1.  PRMIA Meeting 16 July 2003 Liability Benchmark Portfolio The relationship between Pension assets and liabilities Institute/Faculty Working Party

2. Terms of reference To address and make recommendations to the Myners/Sandler Steering Group on the contents of a briefing document for trustees and sponsors on the relationship between pension fund assets and liabilities.

3. Assets and Liabilities nAssets nmajority traded therefore market prices nLiabilities nuntraded nbenefit payments in the future nthese are a series of cashflows

4. What liabilities to consider nPension entitlement for a member is based on nservice to date ncurrent salary nincluding statutory revaluation, and increases nexclude discretionary payments nPresent value of the accrued liabilities are a measure of their “fair value” nLiabilities are not traded so we need a proxy nthe Liability Benchmark Portfolio (LBP)

5. The liabilities

6. What is the LBP? nLiability benchmark portfolio is nthe portfolio of assets such that, in the absence of future contributions, benefit accrual or random fluctuations around demographic assumptions, the scheme maintains its current solvency level (the ratio of assets to liabilities) as economic conditions change. As at 1 January 2003 PV = £175m ChangeNew Liability % change Interest rates -1%£200m14.3% Inflation +1%£197m12.7%

7. Relationship between assets and liabilities? nIs given by the relationship between the schemes assets and the LBP (a liaby proxy). nConsider a scheme which holds assets Asset class% of portfolio Equities40% Index-Linked35% Fixed Interest25%

8. LBP v asset returns Asset returns relative to LBP Q1Q2Q3Q4

9. LBP v asset returns Asset returns relative to LBP Q1 0.9% Q2Q3Q4

10. LBP v asset returns Asset returns relative to LBP Q1 0.9% Q2 -6.8% Q3Q4

11. LBP v asset returns Asset returns relative to LBP Q1 0.9% Q2 -6.8% Q3 -10.0% Q4

12. LBP v asset returns Asset returns relative to LBP Q1 0.9% Q2 -6.8% Q3 -10.0% Q4 2.2%

13. Technical details nPension liabilities are too long nduration is important nLiabilities’ link to inflation (cap of 5% and floor of 0%) nthese are embedded options ninfluences the proportion of FI and IL in the LBP nYield curves are not flat

14. Yield curves at 1 January 2002

15. Yield curves at 1 January 2003

16. Limitations of the LBP nneeds to be dynamic – changes with economic conditions nDoes not capture demographic changes nNo allowance for the benefit outgoes and contributions paid nRegular re-estimation mitigates these risks

17. Mis-interpretations nPensions are identical to corporate debt nnot (usually) traded, ndemographics, nterm of the liabilities, nissuance, and redemption, nPensions are 100% guaranteed - No nFunding nworks for any solvency level nInvestment strategy nTrustees’ decision nTime horizons Pensions are still debt-like

18. 11 th June – White Paper n“Debt on the employer” is the full buy-out cost nClarifies the nature of the pension promise nPension Protection fund nCost estimated at £340-375m nPremiums based in flat levy and “risk-based” premium

19. Conclusions nA practical way of understanding the relation between pension scheme assets and liabilities ntransparent nstandard financial techniques nsome actuaries already use similar approaches neducational tool for better informed decision making n…consistent with Myners

20.  PRMIA Meeting 16 July 2003 Liability Benchmark Portfolio The relationship between Pension assets and liabilities Institute/Faculty Working Party