CN Pension Plan. Managing Pension Risks: How We Work and Why. CIA Pension Seminar - April 16, 2007 Caroline Drouin

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1 CN Pension Plan Managing Pension Risks: How We Work and Why CIA Pension Seminar - April 16, 2007 Caroline Drouin 1

2 Table of Contents Background 3 CN Pension Plan CN Railroad Railroad Industry Managing Pension Risks 11 Plan Design Plan Governance Funding / Accounting Policy Investment Policy Summary 20 2

3 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

6 pensioners for every active member Pays monthly pensions to 42,500 pensioners at January 1, 2006 Retirees represent

4 Comparison to Other Class I Railroads PBO divided by service cost, fiscal year end x 110 x 100 x 90 x 80 x 70 x 60 x 50 x 40 x 30 x 20 x 10 x 0 x th - 25t h 25th - 50th 50th - 75th 75th - 90th CN Source: Mercer Human Resource Consulting 44

x 40 x 30 x 20 x 10 x 0 x 2004 2005 2006 10th - 25t h 25th - 50th

5 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 2006 Pension Expense CN $85M -- CN $50M Employee $50M 5

2B Solvency Assets (MV) $14.1B Liabilities $13.7B Surplus $0.

6 Background CN Pension Plan Comparison to other Canadian Public Companies Funding Going Concern Funding Solvency Accounting Proportion of plans in deficit 59% 75 % 78% Average ratio of assets to liabilities Plans in surplus 117% 128% 122% Plans in deficit 90% 81% 82% All plans 101% 92% 90% CN 102% 103% 105% Based on most recent actuarial valuations (145 pension plans) Source: Mercer Pension Database 6

liabilities Plans in surplus 117% 128% 122% Plans in deficit 90% 81% 82% All plans 101% 92% 90% CN

7 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: 60.7 % Total Assets: $ B Free cash flow: $1.343 B 7

America 2006 Financial Highlights Total revenues : $7.

8 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

goods This combined with our geographic diversity positions CN well to face economic fluctuations CN also faces financial risks that can be mitigated in

9 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

their books At $14B, CN pension liabilities are comparable to CN corporate liabilities Pension liabilities are approximately 10

10 Comparison to Other Class I Railroads PBO as a percentage of corporate liabilities, fiscal year % 100.0% 80.0% 60.0% 40.0% 20.0% 0.0% th - 25th 25th - 50t h 50th - 75th 75th - 90th CN Source: Mercer Human Resource Consulting 10 10

11 CN s Risk Management Approach 11

12 Managing Pension Risks Funding Investment Business Objectives Governance Managed Plan Costs Benefits Accounting 12

13 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

actives and pensioners 50/50 mortality experience sharing with pensioners Escalation Account (EA) was created in

14 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

the same time, EA/IAs absorb part of the loss during the "rainy days Risk sharing with members Pension improvements are

15 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

representatives Oversees the administration of the Plan rules and can recommend plan improvements CN Board of

16 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

as % of operating income is low compared to other class I Railroads Comprehensive review of valuation basis conducted every 5-year in

17 Comparison to other Canadian Public companies Cash Contribution/Free Cash Flow 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% All Companies Canadian National Railway Company Quartiles Transportation & Environmental Services Median Source: Watson Wyatt's Pension Finance Indicator Database 17

Canadian National Railway Company Quartiles Transportation &

18 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 : $14,094M Actuarial value on : $11,794M Difference: $ 2,300M Proactive and conservative approach in setting actuarial assumptions 18

anticipate future improvement in mortality Conservative asset method: Five-year smoothing of realized and unrealized gains/losses is used to calculate actuarial value of

19 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. 19

investments in attractive, diversified asset classes have added substantial value Fund achieved annualized return of 11.

20 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 20

funding policies combined with a robust governance structure Fund s long-term ownership oriented philosophy has

Rating Methodology for Domestic Life Insurance Companies

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