PD-22 Risk Management Outside the Insurance Industry André Choquet, FSA, FCIA General Meeting/Assemblée générale 2007, Montréal, Québec PD-22 Risk Management Outside the Insurance Industry André Choquet, FSA, FCIA General Meeting/Assemblée générale 2007, Montréal, Québec Canadian Institute of Actuaries Canadian Institute of Actuaries L’Institut canadien des actuaires L’Institut canadien des actuaires

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 From Pension Risk Management to Enterprise Risk Management Setting the Stage Inside Pension Risk Management Moving Toward Enterprise Risk Management

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 Why do organizations have pension plans? Both workforce and organizational life cycles drive decisions about pension plans ! Optimize human capital investment Attract and retain labour Ensure orderly transition of workforce

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 Value at Risk Risk is relative to expectations Risk measurement is evolving Unipolar Risk Risk Volatility Greater volatility equals greater risk Evolution Compliance with regulations brings no rewards; non- compliance results in penalties Bipolar Risk Research expenditures lead to high returns or loss of capital Fair Price of Risk Protection offered through use of hedges

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 From Pension Risk Management (PRM) to Enterprise Risk Management (ERM) Measure Tangible Risk Illustrate Intangible Risk Is risk appropriate? Hedge or not? How much risk? ERM MonitorImplement PRM

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 Pension Risk Management involves multiple parties Financial Management Financial Management Portfolio Management Portfolio Management Benefit Delivery Benefit Delivery Benefit Policy Benefit Policy Compliance Source: Watson Wyatt Worldwide

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 How large is the plan to shareholders’ equity? Pension Liability/Sharholders’ Equity Source: Watson Wyatt Worldwide

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 Solvency ratio stayed flat despite good returns Source: Watson Wyatt Worldwide

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 Achieving 100% solvency… Source: Watson Wyatt Worldwide

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 …And remaining 100% Solvent With a new Bond Portfolio Using current portfolio with swaps and futures DB Buy-out, annuity purchase

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 How a DB Buy-out could work in Canada

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 Longevity risk difficult to hedge Source: Watson Wyatt Worldwide

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 Not all mature plans are shifting away from equities Plan Maturity % Compared to Equity % Source: Watson Wyatt Worldwide

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 Risk budgeting: A framework to allocate risk Asset/Liability Stochastic Simulation Setting risk budget Decision 3 $205$210$215$220$225$230$235 PV of Contributions (10 Years) Plus Solvency Deficit ($ Million) 50 th Percentile PV of Contributions (10 Years) Plus Solvency Deficit ($ Million ) VaR95 55% equity, LB, +5% intl, +5% HY and alt structure 55% equity, LB, +5% intl, +5% HY and current structure 55% equity, LB, +5% intl and current structure 55% equity, LB and current structure Policy (65% equity) and current structure $325 $330 $335 $340 $345 $350 $355 $360 Source: Watson Wyatt Worldwide

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 Risk shifts from employer… Balanced Fund Present Value of Cumulative Net Expense ($M) $0.0 $10.0 $20.0 $ % Non-Contrib DB1.5% Contrib DB w 3% EE Contrib1% DB + 3% DC6% DC 5th-25th percentile25th-50th50th-75th75th-95thMean Source: Watson Wyatt Worldwide

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 …to members 0.0% 0.2% 0.4% 0.6% 0.8% 1.0% 1.2% 1.4% 1.6% 1.8% 2.0% 1.5% Non-Contrib DB1.5% Contrib DB w 3% EE Contrib 1% DB + 3% DC6% DC Plan Annual Plan Accrual as a Percentage of Pay 10%25%50%75%90%Mean Risk for Employee at Age 40 Source: Watson Wyatt Worldwide

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 Relative pension after 20 years of contributions as a percentage of the best outcome (Based on UK market data) Defined contribution risks: Investment decisions and annuitization Source: Watson Wyatt Worldwide

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 Another looming mismatch? Labour needs vs benefit design GDP (%) Labour Productivity (%) Required Labour Input (%) Labour Supply (%) Estimated Labour Shortages End of Period (Mil) 2006– – – – Living Standards Improvement = 1.85% Source: Watson Wyatt Worldwide

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 Use qualitative methods to assess other risks Compliance Governance Benefit Delivery

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 Risk Workshops Resolver*Ballot manages risk assessment workshops to build consensus and provide results in real-time Risk workshop participants evaluate and prioritize risks (and controls). Results are viewed and discussed to provide clarity, then re-evaluated. Risk workshop results are reviewed by all. Source: Resolver Inc.

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 A holistic framework: Moving toward enterprise risk management Measure Tangible Risk Illustrate Intangible Risk Is risk appropriate? Hedge or not? How much risk? ERM Monitor Implement PRM

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 The ERM risk management process Understand Manage Measure “ Risk comes from not knowing what you are doing” Warren Buffet

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 Websites and references PWC Saratoga Institute : 2006 Key Trends in Human capital Report A85256EBA0058B5C4 A85256EBA0058B5C4 Mortality Derivatives and the Option to Annuitize: M. Milevski and D. Promislow Revisiting CAPM Bill Sharpe "Investors and Markets: Portfolio Choices, Asset Prices and Investment Advice," DC Risks –DC - a ticking time bomb? M-UK-32 M-UK-32 –SEI surveys on DC member investment behaviour. – ort_1104.pdfhttp:// ort_1104.pdf – fer_Consequences_of_Overconfidence.pdfhttp:// fer_Consequences_of_Overconfidence.pdf

2007 General Meeting Assemblée générale General Meeting Assemblée générale 2007 Websites and references 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: english/topics/htrender.asp?ID= english/topics/htrender.asp?ID=15104 WW study on labour shortages: english/pubs/specialmemoranda/showarticle.asp?Artic leID=16466&pdfURL=pdf/sm pdf&articledate=9/25/2006&Component=Memora ndum english/pubs/specialmemoranda/showarticle.asp?Artic leID=16466&pdfURL=pdf/sm pdf&articledate=9/25/2006&Component=Memora ndum On DB Buy-out in the UK