1. 2009 Annual Meeting ● Assemblée annuelle 2009 Halifax, Nova Scotia ● Halifax (Nouvelle-Écosse) 2009 Annual Meeting ● Assemblée annuelle 2009 Halifax, Nova Scotia ● Halifax (Nouvelle-Écosse) Canadian Institute of Actuaries Canadian Institute of Actuaries L’Institut canadien des actuaires L’Institut canadien des actuaires

2. Christian-Marc Panneton 2009-06-25 WS-30 LDI for Pension Plans: Moving from Theory to Practice AT-30 Les placements fondés sur les passifs pour les régimes de retraite: de la théorie à la pratique WS-30 LDI for Pension Plans: Moving from Theory to Practice AT-30 Les placements fondés sur les passifs pour les régimes de retraite: de la théorie à la pratique 2009 Annual Meeting Assemblée annuelle 2009 2

3. LDI for Pension Plans Agenda Liabilities Interest Rate Risk Credit Spread Risk Risks Management Process Conclusion 2009 Annual Meeting Assemblée annuelle 2009 2009 Annual Meeting Assemblée annuelle 2009 3

4. Interest Rate Risk Objective: Mitigate interest rate risk 1 st Step: Determine risk exposure – Duration is a simple metric A single number indicating sensitivity to interest rate changes Duration gap between assets and liabilities 2009 Annual Meeting Assemblée annuelle 2009 2009 Annual Meeting Assemblée annuelle 2009 4

5. Interest Rate Risk – Need liability characteristics – Typically monthly expected CF – Must be updated regularly Adjust for actual vs expected – Case Study: retirees 2009 Annual Meeting Assemblée annuelle 2009 2009 Annual Meeting Assemblée annuelle 2009 5 PV @ 4.50% = 106,63 millionsDuration = 8.50

6. Duration – rule of thumb –Given a duration of D, a variation of  y in yields will change the value by  D  y Duration = 8.5, y increases by 1% => decrease of 8.5% Interest Rate Risk 2009 Annual Meeting Assemblée annuelle 2009 6 PV @ 4.50% = 106.63 millions PV @ 5.50% = 98.23 millions  = 7.88%

7. Duration metric is not precise –PV is not a linear function Convexity –Indicates Duration sensitivity to interest rate changes Interest Rate Risk 2009 Annual Meeting Assemblée annuelle 2009 7 Duration @ 4.50% = 8.50 Duration @ 5.50% = 7.92 Convexity @ 4.50% = 132.65 –Expected change in PV –with duration only:- 8.50% –With duration and convexity: - 7.83% –Actual change:- 7.88%

8. Assumptions Liability duration:8.50 Funded ratio:100% Traditional 60-40% Mix Equities Duration:0 DEX Universe Duration:6.57 (2007-12) 60%-40% Mix Duration:2.63 –Impact of a decrease in yield of +50bps Assets increase by 1.32% Liabilities increase by 4.25% Funded ratio decreases to 97.07% Case Study 2009 Annual Meeting Assemblée annuelle 2009 8 Material interest rate risk with Traditional 60-40% Mix

9. Using Long-Term Bonds Equities Duration: 0 DEX Long-term Duration:12.61 (2007-12) 33%-67% Mix Duration: 8.45 –Impact of a decrease in yield of +50bps Assets increase by 4.23% Liabilities increase by 4.25% Funded ratio almost unchanged! (99.98%) Case Study 2009 Annual Meeting Assemblée annuelle 2009 9 Taking into account the liability’s CF duration in selecting assets can reduce exposure to interest rate changes.

10. Not So Easy! –From Dec. 31, 2008 to March 31, 2009 TSX Total return:  2.0% DEX Universe:+ 1.5% DEX Long-term:+ 0.3% Solvency liability:  1.5% Liability valued with Canada yield curve:  0.3% CF Matching Liability (AA yield curve):+ 4.4% –From Sep. 30, 2008 to Dec. 31, 2008 TSX Total return:  22.7% DEX Universe:+ 4.5% DEX Long-term:+ 5.2% Solvency liability:+ 3.2% Liability valued with Canada yield curve:+ 8.9% CF Matching Liability (AA yield curve):  4.8% Case Study 2009 Annual Meeting Assemblée annuelle 2009 10

11. Case Study 2009 Annual Meeting Assemblée annuelle 2009 11 Assets (at market) Stocks TSX Total Return Bonds DEX Universe DEX Long-term Solvency Liability Funded Ratio Sep 30, ‘08 60.0 40.0 - 100.0 100.0% Dec 31 ‘08 46.4 41.8 - 88.2 103.2 85.4% Mar 31 ‘09 45.5 42.4 - 87.9 101.7 86.5% Sep 30, ‘08 33.0 - 67.0 100.0 100.0% Dec 31 ‘08 25.5 - 70.5 96.0 103.2 93.0% Mar 31 ‘09 25.0 - 70.7 95.7 101.7 94.1% 60-40% Traditional Asset Mix33-67% Alternative Asset Mix Taking into account the liability’s CF duration in selecting assets did reduce exposure to interest rate changes!

12. Case Study Solvency Liability – Based on a single rate: Canada over 10-years bond + spread – Doesn’t capture full yield curve dynamic Better Approach to Risk Management – Consider the complete yield curve Start with the Canada Bond yield curve Bootstrap to get spot curve… 2009 Annual Meeting Assemblée annuelle 2009 2009 Annual Meeting Assemblée annuelle 2009 12

13. Case Study Partial Duration – Measure the sensitivity of change in yield for a given maturity – Sums to duration (2008-12-31) 2009 Annual Meeting Assemblée annuelle 2009 2009 Annual Meeting Assemblée annuelle 2009 13 Low sensitivity to short-term rates High sensitivity to long-term rates

14. Case Study Evolution Canada Yield Curve 2009 Annual Meeting Assemblée annuelle 2009 2009 Annual Meeting Assemblée annuelle 2009 14 From Dec 07 to Sep 08 Large short-term rates decrease dominates => +0.3% From Dec 08 to March 09 Long-term rates increase dominates =>  0.3%

15. Case Study Yield Curve for Liabilities – Investment Policy: Assets allowed – Based on Target or Benchmark portfolio – Provincial spreads vs Canada Ontario spreads increased by 47bps in Q4 2008 2009 Annual Meeting Assemblée annuelle 2009 2009 Annual Meeting Assemblée annuelle 2009 15

16. Case Study Yield Curve for Liabilities – Spreads on Corporate raised even more in 2008 Ontario spreads increased by 93 bps A-rated Corporate spreads increased by 305 bps 2009 Annual Meeting Assemblée annuelle 2009 2009 Annual Meeting Assemblée annuelle 2009 16

17. Case Study Credit Spread Risk – Can be more material than interest rate risk – From Sep ‘08 to Dec ’08 Canada curve decreased => + 8.9% Ontario curve decreased by smaller amount => + 4.2% A-rated Corp. curve increased =>  5.5% 2009 Annual Meeting Assemblée annuelle 2009 2009 Annual Meeting Assemblée annuelle 2009 17 Liability

18. Case Study Credit Spread Risk – From Dec ‘08 to March ’09 Canada almost unchanged =>  0.3% Ontario stepped lightly =>  0.2 % A-rated Corp. curve decreased => + 5.8% 2009 Annual Meeting Assemblée annuelle 2009 2009 Annual Meeting Assemblée annuelle 2009 18 Liability Type of Bonds in portfolio can make a huge difference!

19. Risks Financial Risks – Interest rates – Credit spread – Liquidity – Inflation – Market risk –…–… Non-financial Risks – Mortality – New entrants / Turnover –…–… 2009 Annual Meeting Assemblée annuelle 2009 2009 Annual Meeting Assemblée annuelle 2009 19

20. Portfolio construction Development of an investment policy Analysis of client’s needs Optimization Reports to clients Portfolio rebalancing Follow-up of matching LDI - ALM Process 20

21. Portfolio Management Not “Active” in traditional sense, Not “Buy-and-Hold” either! Decision-making process – Continuous process – Close collaboration between Team members – Assumption testing – Portfolio Decision – Validation 2009 Annual Meeting Assemblée annuelle 2009 2009 Annual Meeting Assemblée annuelle 2009 21

22. Portfolio Management Yield curve analysis and bond pricing – Internal and External sources – Securities allowed in portfolio: detached coupons, asset-backed securities, asset-backed mortgages, synthetic bonds, corporations (public and private), derivative products, RRB, … Buy and Sell decision – Portfolio Rebalancing – Opportunities – Market Events 2009 Annual Meeting Assemblée annuelle 2009 2009 Annual Meeting Assemblée annuelle 2009 22

23. Portfolio Management Portfolio Construction Process – Objective: Ensure matching of liabilities according to risk metrics defined in investment policy. – Steps: Replication of the benchmark portfolio with a portfolio of zero coupons and/or bonds, Diversification of fixed income securities (issuers, activity sectors, geographic regions,…), Credit risk limited (e.g., maximum concentration rules by asset item class, sub-class, activity sector, issuer), Currency risk must be managed if allowed, Counterparty risk limited by concentration rules, Portfolio optimization, Final portfolio construction. 2009 Annual Meeting Assemblée annuelle 2009 2009 Annual Meeting Assemblée annuelle 2009 23

24. Conclusion Managing the Financial Risks associated with a Pension Liability Requires: – A very good understanding of the liability financial characteristics. – Risk tolerance limits which reflect the risk appetite of the Pension Plan. – Tools to measure and assess current risk position. – Portfolio managers which can generate added- value within pension plan risk appetite. 2009 Annual Meeting Assemblée annuelle 2009 2009 Annual Meeting Assemblée annuelle 2009 24

25. Thank You! 2009 Annual Meeting Assemblée annuelle 2009 2009 Annual Meeting Assemblée annuelle 2009 25