Pensions and the Future of Retained Risk

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1 Institutional Investor Corporate Financial Executive Summit Pensions and the Future of Retained Risk June 19, 2013 Glenn O Brien Managing Director, Pension Risk Transfer Prudential Retirement Not for further distribution.

2 Pensions and the Future of Retained Risk The Pension Market 3 The Changing Landscape 13 Improving Shareholder Value 21 Solutions and Considerations

3 The Pension Risk Transfer Market Breaks $100 Billion $36.7B of risk transfer transactions in 2012 alone* $74B U.K. risk transfer transactions completed since ** General Motors Verizon $25 billion $7.5 billion *Source: LIMRA Group Annuity Risk Transfer Survey Q **Hymans Robertson: Buy-outs, buy-ins and longevity hedging Q

4 Current Environment 86% average funded status as of May 31, 2013, up from 77.2% as of 12/31/ Increased interest in lump sum programs Pension funding stabilization, retroactive to January 1, 2012, provides short-term reduction in funding requirements PBGC premiums are set to nearly double In 2012, the Society of Actuaries (SOA) released a new mortality improvement scale intended to better reflect current mortality experience; implementation likely required in 2015 The move to mark-to-market 4 1 Milliman 100 Pension Funding Index for the top 100 corporate DB plans

5 What is Driving Change in the Current Environment? The Defined Benefit Rollercoaster Source: Milliman 100 Pension Funding Index *New mortality table likely to be required by

6 U.S. Pension Plan Sponsors Face Increasing Longevity Risk Increase in Liability due to Mortality Table Updates Source: Prudential calculations. 1980s using GAM 71 Mortality Table, 1990s using GAM 83 Mortality Table, 2000s using RP 2000 Mortality Table, Current using RP 2000 Mortality Table with PPA longevity improvements, and Possible 2014 using RP 2000 with Scale BB longevity improvements. 6

7 The Mindset of a CFO/Treasurer I make widgets, I can t effectively manage pension risk. I m not being rewarded for taking pension risk. My operating planning is impacted by uncertainty of cash hflows from my pension plan. I can t take this volatility. I need to do something about this. BUT Interest rates are low. Risk transfer strategies are too expensive. 7

8 A corporate finance lens makes the logic for pension de-risking clear and compelling. * 8 *Oliver Wyman/Mercer, Funny Money The increasing irrelevance of pensions earnings, 2010.

9 General Motors the move helps significantly reduce economic volatility, improves valuation transparency and enables GM to focus more on making cars rather than managing a pension fund. Morgan Stanley Source: General Motors: Pension Down, Credibility Up. Morgan Stanley. June 1, Used with permission. As GM continues to fund and de-risk its pension, investors should develop increased confidence that incremental cash flows will accrue to them, and not the pension. As this happens, GM s multiple should expand. Credit Suisse Source: Doing the Right Thing GM Further De-risks Pension; Positive for Equityholders. Credit Suisse, Equity Research. June 4, Used with permission. Analyst reactions illustrate the impact of the transaction on perceptions, are not meant to imply endorsement of specific analysts views, and do not necessarily represent the views of all analysts. General Motors U.S. Salaried Plan In the words of the CFO Dan Ammann, SVP and CFO, General Motors it illustrates the significant volatility and ebbs and flows to the company s risk profile as discount rates move and capital market returns fluctuate, notwithstanding contributions of over $7 billion we ve made into just the salaried plan over this time horizon. It allows us to transition the business of taking pension risk to Prudential, that is their core business, and it allows us to spend more time and resources on our core business of designing, building, and selling the world s best vehicles. 9

10 Verizon While some observers may have believed that the GM deal was unique to its circumstances, and perhaps, a one-off, the contrasting Verizon deal will likely cause more senior managers and boards to pose the question, Why not us? Source: Verizon s $7.5B Pension Annuity Transaction, Mercer s Analysis, Mercer Analyst reactions illustrate the impact of the transaction on perceptions, are not meant to imply endorsement of specific analysts views, and do not necessarily represent the views of all analysts. 10

11 Liability Segment Strategy A strategic approach based on the status and duration of three participant groups. 11 *Estimated cost to exit based on a hypothetical plan of 50% retirees and 50% non-retirees.

12 Evaluating a Retiree Pension Buy-out Plan sponsors own these I. Costs not included d in the GAAP retiree obligation include per person administrative i ti expenses of $40 per year and flat-rate t PBGC expenses per person of $42 in 2013, $49 in 2014, and indexed d after Variable-rate premiums paid by underfunded plans, currently at $9 per $1000 of unfunded vested benefits, will be indexed for inflation beginning in 2013 and will increase by $4 in 2014 and by $5 in They will be capped, however, at $400 per participant (indexed for inflation) beginning in Variable-rate premiums are not included in this illustration. II. GAAP obligations are discounted using rates unadjusted for investment management fees and the risk of credit defaults and migrations. These are estimated at 25 and 24 basis points per annum respectively. III. This exhibit reflects a change in the mortality basis from the PPA prescribed mortality table using scale AA to the RP2000 generational table using scale BB. Pricing is indicative, and provided for discussion purposes only. Pricing is subject to change per market conditions and specific client demographic information. 12 This is for hypothetical purposes only and not a projection of any performance.

13 De-risking Options Controls pension Transacted for Transfers risk to Transacted for investment risks specified lives participants specified lives through liabilitybased investment Assets remain in PPA Corporate Assets transfer the pension plan Bond basis fully to insurer strategy t Does not reduce funded status Does not require settlement accounting Convertible to buy-out at any time phased-in May trigger settlement accounting and reduce funded status Reduces funded status if transacted for only a portion of plan Requires settlement accounting 13

14 Size of Key Fixed Income Markets Source: BarCap Live, Aon Hewitt Pension Risk Management Conference, 2011 This is for hypothetical purposes only and not a projection of any performance. 14

15 Capacity U.S. insurance capacity likely to exceed tens of billions of dollars Could handle significantly more over time, with new entrants and reinsurers Supply of corporate bonds is bigger issue Early-mover advantage? - Currently plenty of capacity - Better availability of corporate bonds - Insurance company appetite to open the market De-risking strategies not just risk transfer activities constrain supply of corporate bonds and that demand drives down yields. This can be seen in the U.K. where supply is tight and spreads have narrowed. 15

16 Considerations LIFT-OUT VS. SPIN-OFF Lift-out Transfer liability and assets for a specific group of participants to insurer Existing plan remains intact Spin-off Spin off transaction group (liability and assets) to a separate plan Formally terminate that plan Annuitize after obtaining PBGC and IRS approvals RETIREE LUMP SUMS With specific government approval, some plans offered lump sums to current retirees For a plan that relies on the 417(e) basis for calculating lump sums, the cost to the plan for those who elect would be close to 100% of GAAP However, this approach would likely increase the annuity cost for non-electing retirees, due to opportunity for anti-selection 16

17 Parties Involved in a Risk Transfer Transaction CFO / Treasurer Board of Directors Investment bank Actuary Legal counsel Fiduciary y( (sponsor or independent) 17

18 This presentation is intended only for the use of the individual or entity to which it is addressed, and may contain confidential information. The information contained herein is not for further distribution without the express consent of Prudential Retirement. This discussion document describes product concepts that are not final. It has been prepared for discussion purposes only. It is not an offer to enter into any agreement. This document does not completely describe the terms of any potential transaction or final product design, and any transaction would be subject to applicable legal and regulatory requirements; internal, legal, and regulatory approvals; and final legal documentation. Any indication of pricing provided in this document is for illustrative purposes only. Prudential does not provide legal, regulatory, or accounting advice. Therefore the plan sponsor and its advisors should seek legal, regulatory and accounting advice regarding the legal, regulatory, or accounting implications of the insurance contract. This information is provided with the understanding that the recipient will discuss the subject matter with its own legal counsel, auditor, and other advisors. Prudential Retirement Insurance and Annuity Company (PRIAC) and The Prudential Insurance Company of America (PICA) provide insurance products for U.S. pension plans but are not authorized to provide insurance products for U.K. pension plans. Neither PRIAC nor PICA nor Prudential Retirement are authorized or regulated by the U.K. Financial Services Authority, nor do they offer insurance or reinsurance in the United Kingdom. PRIAC does provide off-shore reinsurance to U.K. insurance companies that have acquired U.K. pension risks through transactions with U.K. plan sponsors. Prudential s Traditional Buy-out is a group annuity contract issued by PICA, Newark, NJ Amounts contributed are deposited in PICA s general account. Any payment obligations or guarantees are contingent on the claims paying ability of PICA. Prudential s Portfolio Protected Buy-out is a group annuity contract issued by PICA, Newark, NJ Amounts contributed to the contract are deposited in a separate account established by PICA. Payment obligations specified in the group annuity contract t are insurance claims supported by the assets in the separate account and, if such assets are not sufficient, by the full faith and credit of PICA. Prudential s Portfolio Protected Buy-in is a group annuity contract issued by PICA, Newark, NJ Amounts contributed to the contract are deposited in a separate account established by PICA. Payment obligations specified in the group annuity contract are insurance claims supported by the assets in the separate account and, if such assets are not sufficient, by the full faith and credit of PICA. Insurance products are issued by either PRIAC, Hartford, CT, or PICA, Newark, NJ. Both are Prudential Financial companies. Each company is solely responsible for its financial condition and contractual obligations. Guarantees are based on the claims-paying ability of the insurance company and are subject to certain limitations, terms and conditions. Products not available in all states. S&P 500 Index: (registered trademark of The McGraw-Hill Companies, Inc.) is an unmanaged index of 500 common stocks primarily traded on the New York Stock Exchange, weighted by market capitalization. Index performance includes the reinvestment of dividends and capital gains. The Milliman 100 Pension Funding Index projects the funded status for pension plans included in the annual Milliman study of the 100 largest defined benefit plans sponsored by U.S. public companies, reflecting the impact of market returns and interest rate changes on pension funded status, utilizing the actual reported asset values, liabilities, and asset allocations of the companies pension plans Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions worldwide. 18

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