Pensions – managing risk in volatile economic times 3 ... · – HR – Pensions • December 2008. PricewaterhouseCoopers LLP Slide 18 Context for employers ... -200-100-100 200

Pensions – managing risk in volatileeconomic times3 March 2009

Introduction

Philip Wright

Partner

Telephone: +44 20 7804 5021

Mobile: +44 (0) 771 006 3398

Email: [email protected]

What the government expectsfrom employers and trustees

Rt Hon Rosie Winterton MPMinister for Pensions and the Ageing Society, DWP

The impact of legislation – oldand new

Peter Tompkins

Slide 5PricewaterhouseCoopers LLP

Will Changes to Pensions

Mean More or Less Saving

Over Next 5 Years?




Over Next 5 Years

for your staff?




Over Next 5 Years

for you?


Pensions – The deciding factors?

• Tax and Government Incentives(eg 1978 contracting-out, 1988 personal pensions)

• Competition – keeping up with other firms(eg setting up final salary plans in the 60s and 70s)

• Financial attraction(does it look like a good bet?)


So where are we now?

• Loss of employer tax incentives (ACT)

• Poorer DB contracting-out terms & end of DCcontracting-out in 2012

• Closures of plans to new members and now tofuture accrual

• 83% of employers don’t think they get value fromtheir contributions

• Will people be convinced that auto-enrolment in aDC pension is worth it?


Who decides?

– Employer choice

“Levelling down” of existing benefits looks likely. “Do I reallyneed to spend more on pension than my competitor if it isn’tproperly valued by my staff?”

+Auto-enrolment

It will make a difference, but how much? So much dependson the climate in 2012

– Employee choice

“It hasn’t been worth saving for a pension for the last 10years, so why should it be worth bothering now?”


DB – Expectations of increasing pensions are met – as your salary

rises, the amount you can expect at retirement also increases

0

2000

4000

6000

8000

10000

12000

14000

Expecte

dR

etire

ment

Pensio

n

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

DB Pensionexpected atretirement


DC – Expectations probably lower than 10 years ago – despite salary

rises. “What’s the point of saving?” is the reaction.

0

2000

4000

6000

8000

10000

12000

14000

Expecte

dR

etire

ment

Pensio

n

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

DB Pensionexpected atretirement

DC Pension


Employee decision-making

• Employees only value what they understand

• Who do they trust any more on financialservices?

• How much effort should employers put intocommunication?


Conclusion

• Much uncertainty over the future landscape foremployer provision and employee take-up

• Widespread suspicion of a pension’s worthespecially given the attitude of the media

• Communications challenge, especially with atwo-tier pensions workforce

• What others are doing will be increasinglyimportant

Unprecedented times needunprecedented action

Marc T HommelPartner, head of pensions for PwC HR Services

Telephone: +44 20 7804 6936

Mobile: +44 (0) 780 176 7373



• Unprecedented times, unprecedented actions

• Three main areas of employer concern

• Demise of ‘sacred cows’

• New ‘rules of the game’

Key messages

Cash RiskCost and

value


PwC pensions survey

• Around 100 organisations

• Tracks employer attitudes:

– Finance

– HR

– Pensions

• December 2008


Context for employers

• Market turmoil

• Debt financing

• Impact of pensions on rest of business

• Future employment deal

• Threat to dividends

• Accounting vs funding (£300bn)

Slide 19PricewaterhouseCoopers LLP-400

-300

-200

-100

-

100

200

300

Jan 06 Apr 06 Jul 06 Oct 06 Jan 07 Apr 07 Jul 07 Oct 07 Jan 08 Apr 08 Jul 08 Oct 08

Su

rplu

s/

(De

fic

it)

£300bn funding and accounting difference

funding deficit

accounting surplus

£b

n

total UK schemes


Not easy being a trustee!

• Increasing liabilities

• Declining assets

• Sponsors in crisis


Employers and trustees need to worktogether to address challenges

Reduceemployer cashcommitments

Maintainpension scheme

security

More assertive employer action thantraditionally been the case



Cash


Cash

concernedabout the size of

cash commitments


concerned about thePensions Regulator’sposition on prudence

Cash

over


of Finance Directorsexpect weaker employercovenant

Cash


of FTSE100 concernedabout impact on

dividends

Cash


Taking control of scheme funding

• Explain objectives and constraints

• Covenant and cash availability

• Way we use advisers

• Offering contingent assets

Open and early engagement with trustees

Cash

49%

43%

41%

30%



Risk


concerned about risks thatthe pension scheme posesto the business

Risk


Actively considering

• Buy-out or buy-in

• Longevity hedging

• Enhanced transfer values

• Pension increase trades

Risk

39%

34%

33%

13%

Cost? Cash? Capacity?



Cost and value


don’t think they get

value for moneybeing spent

Cost and value


anticipate greater costsdue to auto-enrolment

Cost and value


Cost and value

Importance of pensions in employment(change in last 3 years)


Cost and value

Importance of pensions in employment(change in last 3 years)


Changes to future service DB benefits

Recession an opportunity?

14% Lower DB benefits +45%

3% Freeze DB benefits +17%

Alreadyimplemented

Cost and value

Currentlyconsidering


• Unprecedented times, unprecedented actions

• Areas of employer concern

• Demise of ‘sacred cows’

• Employers & trustees face new ‘rules of the game’

Key messages

Cash RiskCost and

value

Optimising decision making inpension schemes

Andrew Evans

Partner, Assurance

Telephone: +44 20 7804 3887

Mobile: +44 (0) 771 031 9449



A corporate perspective

Ian HowardPensions Director, Siemens plc


Our history – over 160 years in the UK

• Pioneers of innovation in the UK sinceWilliam Siemens arrived in 1843 aged19 years

• First ever water meter (1852)London-Calcutta telegraph link (1869)

• Laid first submarine cable to link Britainand the USA (1873)

• First ever electric street lighting (1881)

• First electric lighting in a British theatre– Savoy Theatre, London (1881)


Siemens Benefits Scheme (“SBS”)

• 30,000 DB members - 3,100 “protected” actives

• 19,000 DC members - 14,500 actives

• DB assets and liabilities of £2bn

• DC assets of £200m

• 10 other trust based DB schemes with 6,300members and liabilities of £400m

• Low volatility investment strategy

• 11 Directors of SBS Trustee Company


The corporate agenda

• Closure of DB schemes to future accrual

• Merger of smaller schemes into the SBS

• Buy out of some (very small) schemes

• Simplification/harmonisation of remaining schemes

• Risk Reduction actions

• Ongoing reduction of liability growth and costs

• Continuous improvement of governance and bestpractice


Optimising decision making

• Stay close to your Trustees – understand theirconstraints and needs

• Recognise areas of common interest– Investment sub committee

– Accounting and reporting

– Observing good governance and best practise

• Support development and maintenance of robustprocesses– Risk register

– Payroll/administration

– Advisor reviews

• Roles of Independent Trustees, Secretary,Trustee/Company Advisors


Optimising decision makingThe Corporate Pensions Department

• Responsible for strategy, accounting andreporting

• Runs Pensions Strategy Committee– Medium/ long term planning

– Augmentations

– Early Retirement Applications

– Rule changes

– Financial Performance

• Provides secretarial service to Trustees

• Dotted line responsibility for administration


Optimising decision makingProject Gloaming

• Company Objective: reduce volatility risk andcost of DB schemes

• Trustee Objective: to protect accrued benefits


Optimising decision makingProject Gloaming

The Deal:

• Final salary pensions closed to future accrual

• Deficits plugged 100% (on an IAS accountingbasis)

• Top up of schemes each year

• Generous DC augmentations

• Revaluation of deferred pensions for 15 years toinflation plus 2% max


Optimising decision making - summary

“Trustees should ensure that decisions are taken by persons ororganisations with the skills, knowledge, advice and resourcesnecessary to take them effectively and monitor theirimplementation. Trustees should have the necessary expertise tobe able to evaluate and challenge the advice they receive, andmanage conflicts of interest”

Myners

“Through mutual cooperation and engagement, beneficial andeffective decision making is likely to ensue”

Edmund Truell


A day in the life of a Trustee(in uncertain times)

Tony AshfordChairman, HSBC Bank (UK) Pension Scheme


HSBC Pensions Trust

Equities 18%

Property 8%

Alternatives 11%

Bonds 48%

Cash/ Other 15%

DB 104,000

DC 51,000

DB £11bn

DC £0.5bn

Members Assets DB Asset allocation


A day in the life of a Trustee

A day in the life

of a Trustee

(in uncertain times)

My reputation

is on the line

How much

time?

How many

meetings?

You want me

to sit exams!

This is a

complex issue

(I don’t understand)


It’s not rocket science

Governance framework

Expert advisors

Commercial

relationships

Rigorous supervision/

monitoring

Effective Board/

Committees

People

Process

Structure

It’s not

Rocket Science


Looking after those investments

Andrew Evans


Investment Governance

Trustee objectives

• Asset exist

• Assets safeguarded

• Valuations are accurate

• Counterparty, contract and other risks managed

• Doing what was intended

• Appropriate monitoring of reconciliations andother internal controls

Corporate objectives

COMMONALITY OF INTEREST


So what does this mean?Symptoms

Increasingcomplexity

of investments

Current marketconditions

Caution withinfinancial services

industry

Reliance onthird parties

Awareness

Education

Challenge ofadvisers

Regular monitoring

Needs Prescriptions

Due diligence overback office

Ensure sufficientresources available

Share and sharealike

Risk Transference

Chris Massey

Partner and actuary

Telephone: +44 20 7804 3637

Mobile: +44 (0) 773 987 4800



Key messages

• Manage pension risks like other business risks

• Focus your objectives on key risks and impact

• Target efficient solutions

• Timing is critical, particularly in volatile markets

• Buy-out is not always efficient


Manage pension risks like otherbusiness risks

Identify and

understand

the risksDefine

objectives

Execute and

monitor

Develop a risk

management

plan

Evaluate the

available risk

reduction

options


Objectives – focus on key risks &impact

Risks Impact

Asset Liability mismatch

Demographic

Current deficit

Regulatory

Operational

Balance Sheet

P&L

Cash

Benefit security

External perception

Employee engagement

Capital requirements


Target efficient solutions

Reduce futurecosts

Add to theassets

Reduce pastservice

liabilities

Timing is critical

Changeexistingassets

Transfer risk

Risks Impact

Asset Liability mismatch

Demographic

Current deficit

Regulatory

Operational

Balance Sheet

P&L

Cash

Benefit security

External perception

Employee engagement

Capital requirements


Buy-out challenges

• “Buy-in” does not remove the gross liability

• Impact on P&L

• Deficit is “geared-up”

• Often requires additional funding

• Confidence in the insurance sector

• Lengthy process

PricewaterhouseCoopers LLP

Simplicity is Key!

Rita Powell

Pension Risk Transference

Inside Pensions

Telephone : +44 (0) 8454 377321

Mobile: +44 (0) 7793 296343



Key messages

Keep it simple….

Make it happen…..


First Simple Steps

A Appointments, Advisors, Administrators, Assets and Attitude to change

B Balance of Power, Building strong working relationships, business

plans

C Conflicts of interest, Cleaning up data

D Direction, decisions, developing strategy, delegation of authority

E Executive Responsibility?


Make it happen with

• One Strategy

• One Business Plan

• One Team

• One Timetable

Scheme funding in volatile times

Jonathon Land

Partner and credit advisory specialist

Telephone: +44 (0) 20 7212 8629

Mobile: +44 (0) 787 941 1796



Key messages

• Managing a scheme funding negotiation in the currenteconomic climate is very challenging

• The Regulator is increasing pressure to raise fundinglevels

• The economic downturn constrains cash

• Understanding the employer covenant is vital

• Increased focus on what is affordable by the company

• Understand the issues and take control now


The case study

• Now it is your turn

• What is your role?

• What angle are you looking at?

• We will be asking you for your views


Background - how has the landscapechanged?

Control ofcontributions

Company (often) Trustee negotiation

Regulator's power Insignificant

Pierce corporate veil

Impose liabilities oncompanies and

individuals

Pension deficit Contingent liabilitySignificant

unsecured creditor

BEFORE 2005

Trusteesimposition?

Flexing muscles?

Super materialcreditor?

Today

What is the impact of downturn?


What is the problem?

• Credit crunch

• Equities falling

• The value of employer covenants are falling

• Companies short of cash

• Higher bond yield – neutral FRS17 position

• High profile insolvencies with pension schemes


The impact of the credit crunch

-400

-300

-200

-100

-

100

200

300

Jan 06 Apr 06 Jul 06 Oct 06 Jan 07 Apr 07 Jul 07 Oct 07 Jan 08 Apr 08 Jul 08 Oct 08 Jan 09

Su

rplu

s/(D

efi

cit

)

Funding FRS 17


Linking employer covenant to fundingand investment

Investment strategy Funding target

Employer covenant

Deficit

TPR now says scheme funding objective= Section 75 - employer covenant


The seven dwarfs 2005?

Buy-out

FRS17

Oldfundingbasis

PPF

MFRSSAP 24

Transfervalues

Assets atmarketvalue

Buy-out


The seven dwarfs today?

Buy-out

FRS17

Oldfundingbasis

PPF

Assets atmarketvalue

NewSchemeFunding

SwapCurve

EmployerBuy-out

Strongcovenant

Self-Sufficiency

Buy-out

NewSchemeFunding?


Factors influencing trustees’negotiating position

• Change in the covenant

• Composition of the trustee board – position,power and personality

• Trust Deed and Rules, trustees’ powers

• Use of public relations

• Fear of personal liability

• Negotiating skills, and who are their advisors

What drives your trustees?


Agreeing scheme funding

The Regulator’s code of practice states

“It is essential for the trustees to form an objectiveassessment of the employer’s financial position andprospects as well as his willingness to continue tofund the scheme’s benefits (the employer’scovenant)”

“This will inform decisions on both the technicalprovisions and any recovery plan needed”



The Regulator’s press release 11 Dec 2008 says

“Trustee’s should not over-react in the face of thedownturn, but should ensure they are active and alertto potential changes in the health of the sponsor, andto the funding level of the scheme”

“In responding to short-term cash flow difficultiestrustees should first consider back-end loadingrecovery plans”



The Regulator’s press release 18 February 2009 says

"We are sensitive to the pressures employers face.There is no reason why a deficit should push anotherwise viable employer into insolvency”

"Employer and trustees should understand thedifference between temporary impacts of theeconomic cycle and longer term structural changes tothe strength of their scheme sponsor"


What is an employer covenant review?

• An objective and independent assessment of theoverall financial strength of the scheme employer(s)

• Combining credit advisory skills with the knowledge ofthe scheme actuary and the legal advisors

• Provides clear recommendations from detailedanalysis, proportional to the risk

• Required for both the employer and the trustees

You should take control by measuring andunderstanding the covenant


How do you measure the strength ofthe employer covenant?

Weak

Tending to Weak / Tending to Strong

Strong


How do you measure the strength ofthe employer covenant? Key areas:

7.Market andIndustry

3.Willingness tosupport and legalpowers

6.Forecasts2.Scheme specifics

5.Current profitabilityand cash flow

1.Group Structure

4.Balance sheetOverall current

assessment

AssessmentSectionAssessmentSection


How do you measure the strength ofthe employer covenant? Example:

7.Market andIndustry

3.Willingness tosupport and legalpowers

6.Forecasts2.Scheme specifics

5.Current profitabilityand cash flow

1.Group Structure

4.Balance sheetTending to strongOverall current

assessment

AssessmentSectionAssessmentSection

Scheme funding in volatile timesCase Study

Nigel Casson

David Davies


Company Issues

• Underperforming divisions

• High interest charges

• Tight cash flow and banking covenants

• Poor forecasting accuracy

• Depressed share price

• Scheme still accruing benefits


Company Issues

Actual Forecast Forecast Forecast Total

Sept 08 - 09/10 10/11 11/12

Mar-09

Operating cash b/f 100 100

Restricted cash b/f 200 200

Cash from operations 20 40 120 160 340

Total 320 40 120 160 640

Original company proposal 15 40 40 40 135

Forecast cash available and proposed pension contributions (£'m)


Case study – Project CakeFuture prospects - bank covenants

Cash is clearly constrained

Gross Debt : EBITDA Covenant

3.00

4.00

5.00

6.00

7.00

8.00

Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13

Ratio

Gross Debt : EBITDA Covenant

Senior Debt : EBITDA Covenant

1.00

1.50

2.00

2.50

3.00

3.50

4.00


Ratio

Senior Debt : EBITDA Covenant

Cash Flow Coverage Covenant

0.50

1.00

1.50

2.00

2.50

Mar-09 Sep-09 Mar-10 Sep-10 Mar--11 Sep-11 Mar-12 Sep-12 Mar-13

Ratio

Cash Flow coverage ratio Covenant

EBITDA Interest cover

1.50

2.00

2.50

3.00

3.50


Ratio

EBITDA : Interest Covenant

7% Headroom


Trustee Issues

• Deficit £350m FRS17

• Is company going concern?

• Poor employer covenant with little chance ofimprovement

£1.5bnBuy-out

£750mGovernment bond (gilts)

£350mCorporate bond (FRS17)

£100mPrevious approach

DeficitBasis


Questions for the audience

• Trustees

>What is your biggest concern in your role?

>What would you ask for?

• Company

>What is your fall back position?

>What would you ask for?


Case study – Project CakeWhat can trustees ask for?

1. Immediate cash settlement of the deficit

2. All free cash to be paid to the Scheme

3. Recovery plan to coincide with refinancing

4. Escrow account for deficit

5. Proportion of all future disposal proceeds to be paid to the Scheme

6. Security over assets

7. Letter of credit/ bank guarantee

8. Group guarantee over funding objective/ buy-out deficit

9. Increase number of participating employers

10.Do nothing until the time of the refinancing

11.Seek joint and several liability


Case study – Project CakeThe company’s position?

1. No increase in the proposed offer

2. Ask the Trustees to work with the company

3. Understand that we have always supported the Scheme and to stopbeing so unreasonable

4. The Regulator has said that you should “work with the company andhelp it through the down turn”

5. Consider – a contribution holiday for two years

6. Back end load the recovery plan

7. Set deficit at FRS 17 levels – funding above this level the ratingagencies will not give us credit


Case study – Project CakeOutcome

Actual Forecast Forecast Forecast Total

Sept 08 - 09/10 10/11 11/12

Mar-09

Operating cash b/f 100 100

Restricted Cash b/f 200 200

Cash from operations 20 40 120 160 340

Total 320 40 120 160 640

Original company proposal 15 40 40 40 135

Revised proposal 105 20 20 35 180

Forecast cash available and proposed pension contributions (£'m)


Case study – Project CakeOutcome

• Secured for the trustees

– Joint and several liability

– Increased information provision

– Agreed percentage of subsidiary disposalproceeds to the scheme

– Equitable contribution level for all parties


In our experience

Both company and trustees need to

• Know and understand the trustees’ powers

• Think through what information is required and how it willbe used

• Work together to secure a balanced solution

There is no right answer, the final solution is dependent onreally understanding the position and the negotiationskills of the parties

How good a deal would you negotiate?


Key messages

• Managing a scheme funding negotiation in the currenteconomic climate is very challenging

• The Regulator is increasing pressure to raise fundinglevels

• The economic downturn constrains cash

• Understanding the employer covenant is vital

• Increased focus on what is affordable by the company

• Understand the issues and take control now

Levies, life and the (pensions)universe

Partha DasguptaCEO, Pension Protection Fund

Raj Mody

Partner and Chief Actuary

Telephone: +44 (0) 20 7804 0953

Mobile: +44 (0) 7974 969320


Panel Session

Marc Hommel

Andrew Evans

Jonathon Land

Pensions – managing risk in volatile economic times 3 ... · – HR – Pensions • December 2008. PricewaterhouseCoopers LLP Slide 18 Context for employers ... -200-100-100 200

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