1. Reducing risk in corporate pensions Myles Pink, Paternoster
Faculty of Actuaries
6 December 2006
P A T E R N O S T E R

2. Drivers of change in the defined benefit pension buy-out market
Securing pension promises “safe haven”
Pensions Regulator
Increasing disclosure obligations
Pension Protection Fund
Employee / union pressures
Pension
fund
trustees
Company directors
Defined
benefit pension
plan
Concerns about “unsecured creditor” status
Improving longevity
Deficit volatility

3. How did we get here? 2005: The Pensions Regulator replaces OPRA
1997: Gordon Brown removes tax relief on dividends
OPB is replaced by OPRA
MFR introduced
8000
6000
1988: Nigel Lawson taxes surpluses under SSAP24
4000
2006: SSF and PPF introduced
2001: FRS 17 disclosures introduced
2000
1990s: Contribution holidays
1985
1989
1993
1997
2001
2005
2006

4. Mortality rate for men aged 65-74 in England & Wales
The life expectancy revolution
1841
1981
140
years
1999 18
2007 8
7.00%
Mortality rate for men aged in England & Wales
6.00%
5.00%
4.00%
3.00%
2.00%
In 1841 the mortality rate for men in England & Wales aged was 6.6%
In years later - this mortality rate was 30% lower
The next 30% fall was achieved in just 18 years (by 1999)
We now expect a further 30% fall will be achieved by 2007 – a period of just 8 years
1.00%
0.00%
1800
2050

5. The pace of change has accelerated dramatically
4.0%
3.5%
Average annual reduction in mortality rates for men in England & Wales aged (smoothed)
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
1855
1885
1915
1945
1975
2005

6. This is partly due to the emergence of the “cohort effect”
In the UK men and women born in the period have experienced more rapid reductions in mortality rates than generations born either before, or after, this period

7. Deaths from heart disease have reduced dramatically
1.8%
1.6%
1.4%
Mortality rate from heart disease for men aged in England & Wales
1.2%
1.0%
0.8%
0.6%
“Premature deaths from heart disease could be eliminated with 10 years”
Professor Roger Boyle, 2004
0.4%
0.2%
0.0%
1950
1960
1970
1980
1990
2000

8. We are now seeing mortality improvements in cancers not linked to smoking
-40%
-30%
-20%
-10% 0%
10%
20%
30%
Age 40-49
Age 50-59
Age 60-69
Age 70-79
Change in
incidence
mortality
Change in breast cancer incidence and mortality over the period for females in England & Wales

9. Projected future improvements for the 1930-34 generation…
6.0%
5.0%
4.0%
3.0%
2.0%
Medium cohort projection
Published in 2002 by the Continuous Mortality Investigation
Became an almost universal standard for annuity pricing
Generally speaking, actuaries advising pension schemes have been somewhat slower to adopt
“It’s been very difficult to persuade clients to move all the way to medium cohort”
Perhaps 50% of pension schemes use medium cohort. Most of the remainder assume less rapid future improvements
A Lane Clark Peacock survey showed the average life expectancy assumption for FTSE100 companies was 2 years less than implied by the PXA92 standard mortality tables with the medium cohort projection
Implications
Most pension schemes are using assumptions that understate likely future mortality improvements
There is considerable uncertainty as to the exact magnitude of future changes
Pension schemes should consider the impact of different scenarios on liabilities
1.0%
0.0%
1972
1982
1992
2002
2012
2022

10. Deficit for final salary pension plans
Increased disclosure requirements
Watson Wyatt
Deloitte
Willetts
£-42bn
FTSE 100
FRS17
£-100bn
All UK companies
FRS17
£-180bn
All UK companies
Buyout cost
Deficit for final salary pension plans

11. Increased disclosure requirements
Pension liabilities
Insurance companies must operate in surplus
True economic cost
Pension funds can be managed in deficit
Pension regulation
Insurance regulation

12. Scheme specific funding
Changes in pensions regulation
PPF
Pensions regulator
SPV
Scheme specific funding
Section 75

13. Bulk annuity market volumes (£bn)
Past performance – a growing market 3 2
Bulk annuity market volumes (£bn) 1
2000
2001
2003
2005
2002
2004

14. Bulk Annuity Market Volumes (£bn)
Future outlook – an exploding market
100
200
300
400
500
600
700
800
900
LIABILITIES £900 billion
FRS17 deficit £100 billion
Buy-out deficit £300 billion
No. OF SCHEMES 10,000
No OF MEMBERS 15 million
Bulk Annuity Market Volumes (£bn)
2000
2001
2003
2005
2002
2004
2007+

15. Paternoster’s proposition
Traditional buyout
Low risk
Risk transfer with profit share
Partial/ progressive risk transfer
ALM
Asset return optimisation
Managing deficits
High risk
No action
Increased contributions
Low funding
High funding

16. A pension scheme buy-out
Cash payment (net of tax relief)
Assets
Paternoster
Scheme
Sponsoring Company
100% of benefits
Members become annuitants of Paternoster
Annuitants

17. Partial/ progressive risk transfer
A scheme can be naturally split into the liability cash flows payable to its pensioners and those to its deferred members…

18. Partial/ progressive risk transfer
It is also possible to completely remove the liability cash flows of a scheme for a period of time…

19. Risk transfer with profit share
£ Y m
Increased benefits for former Scheme members
£ Z m
£ X m
Paternoster
Escrow account
Sponsoring Company
Annuitants
Payment of benefits + cash commutations
£ X m + £ Y m + £ Z m = Total available cash for commuted pensions

20. P A T E R N O S T E R

21. The DB scheme risk transfer process
Buy-out price and structure agreed
Employees informed
Trustees and Pensions Regulator approval
Scheme closed
“On risk” events
Group policy issued
Employer triggers termination
Liabilities assumed by Paternoster
Assets plus premium paid to Paternoster
Escrow established
Derivatives overlay
“Exchange for physicals”
Data transfer
Contracts novated
“clean up”
Escrow release
Trustees wind up scheme
Trustees sign deed of termination