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The survey findings, developed with CFO Research Services, reflect survey responses and in-depth interviews with more than 400 CFOs, treasurers and other finance executives in the United States, Canada and the United Kingdom.
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A Qualified Commitment to DB Plans: A Qualified Commitment to DB Plans: Risk Management Amid a Steep Downturn
The 2009 Towers Perrin — CFO Research Services Pension Study y
Key findings and business implicationsJune 30, 2009
© 2009 Towers Perrin
Today’s Agenda
Describe the studyReveal the headlinesShare some insights behind the headlinesPut this in context and look ahead to the next few months and yearsExplore a decision-making framework that achieves desired pension risk p g pmanagement objectives
© 2009 Towers PerrinProprietary and Confidential
Not for use or disclosure outside Towers Perrin and its clients 2
About the 2009 Study
Third annual defined benefit pension study of senior finance executivesGoal
Gain corporate finance insights into impact of the financial turmoil on defined benefit (DB) plans— Funding, investment and business implications
Plan design and risk reduction alternatives— Plan design and risk reduction alternatives— Future plans
Methodology439 senior finance responses from large U.S., UK and p g ,Canadian organizations across all industries18 senior finance executive interviewsConducted in April/May 2009Incorporates financial data from Capital IQIncorporates financial data from Capital IQResults segmented by: — Company size— Investment objectives
© 2009 Towers PerrinProprietary and Confidential
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j— Long-term DB plan commitment
The headlines – funding perspective
The financial crisis has hurt operating performance and the financial health of most DB
Which of the following best describes your DB plan funding policy 2 years ago and today?
financial health of most DB plans
Impact on cash flow is of greatest concern (57%),
30%
29%
29%
Contribute the amount that ensuresf f
Contribute enough to achieve explicitfunding targets
g ( %),followed by income statement and balance sheet impact 21%
25%
15%Contribute the legal or negotiatedminimum payment
the plan is fully funded
And although cash and credit are generally scarce, most companies (80%) are confident they’ll have the cash to meet 9%
10%
10%
14%
Make ad hoc decisions on pensionfunding without a formal funding
policy
Contribute the maximum tax-deductible amount
they ll have the cash to meet plan funding commitments
With a number changing / having changed the overall
5%4%
0% 20% 40%
Don't know/Not applicable
policy
© 2009 Towers PerrinProprietary and Confidential
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g gfunding policy
0% 20% 40%
Funding policy today Funding policy two years ago
The headlines – commitment and investment
Despite tough times, most executives remain committed to the financialcommitted to the financial health of their DB plans and invest pension assets with an eye towards risk Reduce
riskIncrease returns
Investment Orientation
management7 of 10 respondents plan to pursue long-term i bilit f th i DB
Viability focused
Alternative
risk returns
54%
24%
17%
5%
Long-Term DB
Commitmentviability for their DB plans rather than seek alternatives to DB plan sponsorship
te at efocused 24% 5%Commitment
p pOver 3 of 4 say they will focus more on reducing risk than seeking
© 2009 Towers PerrinProprietary and Confidential
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additional investment returns
The headlines – asset allocation
Many respondents said the proportion of equities included in the pension portfolio is lower either because the
Senior financial executives expect to keep equity content lower than they had beenportfolio is lower, either because the
market has depressed their values more or because of a change in target asset allocation
lower than they had been before this recent crisis took hold
No,
In the last six months, has your company adhered to a consistent portfolio rebalancing strategy?
11%
In your opinion, will recent market events causea long-lasting change in the allocation of equity investments in your company's pension fund?
No, 31%
42%28%
Yes, 69%
18%
Yes likely to decrease allocation
© 2009 Towers PerrinProprietary and Confidential
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Yes, likely to decrease allocationYes, likely to increase allocationNo, will not cause a long-lasting changeDon't know
The headlines – use of derivatives
Synthetic products, such as swaps and futures, have become common pension risk management tools
N l ½ f l U S i (44% ll) i t t tNearly ½ of large U.S. companies (44% overall) use interest rate swaps and a similar number of U.S. companies use futures to manage interest rate risk
Does your company currently use the following
48% 42% 10%Interest rate swaps
Does your company currently use the following financial instruments to manage risk in its DB plan?
38%
46%
50%
43%
12%
11%
Call/Put options
Interest rate futures
31%
35%
56%
53%
13%
12%
0% 25% 50% 75% 100%
Credit derivatives
Currency forwards
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0% 25% 50% 75% 100%
Yes No Don't know
Behind the headlines
While most DB plans have been hurt financially
…1 in 5 respondents said their plans fared well –and most of these companies were substantially and consistently more likely to have used syntheticfinancially… and consistently more likely to have used synthetic instruments to manage pension risk
Percentage of respondents in each segment using financial instruments to manage pension risk
28%
22%
46%
46%
76%
79%
Interest rate swaps
Interest rate futures
29%
28%
35%
72%
74%Currency forwards
16%
19%
39%
33%
70%Credit derivatives
Call/Put options
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0% 20% 40% 60% 80% 100%
Negative effect No effect Positive
Behind the headlines
Relative to “return-seekers,” those focused on mitigating future risks appear to have adopted what seem to be more conservative investment
Those focused on minimizing risk act differently from those what seem to be more conservative investment
strategiesSuffered more damage from pension financial results in 2008
differently from those pursuing higher investment returns
Rely less on synthetic hedging tools Less likely to increase equity exposure
© 2009 Towers PerrinProprietary and Confidential
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Behind the headlines
Relative to those pursuing long-term viability of their plans, those seeking alternatives:
Those seeking alternatives to their DB plans have a different Saw their financial statements hit harder by
recent economic eventsAre more likely to have design changes underway
plans have a different profile from those committed to the DB plans well into the
underwayAre less likely to use synthetic hedging instruments or own illiquid investmentsAre moving away from full funding as a
future
Are moving away from full funding as a contribution policy objective
© 2009 Towers PerrinProprietary and Confidential
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Behind the headlines
…that commitment has its limits and shows signs of fraying
A th itt d t DB l
While commitment to DB plans remains solid…
Among those committed to DB plan viability, half (60% in U.S.) say the economic crisis has made them more likely to seek a DB exit strategy
Has the recent financial turmoil made your company more or less likely to seek an exit strategy for its DB plans?
y gyNearly half would consider settling part of their pension obligation through annuities for 105% of the
61%More likely
obligation (with another 18% going up to 120%)Almost ¾ would reconsider their long term commitment if pension
4%
33%
Less likely
No change
long-term commitment if pension accounting rules made income statements more volatile
2%
0% 25% 50% 75%
Don't know
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0% 25% 50% 75%
Other noteworthy findings
Plan design changes are a constant amongst large companiesLess than 10% of respondents have neither made recent changes nor plan h i th f tchanges in the near future
Alternative investments remains a popular investment option70% have some private equity investments — the rate is higher for the l i i d f h “i i f h l h l”largest organizations and for those “in it for the long haul”Half use “alpha-seeking” strategies and unlisted real estateThe majority are likely to maintain their current investment levels, while a quarter expect to increase their use
Survey findings were generally consistent across marketsThe most notable exceptions include:— Downturn has hit U.S. companies especially hard— U.S. companies are especially likely to shift away from equities; UK
companies are more likely to shift toward equities
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— U.S. companies are more likely to seek termination as a result of regulatory changes
Putting this in contextAsset returns for a common U.S. DB pension plan
25%
60% Equity (40% lg cap, 10% s/mid cap,10% int’l)40% Fixed Income (35% BC Agg, 5% cash)
10%
15%
20%
-10%
-5%
0%
5%
-25%
-20%
-15%
10%
Year 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 May 2009
Annualized % Return YTD 2009
17.1 13.2 -0.3 -3.6 -9.0 20.8 9.8 5.2 12.2 6.3 -22.8 3.5
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Annualized Return 10yr Dec 2008 = 2.4%
Putting this in contextFixed income yields and rates
Key Bond Yields (at end of month)
8 00%
9.00%
6.00%
7.00%
8.00%
Proxy for pension discount rates
4.00%
5.00%
6.00%
2.00%
3.00%
Dec 98 Dec 99 Dec 00 Dec 01 Dec 02 Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Dec 08
30-Year T-Bonds 30-Year Swaps ML 10+ HQ Spreads
Dec. 31, 2007 4.45% 5.03% 6.18% 1.73%
D 31 2008 2 69% 2 69% 5 92% 3 23%
Dec 98 Dec 99 Dec 00 Dec 01 Dec 02 Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Dec 08
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Dec. 31, 2008 2.69% 2.69% 5.92% 3.23%
May 31, 2009 4.34% 4.18% 6.62% 2.28%
Putting this in contextFunded status under varying investment strategies
135%
PBO Funded Ratio
105%
115%
125%
75%
85%
95%
55%
65%
Dec 97 Dec 98 Dec 99 Dec 00 Dec 01 Dec 02 Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Dec 08
Dec ’07 Dec ’08 May ‘09
92.7 66.0 69.7
96.3 66.1 69.6
60/40 Average Duration Fixed Income (FI)
60/40 Long Duration, Corporate FI
0/100 Long Duration Corporate FI / Treasury STRIPS
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95.5 94.0 89.9
111.7 97.4 87.1
0/100 Long Duration, Corporate FI / Treasury STRIPS
60/40 80% Hedged
Business implications of lower funded status
Higher cash requirements at a time when cash and credit are scarceImpact may be greater in 2010 given recent funding “relief” in the U.S.
Higher accounting cost on the Income StatementWith further increases coming through in next few years if assets smoothedAlso lower funded status shown on Balance Sheet
Possible Pension Protection Act (PPA) implicationsBenefit restrictions (lump sum payouts, benefit accruals, etc.)( p p y , , )Employee notices
Deferred employee retirements Given depressed 401(k) balances employees may need to workGiven depressed 401(k) balances, employees may need to work longer
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So what comes next?
In making both strategic and tactical decisions, companies must consider the range of economic and capital market conditions we may face in the coming years
High Growth
Good times Overdrive
may face in the coming years
Pension
Business
Pension
Business
?
+++
High inflation / High interest rates
Low inflation / Low interest rates
Business
Pension
Business
Pension- ?
Perfect Storm Stagflation
Business Business- -
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Low Growth
In particular, funded status could recover slowly
While assets may continue their recent stronger performance…
…discount rates could fall if high grade corporate bond yields continue dropping
Business confidence grows and bond yields declineg p Business confidence grows and bond yields declineCredit ratings decline and debt drops out of the relevant bond universeNote that any Treasury-based swaps in place before the
Global Equity Returns
U.S. RATE:Link Bond Universe as of May 31, 2009
11%12%
y y p ptightening would exacerbate the negative impact on funded ratio25-Jun-09
YTD%Change
S&P 500 3.23%Russell 2500 Index 6.03%MSCI EAFE Index 6.38%
7%8%9%
10%11%
7.00%
8.00%
2%3%4%5%6%
2.00%
3.00%
4.00%
5.00%
6.00%
Financial industry bond yields (May)
Non-financial industry bond yields (May)
Dec. 10-90th yield curve/all bond issues
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Maturity (Years)
0%1%
0 5 10 15 20 25 30
1.00%
May 10-90th yield curve/all bond issues
So what are you to do as a plan sponsor?It depends on your near-term and longer-term objectives
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Panel discussion
Our PanelistsSam KnoxSylvia PozezanacVP, Director of ResearchCFO Research ServicesBoston, MA(617) 345-9700, Ext. 243
Managing PrincipalRetirement Risk SolutionsTowers PerrinNew York NY (6 ) 3 5 9 00, 3
[email protected] York, NY(212) [email protected]
Mike ArcherChief ActuaryTowers PerrinTowers PerrinParsippany, NJ(973) 331-3562 [email protected]
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