0194866-00007-01 Confidential; notProfessional Use Only. For Financial for further distribution.For Financial Professional Use Only.
Opening RemarksPaul Rogers, EVP & COO, Pacific ResourcesManaging Employee Benefits in a Challenging EnvironmentCharles Lowrey, EVP & COO, U.S. Businesses, PrudentialThe Significance of 2/7/64 and the Implications of Pension De-risking in the U.S.Richard Farr, Head of Pensions Advisory, BDOHealthcare Reform and the Use of Technology to Manage Employer CostsRohail Khan Executive Managing Director, ACS, Human Resource Services, A Xerox Company Khan, Director ACS ServicesAudience Q&APaul Rogers, EVP & COO, Pacific ResourcesClosing RCl i RemarkskPaul Rogers, EVP & COO, Pacific Resources For Financial Professional Use Only. For Financial Professional Use Only.
Charles Lowrey Executive Vice P id t & E ti Vi President Chief Operating Officer, U.S. Businesses Prudential Financial, Inc. Managing E l M i Employee B Benefits fit in a Challenging Environment Confidential; notProfessional Use Only. For Financial for further distribution.For Financial Professional Use Only.
Senior What senior finance executives are saying Executive Forum about managing employee benefits Playing more of a role in benefits decisions Increased focus on pension benefits risk management Reliance on DC plans for employees’ retirement p y savings and income Increased focus on cost of benefits, particularly b fit ti l l healthcare costsSource: 2010 Prudential Financial survey of CFOs. Survey results shown are based on companieswith DB plans with $5 billion or more in assets. 4 For Financial Professional Use Only.
SeniorExecutiveForum Increased Focus on Pension Benefits Risk Management M t 5 For Financial Professional Use Only.
Senior Executive Increased focus on pension benefits risk management Forum Drivers of i Di f increased focus df Implications for companies I li ti f i by finance executives Funding • 54% of finance executives • Stiffer funding requirements report that their companies are h h i i introduced by 2006 Pension either likely to increase, or have Protection Act (PPA) already increased, contributions • Although conditions are to close a funding gap improving, the financial crisis continues to have an impact on DB plans Accounting • Increases in financial statement • Funding status appears on the volatility affect a company’s: ff ’ corporate balance sheet – no – Stock price longer relegated to footnotes – Beta • FASB is likely to reconsider – Cost of capital p pension smoothing rules in favor of mark-to-market accounting, • Risk management strategies which would increase income more important statement volatilitySource: 2010 Prudential Financial survey of CFOs. Survey results shown are based on companies 6with DB plans with $5 billion or more in assets. For Financial Professional Use Only.
Senior Executive Current environment for pension risk transfer ForumThe environment has changed You wouldn’t acquire a pension plan• Balance sheet volatility is here • Pensions are not a core business• Income statement volatility is for most companies inevitable • Rating agencies and equity analysts• PPA funding rules shift focus to view pension underfunding as debt short-term investment results • Company stock prices incorporate• PPA allows employer to fully fund pension risk plan on a tax deductible basis • Financial leverage is better taken elsewhereValue is attractive Waiting entails risk• First-mover pricing is available today • Waiting for the “right” interest rate• Attractive borrowing rates mitigate environment to execute a risk transfer concerns about Buy-In or Buy-Out strategy raises the challenge of how to costs in a low interest rate invest assets in the meantime environment • Capacity is available today, but may not be tomorrow • The market is beginning to move 7 For Financial Professional Use Only.
Senior Executive Range of solutions to mitigate or transfer risk in DB plans Forum Buy-out Buy-in • Liability transferred to insurance company • A guaranteed annuity • Settles a plan asset with a market value sponsor’s obligation p g Liability Driven Investing to match the value of a (LDI) –Does trigger Funding liability settlement accounting • An investor’s approach –Insurance contractinsulation that correlates version of LDI investments in a DB plan –Does not disrupt current to the liabilities in the funded status plan –Liability remains on plan –Imperfect hedge sponsors balance sheet –Credit and duration risk –Revocable – does not • Liability remains on plan trigger settlement gg sponsors balance sheet accounting Cost Annual One time One time premium management fee premium + Settlement charge 8 For Financial Professional Use Only.
Senior Executive Developing a long-term pension risk transfer strategy Forum • DB plan sponsors are monitoring the capital markets to determine when favorable pricing exists to implement a buy-in, possibly as a transition to a buy-out • Pricing varies by plan population and is a function of mortality, interest rates, and investment spreads • Liability tranches (portions of the plan population) should be selected in a strategic manner • Develop • Price • Transition buy-in or assets buy-out • Market rates strategy and spreads • Identify Work Determine Prepare insurer(s) with • Identify action • Settlement toactuaries tranches to triggers charge transact • Establish transfer terms • Impact on • Prepare investment • Monitor the data return market 9 For Financial Professional Use Only.
Senior Executive CFO perspectives on pension risk management Forum Likelihood of adopting DB Key factors that would drive risk management strategies companies to transfer DB risk in next two yearsSource: 2010 Prudential Financial survey of CFOs. Survey results shown are based on companieswith DB plans with $5 billion or more in assets. 10 For Financial Professional Use Only.
SeniorExecutiveForum Shift from DB to DC Plans 11 For Financial Professional Use Only.
Senior Executive Shift from DB to DC plans Forum Solutions for creatingImplications of shift from Guaranteed income trends more DB-like outcomes DB to DC plans in large plan market from DC plans• For individuals: • Several solutions have • Accelerated demand to increasing responsibility been firmly established augment target date for managing risks they in DC plans funds with income are typically ill-equipped – Automatic guarantees to h dl t handle enrollment and – Investment risk escalation • Fewer portability – Longevity risk – Portfolio concerns: critical mass rebalancingg p of recordkeepers• For employers: – Investment defaults participating in industry responsibility to offer – Stable value initiative to accommodate more robust DC plans to income solutions fill the DB void • H However, guaranteed t d lifetime income solutions • Additional safeguard are missing from most developed to address DC plans insolvency, replaceability, y and continuity 12 For Financial Professional Use Only.
Senior Executive CFO perspectives on guaranteed lifetime income Forum50% have already adopted or are Key factors that would drive companies tolikely to offer products that generate adopt guaranteed lifetime income productsguaranteed lifetime income in thenext two yearsSource: 2010 Prudential Financial survey of CFOs. Survey results shown are based on companieswith DB plans with $5 billion or more in assets. 13 For Financial Professional Use Only.
SeniorExecutiveForum Focus on Benefits Costs 14 For Financial Professional Use Only.
Senior Executive CFO perspectives on managing benefits costs Forum Expected implications of healthcare legislation * Planned approaches to control healthcare costs * Percentage of plan Role of voluntary sponsors that rate benefits in managing as highly important benefits costs *** Source: 2010 Prudential Financial survey of CFOs. Survey results shown are based on companies with DB plans with $5 billi or more i assets. ith l ith billion in t** Source: Prudential’s “Fifth Annual Study of Employee Benefits: Today and Beyond,” 2010. Survey results shown are based on companies of all sizes. 15 For Financial Professional Use Only.
Senior Executive Solutions for managing employee benefits offerings Forum• Finance executives face a number of challenges related to employee benefits p y• Employers express concerns about managing the rising cost of healthcare benefits, reducing DB risk, and ensuring employees are adequately prepared for retirement• There is a wide range of solutions to help companies manage their employee benefits offerings, including the expansion of voluntary p y g g p y benefits• Many employers are poised to consider adopting DB risk management strategies and adding guaranteed lifetime income options to DC plans 16 For Financial Professional Use Only.
Richard Farr Head f P i H d of Pensions Ad i Advisory, BDO The Si ifi Th Significance of 2/7/64 and i li ti f d implications f for Pension De-Risking in the U.S. Confidential; notProfessional Use Only. For Financial for further distribution.For Financial Professional Use Only.
The Beatles bring a UK Pop explosion to the U.S.• On February 7, 1964, the Beatles landed in New York for Y k f an appearance on Th Ed S lli The Sullivan Sh Show and by 4 April 1964, the Beatles held twelve positions on the Billboard Hot 100 singles chart, including the top five positions• So started the British Pop explosion in the U.S.• 40 years later the UK enacted a new pensions regulatory regime which aimed to give UK pension plans more control to maintain adequate funding• Today that regime has created an environment of higher funding targets and more control in the hands of the Pension Plan trustees, supported by a regulatory framework predicated on the threat of action• What started out as a well meaning attempt to protect ‘deferred pay’ has turned into a headache for many UK CEOs and CFOs…and its arrival in the U.S. is as inevitable as the Beatles in 1964 Page 18
The Employer’s position• Focus on cash • Liabilities matter as deficits consume cash that could be generate better return on capital from internal projects or growth e g acquisitions e.g. • The UK Pensions Regulator has dramatically improved the funding regime of UK pension plans • The U S eq i alent PPA f nding r les which strengthen f nding req irements in U.S. equivalent: funding rules, hich funding requirements the U.S., are fully phased-in beginning in 2011• Forecasting cash requirements (amount and timing) is very difficult • Alternative sources of capital cannot b assumed t b f l available now Alt ti f it l t be d to be freely il bl • Under PPA, funding is essentially market-to-market, resulting in volatile, difficult to forecast contribution requirements• Accounting deficit is not a true reflection of the Employer’s f f f f funding obligation • IAS19 and FAS in the U.S. are at least regular and comparable • What started out as a target has now become a minimum requirement…… Page 19
Shareholders and other Stakeholders• Short-termism • Shareholders typically focused on prospects over the next two years at most and believe pensions is a long term issue and will not bite short term • Demographic change (e.g. longevity) will be the greatest long term impact, but is little understood and is not currently an easily tradable risk• Analysts • Very few analysts focus on pricing in pensions risk, therefore “off radar” for shareholders…but this is changing, increasingly the p g g, gy pension deficit ( a (on scheme funding, not an accounting basis) is treated as debt• Banks/Debt Providers • See pensions as a potential for profitable hedging business on a vast scale • Bank providers are starting to treat pension plans as competing debt providers Page 20
The investor’s position• Increasing publicity of public pension deficits is increasing awareness• Whether deb o equ y, s ou d as e e debt or equity, should ask: • What is the pension deficit and on what basis (accounting, self sufficiency, buy-out)? • What Wh t are th cash fl the h flow consequences/priorities? / i iti ? • What risks are is the company exposed to? • Can the risk be measured, managed or migrated? , g g• IAS19 deficit is considered as debt, but is this the right number?• Comparing total liability with market capitalisation indicates “pension leverage” and so sensitivity to a change in yields l ” d iti it t h i i ld • Transparency is limited in current published information, it doesn’t help identify those companies that would benefit most from de-risking Page 21
The Gorilla in the Garden (data) shed• Investors hate uncertainty• Corporate activity (M&A restructuring) means the valuation basis shifts (M&A, to buy out pricing • A peculiarly British problem!• Solvency basis rarely assessed, even more rarely disclosed IT’S A CASE OF MUSICAL CHAIRS – THE MUSIC WILL STOP AS SOON AS THE ANALYSTS WAKE UP Page 22
Is the music stopping now?• Latest regulatory pronouncements would point towards this.....• Super priority for pension plans is the new reality…. • e.g. Nortel: court judgement that the pension deficit ranks as an expense of the administration not an unsecured claim• S l Solvency II impacts e.g. impact on Banks and I i t i t B k d Insurers with DB pension ith i plans • When is the general market going to adopt the same approach for the same risk? Page 24
We can’t just do what we’ve always done 1. Understand liability cash flows 2. Ensure assumptions are fit for purpose 3. Forward planning – short, medium and long term strategies g g 4. Reduce liabilities first 5. Long-term risk plan requires co-ordination of asset and liability di ti f t d li bilit strategies 6. De-risking often requires cash, but there are clear benefits th l b fit 7. Employer Covenant - risk or PENSION RISK IS ASYMMETRIC – IGNORE IT opportunity? – treat it as part of the AT YOUR PERIL investment strategy Page 25
A new paradigm• The pension problem is a multi-faceted combination of long-term financial uncertainties and shorter term market sentiment• Investment volatility arises from non-core operations managed inconsistently with wider ERM approaches • Few companies were established as i F i t bli h d insurance risk i k carriers/asset managers• Shareholder value will be created from stabilising cash flows – the “certainty premium”• This requires a clear pension risk transfer plan • Communicated and executed C i t d d t d • There will never be a better time to start! Page 26
What can Pensions learn from The Beatles?Do You Want to Current accounting measures do not accurately represent theKnow a Secret?K S t? economic reality of pensions i lit f iTwist and Pension volatility is already impacting the balance sheet ofShout U.S. corporations, the income statement is nextI Want to Hold A more robust regulatory framework, that embraces economicYour Hand risk may be inevitableBoy, you reBoy you’re going to Pensions will weigh on the bottom line of companies who don’t don t“Carry That Weight” thoughtfully address their pension risk By setting out a thoughtful plan, many companies can addWe Can Work it Out value by de risking today A brighter future awaits de-risking today.Employers should act now to prepare for a UK style pension explosion:De-risk unrewarded risks and manage rewarded risks to close the p g pension deficit Page 27
Important notesWhilst all reasonable care has been taken in the preparation of this presentationno liability is accepted under any circumstances by BDO LLP for any loss ordamage occurring as a result of reliance on any statement, opinion, or any error ord i lt f li t t t i iomission contained herein. Any statement or opinion unless otherwise statedshould not be construed as independent research and reflects our understandingof current or proposed legislation and regulation which may change without notice notice.The content of this document should not be regarded as specific advice in relationto the matters addressed. Page 28
Rohail Khan Executive Managing Di t E ti M i Director, ACS Human Resource Services A Xerox CompanyHealthcare R fH lth Reform and th U of T h l d the Use f Technology t to Manage Employer Costs Confidential; notProfessional Use Only. For Financial for further distribution.
Paul Rogers Executive Vice P id t & E ti Vi President Chief Operating Officer Pacific ResourcesAudience Q&A Confidential; notProfessional Use Only. For Financial for further distribution.
Paul Rogers Executive Vice P id t & E ti Vi President Chief Operating Officer Pacific ResourcesClosing Remarks Confidential; notProfessional Use Only. For Financial for further distribution.
Prudential is not affiliated with ACS Human Resource Services, BDO or Pacific Resources.Prudential, the Prudential logo and th R k symbol are service marks of P d ti l FiP d ti l th P d ti l l d the Rock b l i k f Prudential Financial, I i l Inc. and it related entities, d its l t d titiregistered in many jurisdictions worldwide.For Financial Professional Use Only.