1. Managing funding ratio risk and return Aaron H. Meder, FSA, EA Senior Asset-Liability Analyst, UBS Global Asset Management October 20, 2006 Not intended for public distribution. For important additional information, please see the Additional Disclosures at the end of the presentation.

2. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 2 Agenda Current defined benefit challenges Focus on funding ratio Funding ratio risk and return management process Understanding liabilities Develop a funding ratio risk budget Implement risk budget Monitor risk budget Appendix

3. Current defined benefit challenges

4. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 4 The asset-liability mismatch Source: UBS Global Asset Management, Bloomberg Note: Typical Asset Return represents 40% S&P 500 Index//10% Russell 2500 Index/10% MSCI EAFE Index/35% Lehman Brothers Aggregate Index/5% 3 Month T-Bills. Typical Liability Return represents the PBO of a typical pay-related defined benefit plan. Discount rate is the yield on the Moody’s Aa Corporate Bond Index. Assumes no contributions. Benefit payments and service cost are excluded from each year’s annual growth. Market-related Asset and Liability Returns 1994-2005 A good year or a bad year? “Perfect storm” Difference between asset and liability returns Asset-liability mismatch risk causes funding ratio volatility

5. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 5 The asset-liability mismatch (cont’d) Note: Liability represents the PBO of a typical pay-related defined benefit plan, with approximately 2.5% service cost. Discount rate is the yield on the Moody’s Aa Corporate Bond Index. Assumes no contributions. Includes benefit payouts Managed through investment policy Managed through funding and benefit policies Source: UBS Global Asset Management, Bloomberg

6. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 6 Pension deficits Note: Benefit payments were excluded from analysis. Source: UBS Global Asset Management Liability expected to grow a steady 8%-9% Key factors:  Passage of time (interest cost) = 5.5%-6.0%  Additional benefits earned (service cost) = 2.5%-3.0% Fund must generate large enough returns to meet liabilities Liability relative return needed to close funding gap over various time horizons Majority of plans have deficits; greater the deficit, greater the need for return

7. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 7 Global pension reform Funding regulations US: Pension Protection Act removes majority of smoothing of assets and liabilities harsher penalties for being underfunded Canada: Pension Benefit Act Solvency requirements focus on termination liability drives contribution requirements Accounting regulations FASB and IASB working towards global accounting regulations for pensions Best guess is that they will take away much of smoothing Regulators moving to marked-to-market view of asset and liabilities

8. Our response: Focus on funding ratio

9. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 9 Focus on funding ratio Minimize FR volatility for a given level of FR return The funding ratio, not level of assets in isolation, drives pension risk Pension reform Funding and accounting reform begins 2006 Facing the challenges and “attacking the pension dragon” Large return needs Need for increased returns to keep contributions at a tolerable level Reduce the asset- liability mismatch Causes include duration mismatch and equity market risk Challenges Our response

10. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 10 Funding ratio approach vs. traditional approach For illustrative purposes only.

11. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 11 Measuring risk and return vs. the liability Funding ratio risk/return characteristics Source: UBS Global Asset Management Please see additional disclosures at the end of the presentation Long Gov’t/Credit Equities Traditional 65/35 policy Asset-only frontier Aggregate Bonds Cash Funding ratio frontier Liability matching strategy

12. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 12 Constructing efficient options Hedge liabilities Hedging component  Interest rate derivatives  Long duration bonds Return generating component  Global diversification  Active “alpha” and “beta” Return generation For illustrative purposes only

13. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 13 Liability hedging and return generation Combine liability hedging and return generation efficiently Source: UBS Global Asset Management Please see additional disclosures at the end of the presentation Liability hedging Return generation

14. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 14 Policies structured relative to liabilities Need to eliminate uncompensated funding ratio risk Source: UBS Global Asset Management Please see additional disclosures at the end of the presentation Return generation Equities Traditional 65/35 policy Funding ratio frontier Asset-only frontier Long Gov’t/Credit Aggregate Bonds Liability matching strategy Liability hedging

15. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 15 The funding ratio risk management process ALM Understand liability risk and growth Understand how assets relate to liabilities Understand liabilities 1 Define efficient investment policies in an asset-liability framework Determine appropriate risk/return tradeoff Develop funding ratio risk budget 2 Implement solution that best fits client preferences Assess investment policy in context of current market environment Implement risk budget 3 Dynamically manage risk budget as a function of plan funding ratio Specific to each plan sponsors risk tolerance Manage risk budget 4 Source: UBS Global Asset Management

16. Process: Step 1 - Understanding the liabilities

17. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 17 Key pension liability risks AssetsLiabilities Wage growth Demographic experience (e.g. Longevity) Inflation Interest rates Question: How should we best invest pension assets to cover for pension promises? ? Answer: By taking compensated risk and hedging the uncompensated ones For illustrative purposes only

18. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 18 Liability risks: Discount rate Changes in discount rates have a large impact on the value of liabilities Discount rates determine the present value of the liabilities If interest rates go down, the value of liability increases Discounted future cash flows For illustrative purposes only

19. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 19 Liability risks: Salary growth Salary growth tends to move with inflation and economic real growth. Investing in equities and other real assets can mitigate the impact of these risks Best estimate of cash flows Uncertainty due to salary growth Expected annuity payment, employee age 55 Source: UBS Global Asset Management

20. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 20 Liability risks: Inflation The impact of inflation can be mitigated by investing in real rate bonds or other inflation-sensitive assets There can be ad hoc or contractual benefit adjustments to inflation Best estimate of cash flows Uncertainty due to inflation Expected annuity payment, employee age 65 Source: UBS Global Asset Management

21. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 21 Fundamental Factors Real Rate Inflation Real Growth Asset Risk Premia Focus on fundamental exposures Linking liabilities to assets For illustrative purposes only. Future Real Wage Growth Future Wage Inflation Active Accrued Deferred Retiree Liability Accrued liability Projected liability Fundamental Exposures Inflation Real Growth Interest Rates Assets that mimic Real Rate Bonds Equities & Other Real Assets Nominal Bonds

22. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 22 Correlations between liabilities and cornerstone hedging assets Linking liabilities to assets This information is presented for illustrative purposes only and reflects UBS Global Asset Management’s expectations for prospective return and risk using current market assumptions. There is no assurance that these projections will ultimately be realized.

23. Process: Step 2- Developing a risk budget

24. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 24 Constructing efficient options Hedge liabilities Hedging component  Interest rate derivatives  Long duration bonds Return generating component  Global diversification  Active “alpha” and “beta” Return generation For illustrative purposes only

25. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 25 Example: Efficient options Source: UBS Global Asset Management Please see additional disclosures at the end of the presentation

26. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 26 Example: A range of efficient options Source: UBS Global Asset Management Please see additional disclosures at the end of the presentation Funding ratio risk return characteristics Liability matching strategy A B C Current (65/35) Return Generation Liability hedging

27. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 27 Example: Comparison of investment policies Source: UBS Global Asset Management Please see additional disclosures at the end of the presentation

28. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 28 Example: Scenario analysis – funding ratio Source: UBS Global Asset Management Please see additional disclosures at the end of the presentation

29. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 29 Example: Scenario analysis – surplus/(deficit) Source: UBS Global Asset Management Please see additional disclosures at the end of the presentation

30. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 30 Selecting the risk budget Alternative investment policies Funding ratio risk budget Funding ratio return Required return How much return does client need? Minimize funding ratio risk for the given required return Source: UBS Global Asset Management Please see additional disclosures at the end of the presentation

31. Process: Step 3- Implement risk budget

32. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 32 Implementation challenges Aren’t interest rates too low to implement a liability hedge? we agree that interest rates are low, but they are not that low set up action plan to hedge liability as rates rise Liability hedging strategies reduce risk Investment committee must measure investment performance based on funding ratio, not against peers Client needs to feel comfortable with new types of risk when using interest rate derivatives counterparty collateral and cash flow issues

33. Process: Step 4- Monitoring risk budget

34. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 34 Example: Managing the risk budget Source: UBS Global Asset Management Please see additional disclosures at the end of the presentation Assumption: Plan frozen and goal is to terminate A B C

35. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 35 Example: Managing the risk budget Source: UBS Global Asset Management Please see additional disclosures at the end of the presentation Assumption: Ongoing plan and goal is to avoid falling below 80% FR C B A

36. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 36 Summary Understand liabilities Liabilities are bond-like but they are not just bonds Develop and select risk budget Hedge liabilities with long duration bonds + swap Generate efficient absolute return Select risk budget that balances funding ratio risk and return objectives Implementation Implementation of liability hedge can incorporate interest rate views Managing the risk budget Dynamically manage risk budget as a function of funding ratio Sponsors needs to develop and manage a funding ratio risk budget

37. Appendix

38. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 38 Pensioners SWAPS: An exchange of cash flows Fixed benefit payments Pension Fund Swap counter party Receive fix Net payments are reduced when rates decline and therefore value of SWAP position is increased Result is that when rates go down, value of both the SWAP position and liability position increase The bigger the SWAP position the less impact interest rate movements will have on the funding ratio Interest rate swaps can transform your fixed benefit payments into floating payments Pay floating For illustrative purposes only.

39. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 39 Impact of duration mismatch on funding ratio The value of the liabilities increases faster than the value of the assets do Falling interest rates create a deficit The value of the liabilities decreases faster than the value of the assets do Rising interest rates create a surplus Assets Liabilities Deficit Value Assets Liabilities Surplus Value Currently, interest rate changes cause funding ratio changes For illustrative purposes only.

40. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 40 Impact of swap overlay Funding level reduced: liabilities increase relative to assets Swap has a positive value which precisely offsets the reduction in funding level Swap overlay immunizes funding ratio from interest rate changes Falling interest rates: positive swap value Assets Liabilities Swap Value Assets Liabilities Swap Value Rising interest rates: negative swap value Funding level increased: assets increase relative to liabilities Swap has a negative value which balances the funding level once again Swaps reduce the impact of interest rate movements on funding ratio For illustrative purposes only.

41. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 41 Additional disclosures Past performance is no guarantee of future results. There is no guarantee that investment objectives, risk or return targets discussed in this presentation will be achieved. The opinions expressed in this presentation are those of the UBS Global Asset Management Business Group of UBS AG and are subject to change. No part of this presentation may be reproduced or redistributed in any form, or referred to in any publication, without express written permission of UBS Global Asset Management. This material supports the presentation(s) given on the specific date(s) noted. It is not intended to be read in isolation and may not provide a full explanation of all the topics that were presented and discussed. Information contained in this presentation has been obtained from sources believed to be reliable, but not guaranteed. Furthermore, there can be no assurance that any trends described in this presentation will continue or that forecasts will occur because economic and market conditions change frequently. The information contained in this presentation should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this information or that securities sold have not been repurchased. The securities discussed do not represent an account’s entire portfolio over the course of a full market cycle. It should not be assumed that any of the securities transactions or holdings referred to herein were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities referred to in this presentation. A client's returns will be reduced by advisory fees and other expenses incurred by the client. Advisory fees are described in Part II of Form ADV for UBS Global Asset Management (Americas) Inc. This presentation does not constitute an offer to sell or a solicitation to offer to buy any securities and nothing in this presentation shall limit or restrict the particular terms of any specific offering. Offers will be made only to qualified investors by means of a prospectus or confidential private placement memorandum providing information as to the specifics of the offering. No offer of any interest in any product will be made in any jurisdiction in which the offer, solicitation or sale is not permitted, or to any person to whom it is unlawful to make such offer, solicitation or sale. Any statements made regarding investment performance expectations, risk and/or return targets shall not constitute a representation or warranty that such investment objectives or expectations will be achieved. The achievement of a targeted ex-ante tracking error does not imply the achievement of an equal ex-post tracking error or actual specified return. According to independent studies, ex-ante tracking error can underestimate realized risk (ex-post tracking error), particularly in times of above-average market volatility and increased momentum. Different models for the calculation of ex-ante tracking error may lead to different results. There is no guarantee that the models used provide the same results as other available models. Copyright © 2006 UBS Global Asset Management (Americas) Inc.