liability mismatchÊLiquidityÊCurrency

DesignÊBenefit levelsÊMember electionsÊPlan guaranteesÊEquity

GovernanceÊDelegationÊE&OÊComplianceÊAdministrationÊCommunications

ÊFiduciary liabilityÊITÊDataÊFees


Key Risks / Challenges: Asset Risks

Ê Increasingly expensive to fund shortfalls as plan matures

Ê So, asset returns, both magnitude and volatility, become all the more important

Ê Volatility and magnitude of returns impacted by: – Asset mix– Market / economy– Interest rates / Inflation


Key Risks / Challenges: Asset/Liability Risks

Ê Limited ability to afford further increases in contributions

Ê So, unpleasant surprises concerning liabilities become all the more unwelcome

Ê Assumptions vs experience– Demographic (e.g., termination & retirement rates)

– Longevity

– Salary inflation / Indexation / Interest rates


Key Risks / Challenges: Liability Risks

Ê Funding margins– What margins are required?

– Avoid having margins that are overly conservative, or inadequate

Ê Actuarial methods– Understand short-term implications of long-term smoothing methods

Ê Current service cost vs contributions– Want future contributions to cover true cost of benefit as it is accrued


Key Risks / Challenges: Design Risks

ÊMember elections (potential antiselection)Early retirement Optional forms of pension

Commuted value transfer

Ê Plan guaranteesIndexing Highest average salary formula

Integrated benefit formula Integrated contribution formula

Bridge pension ITA maximum

Minimum contribution refund

Ê Equity issuesEarly vs delayed retirement

Married vs single

Intergenerational


Key Risks / Challenges: Governance Risks

Ê Delegation

Ê E&O

Ê Compliance

Ê Administration

Ê Communications

Ê Fiduciary liability

Ê IT / Data

Ê Fees


Looking for Solutions

1. Asset / Liability Studies

2. Trends

3. Assumptions

4. Integration of benefits, funding, investment policies

5. Employer HR objectives

6. Plan design


Looking for Solutions - Asset/Liability Studies

Ê Determine "optimal" asset mix for the Plan (minimum risk portfolio)

ÊMinimize or stabilize contributions

ÊMinimize worst case (95th percentile results) contributions / maximize worst case surplus/funding ratio


Looking for Solutions - Trends

Ê Continued trend to CAP conversion– Not risk-free, just different risks

Ê Plan design changes to reduce employer cost– Early retirement incentive reduction

– Member contribution increases

– Inflation adjustments eliminated or reduced

ÊMay be some regulatory changes coming– Solvency exemptions / extensions

– Pension reform legislation

– Harmonized legislation?


Looking for Solutions - Assumptions

Ê Caution: Assumptions vs experience

Ê Human genome flow-through?Ê 2002 perfect storm

Ê PandemicÊ 90's heyday

Ê PlaguesÊ 30's depression

Actual:Actual:

Expected: Standard tableExpected: Valuation interest rate

MortalityInvestment


Looking for Solutions - Integrated Policies

Ê Revisit pension deal and clarify benefits policy

Ê Clarify funding policy

Ê Integrate benefits/ investment/ funding policy


Looking for Solutions – Link to HR Objectives

Ê Demographic shortages

Ê Early retirement programs

Ê Flexible retirement programs


Looking for Solutions – Assessing Design

Ê Plan sponsors are reconsidering the value to stakeholders of costly design features, such as:– Early retirement – may not fit with aging workforce strategies– Form of pension – may be source of inequity amongst membership– CV transfer – may be costly; not always to members' advantage– Indexing – other plans are reconsidering the affordability of indexing– Minimum contribution refund – is the plan primarily for the benefit of

retiring or terminating members?

Ê Review normal retirement age– Look ahead on "what if" basis

• 5-year increase in post-age-65 life expectancy of 20 years could increase plan costs by 25%

• Would retirement ages increase? Should normal retirement age increase?

– If appropriate, reserve appropriate powers


Looking for Solutions - Plan Design Features

Ê Career-average earnings formula with ad hoc upgrades

Ê Flat-benefit plan with negotiated or ad hoc increases

Ê Hybrid benefits – greater of DB & DC

Ê Employer contributions capped at fixed % of pay

Ê Ad-hoc indexing

ÊMinimum DB accrual with shared investment gains

Ê CPP Integration changes


Looking for Solutions - Plan Design Features

Ê Fixed-cost variable-benefit plan (past service upgrades / current service accrual reductions)– JEPPS Report :Specified Contribution Target Benefit Plan

Ê Flex DB plan – basic DB employer-paid; can buy ancillary benefits

Ê Employee and employer contributions vary with funded status

Ê Target benefit plan with integrated benefits / funding / investment policies

ÊMember-funded pension plans


Integrated approach - long-term risk-reduction

Long-term, sustainableShort-term, reactive

Monitor opportunities to settle liabilities as Plan matures

Failure to link plan cycle life changes to evolving risk profile

Quarterly performance monitoring of risk metrics linked to assets and liabilities

Asset-driven performance monitoringNo follow-up after ALM study

Liability monitoring done once every 2-3 years

Monitor and manage interdependencies of pension and enterprise risks

Pension risks managed in isolation

Coordinate funding, investment and benefit (design) policies to de-risk

No consideration given to plan design to mitigate risks

Structured governance model reinforced by stress testing and integrated, customized education

leading to well-informed decisions

Trustees are overloaded with uncoordinated information from various sources

Integrated ApproachTraditional Approach

Broader focus –- hedging of risks by designing and executing customized liability-based

strategies

Narrow focus on asset return. Asset-liability modeling may fail to limit downside risk


Conclusion

1. Pension reform proposals likely to accomodate many more plan designsÊ Allow for pension "deal" to be designed strategically

Ê Avoid slotting plans into compartments by type....look for more flexible legislation

2. Fiduciary focus on risk mitigation not plan design

3. Lessons from the past / new challenges for the future

4. Look at big picture and all factors – strategic design and maintenance; proactive not reactive

Documents

Pension Plans of the Future - SHARE€¦ · © Aon Consulting Inc. 2009 – All Rights Reserved Pension Plans of the Future Strategic Risk Management for Long-Term Sustainability