From Pension Risk Management to Enterprise Risk Management André Choquet, FCIA, FSA

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1 From Pension Risk Management to Enterprise Risk Management André Choquet, FCIA, FSA W W W. W A T S O N W Y A T T. C O M Presented at the 2006 Canadian Institute of Actuaries General Meeting Chicago, Illinois, October

3 Why do organizations have pension plans? Social benevolence? Optimize human capital investment Attract and retain labour Ensure orderly transition of workforce! Both workforce and organizational life cycles drive decisions about pension plans 3 Copyright 2006 Watson Wyatt Worldwide. All rights reserved.

4 Risk measurement is evolving Unipolar Risk Compliance with regulations brings no rewards; noncompliance results in penalties Bipolar Risk Research expenditures lead to high returns or loss of capital Risk Volatility Greater volatility equals greater risk Value at Risk Risk is relative to expectations Fair Price of Risk Protection offered through use of hedges 4 Copyright 2006 Watson Wyatt Worldwide. All rights reserved. Evolution

5 Moving from Pension Risk Management (PRM) to Enterprise Risk Management (ERM) Measure Tangible Risk Move to Enterprise How much risk? ERM Hedge or not? Implement Monitor Illustrate Intangible Risk Is risk appropriate? 5 Copyright 2006 Watson Wyatt Worldwide. All rights reserved.

7 How large is the plan to shareholders equity? 180% Pension Liability/Sharholders Equity 160% 140% 120% 100% 80% 60% 40% 20% 0% All Companies Financial Services (Banking) Sample Bank Median Quartiles 7 Copyright 2006 Watson Wyatt Worldwide. All rights reserved.

8 Solvency ratio stayed flat despite good returns Solvency: Growth Portfolio, 50% Active Liabilities Index Value Dec-00 Jun-01 Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Month 8 Copyright 2006 Watson Wyatt Worldwide. All rights reserved. Liability Index MV Asset Index Asset/Liability Index

9 Achieving 100% solvency Solvency: Growth Portfolio, 50% Active Liabilities Asset/Liability Index Value Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Month Historical 16.3% equity return 1.00% long term interest rate increase, 7.1% equity return 0.89% long term interest rate increase, 8.0% equity return 9 Copyright 2006 Watson Wyatt Worldwide. All rights reserved.

11 Not all mature plans are shifting away from equities 90% Plan Maturity % Compared to Equity % 80% 70% 60% Equity % 50% 40% 30% 20% 10% Liability Maturity Index (Total Liability / Total Service Cost) 11 Copyright 2006 Watson Wyatt Worldwide. All rights reserved. Data Liability Median Equity Median

12 Risk budgeting: A framework to allocate risk Asset/Liability Stochastic Simulation $360 Policy (65% equity) and current structure PV of Contributions (10 Years) Plus Solvency Deficit ($ Million) VaR95 $355 $350 $345 $340 $335 $330 Decision 3 55% equity, LB, +5% intl, +5% HY and alt structure 55% equity, LB, +5% intl, +5% HY and current structure Setting risk budget 55% equity, LB, +5% intl and current structure 55% equity, LB and current structure 12 Copyright 2006 Watson Wyatt Worldwide. All rights reserved. $325 $205 $210 $215 $220 $225 $230 $235 PV of Contributions (10 Years) Plus Solvency Deficit ($ Million) 50 th Percentile

13 Risk shifts from employer Balanced Fund Present Value of Cumulative Net Expense ($M) $30.0 $20.0 $10.0 $ % Non-Contrib DB 1.5% Contrib DB w 3% EE Contrib 1% DB + 3% DC 6% DC 5th-25th percentile 25th-50th 50th-75th 75th-95th Mean 13 Copyright 2006 Watson Wyatt Worldwide. All rights reserved.

14 to member 2.0% Annual Plan Accrual as a Percentage of Pay 1.8% 1.6% 1.4% 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% Risk for Employee at Age % 1.5% Non-Contrib DB 1.5% Contrib DB w 3% EE Contrib Plan 1% DB + 3% DC 6% DC 14 Copyright 2006 Watson Wyatt Worldwide. All rights reserved. 10% 25% 50% 75% 90% Mean

15 110% 100% Defined contribution risk: Investment decisions and annuitization timing Relative pension after 20 years of contributions, as a percentage of the best outcome (Based on UK market data) Maximum pension assuming no lifecycle strategy 90% 80% 70% 60% Pension as % of maximum - without lifecycle strategy 50% 40% Pension as % of maximum - with lifecycle strategy 30% 20% Copyright 2006 Watson Wyatt Worldwide. All rights reserved.

16 Another looming mismatch? Labour needs vs plan provisions GDP (%) Living Standards Improvement = 1.85% Labour Productivity (%) Required Labour Input (%) Labour Supply (%) Estimated Labour Shortages End of Period (Mil) Copyright 2006 Watson Wyatt Worldwide. All rights reserved.

18 A holistic framework: Moving toward enterprise risk management Measure Tangible Risk Move to Enterprise How much risk? ERM Hedge or not? Implement Monitor Illustrate Intangible Risk Is risk appropriate? 18 Copyright 2006 Watson Wyatt Worldwide. All rights reserved.

19 Delphi study can aid profession in move toward enterprise risk management Consider the following: A. Companies or industries that would benefit from actuarial techniques in quantifying risks? B. Actuarial tools to use? C. Intangible risks: which ones and how to measure? D. What risks to hedge against? E. Pension actuary s role in the overall ERM strategy? 19 Copyright 2006 Watson Wyatt Worldwide. All rights reserved.

22 Websites and references CIA Bulletin article: January 2006 PWC Saratoga Institute : 2006 Key Trends in Human capital Report 8B5C4 Revisiting CAPM Bill Sharpe "Investors and Markets: Portfolio Choices, Asset Prices and Investment Advice," DC Risks DC - a ticking time bomb? UK-32 SEI surveys on DC member investment behaviour pdf onsequences_of_overconfidence.pdf E&Y Study of risk: Risk Management in Canada: Moving Beyond Assessment Canadian Treasurer: Pension Management: a job for the CFO Feb WW Conference Board of Canada survey: WW study on Labour shortages: 22 Copyright 2006 Watson Wyatt Worldwide. All rights reserved.

Poll Highlights. PENSION MANAGEMENT RESEARCH PANEL Poll: DB Pension Management Mid-Year 2014

Poll Highlights. PENSION MANAGEMENT RESEARCH PANEL Poll: DB Pension Management Mid-Year 2014 PENSION MANAGEMENT RESEARCH PANEL Poll: DB Pension Management Mid-Year 2014 Poll Highlights In the summer of 2014, the Pension Management Research Panel conducted a poll to uncover current practices in