marketplace update
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Marketplace Update. Recent Activity and Implications. A presentation to MAAC by David Speier September 13, 2012. G:\Speier\PRESENTATIONS\P091312_MAAC Annual Mtg.pptx. GM Announcement. - PowerPoint PPT PresentationTRANSCRIPT
Marketplace UpdateRecent Activity and Implications
A presentation to MAACby David Speier
September 13, 2012
© 2012 Towers Watson. All rights reserved.G:\Speier\PRESENTATIONS\P091312_MAAC Annual Mtg.pptx
© 2012 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.com 2
GM Announcement
On June 1st, GM announced that it intends to settle $26 billion in salaried retiree obligations by the end of 2012 Retirees who retired after 10/1/1997 would receive an offer for a lump-sum to be
paid by end of August, 2012 (approximately 55% of retiree obligations) Employees and terminated vested participants would be spun-off into a separate
plan Retiree-only plan would be put through a standard plan termination process Annuity would be purchased from Prudential on behalf of remaining retirees
Reported financial impact: Settle $26 billion in retiree obligations for $29 billion Additional contributions of $4 billion One-time P&L charge of $3 billion, and reduction in pension income of $200
million annually Increased financial flexibility
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Current MarketplaceFord vs. GM: Comparison of De-Risking Action*
Type Action Ford GMPlan Design Plans Closed to New Entrants Yes Yes
Ongoing Benefit Accruals Frozen No Yes
Asset Based Liability Driven Investment (LDI) Strategy Yes Yes
Settlement Based Prospective Lump Sum Option Yes Yes
TV One-Time Lump Sum Offer Yes (~30,000) No
Retiree Lump Sum Offer Yes (~66,000) Yes (~42,000)
Retiree Annuity Purchase No Yes (~100,000)
Estimated Liabilities Settled $5B $26B
Settlement Date End of 2013 End of 2012
* Note: All data provided based on publically available information
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Effective at managing active liability risk profile and long-term plan cost
Effective at managing size of plan and overall risk exposure
Effective only for short-term issues and cost recognition timing
Effective at managing short-term plan costand volatility
Effective at managing long-term plan costand volatility
Pension Risk Management Aligns All Key Levers
LIABILITY TRANSFER/
EXIT STRATEGY
BENEFIT STRATEGY
FUNDINGSTRATEGY
ASSUMPTIONS AND METHODS
INVESTMENTSTRATEGY
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Lump Sum – Opportunity for 2012
Estimated Lump Sum Rates Payable in 2012
Look-back Month Terminated Vested Age 45 Retiree Age 65
August 2011 6.02% 4.66%
September 2011 5.80% 4.54%
October 2011 5.50% 4.54%
November 2011 5.26% 4.43%
December 2011 5.24% 4.42%
May 2012 Rates* 4.99 % 4.10%
* Estimated May segment rates based on April, 2012 segment rates and average yield change during May
Many plans reset interest rates on an annual basis, using a permitted “look-back” to a date up to 5 months prior to the start of the year
Due to declines in interest rates since August 2011, many companies can offer lump sums in 2012 on a favorable basis (i.e., relative to plan liabilities) TV lump sums could be 5% - 20% lower; retiree lump
sums could be 3-5% lower
Value of accelerated lump sum windows will vary with market rates, thus illustrating the impact of preparation and monitoring
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If Not 2012, When?
Sponsors not moving forward are faced with at
least 2 more years of financial risk and operating
expense
Windows not opened in 2012 unlikely to be
opened in 2013 (unless rates rise in 2012)
Falling rates in 2012 suggest value in
accelerating lump sum window
The following would need to occur to imply waiting until 2014 (or beyond) is economically preferable to offering lump sums in 2012 Rates rise enough to get back to 2011 levels plus enough to cover 2 years of
operating cost and liability growth Depending on plan profile, this could require 50-200bps increase in rates
Plan sponsor would also need to be comfortable with the exposure to financial risk during the delay period Sponsors with moderate to high equity exposure (intended to outgrow assets) will
need to address annual volatility Sponsors with high fixed income exposure will be less likely to outearn obligations,
thus increasing expected cost of implementation
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Retiree Lump Sum Offer – Why or Why Not In the absence of clear regulatory guidance on the permissibility of offering
lump sums to retirees, there are several questions that a sponsor can ask to determine if the option could add enough value to warrant further consideration
Why Explore Further? Why Not Explore Further?Plan is well funded Plan is not well funded and additional contributions are
not available
Large retiree population Relatively small obligations
Significant number of younger or recent retirees A majority of retirees are older
Concerns about pricing of annuity purchase alternative Concerns over anti-selection
Other risk management strategies have been addressed or implemented
Other risk management options have not yet been examined or implemented
Desire to provide increased retirement income flexibility to participants
Concerns over retiree relations issues and ability to make informed elections
Comfort with (or ability to get comfortable with) legal considerations
Limited resources to explore regulatory and legal considerations
Retirees were never previously offered a lump sum option Retirees were offered a choice of a lump sum at retirement, but elected an annuity
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Potential Regulatory Impediments – Threshold Issues Current IRC § 401(a)(9) regulations appear to prohibit lump sums to retirees, at least for
those beyond the required beginning date (RBD), specifically due to the following: Potential issues with changing the annuity payment period, except in limited circumstances
such as plan termination or in the event of increased benefits that arise from a plan amendment
The table below highlights potential options to address these regulatory considerations:
Option Potential Approaches
Seek guidance or approval
• Seek legal review or opinion on the ability to offer lump sums to retirees• Seek regulatory guidance (e.g., PLR)
Work within current regulations to allow second election
• Increase benefits provided to retirees • Unclear what level of increase would be acceptable
• Execute a spin-off termination• Increased administrative cost and complexity, plus consideration of cost
of annuity purchase for spun-off retirees not electing a lump sum• Only provide offer to retirees under age 70 ½
• May have limited impact and present technical/interpretive and age discrimination issues
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Other Regulatory Considerations
Lump sum determination Plan subsidies (e.g., ERFs) in payments being made to retirees may need to be included in the lump sum value Social Security supplements likely do not need to be included in the lump sum value, but may have a significant
impact on lump sum take rates if eliminated For many plans, the size of the retiree obligations will increase the importance of the interest rate basis (stability
period / look-back month) in terms of a sponsor’s ability to assess the economic, financial and liquidity implications of a retiree offer In general, there is only limited ability to change the stability period and look-back month
Structure of offer In addition to a lump sum option, single participants will likely need to be offered SLA and married participants will
likely need to receive option to elect QJSA / QOSA annuity forms Rules for converting lump sum value determined at second annuity starting date to annuity forms unclear
Valid QJSA waiver would be required for the current spouse and potentially any former spouse, if applicable Nondiscrimination issues may be more prevalent due to higher number of former HCEs in a retiree population
compared to TV population (especially if the offer is not provided to all retirees) Retiree offer may receive more attention from unions than TV offer and may require agreement/consultation
Issues with temporary offering Potential significant detriment issues may dictate offer consideration period (may be longer than TV offer) Retiree offers that are implemented on a phased approach may encounter “permanent feature” issues
Aside from the legal / regulatory considerations already discussed, offering lump sums to retirees may present additional issues that differ from those involved in a terminated vested offer
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Financial Considerations
Accounting implications Increased likelihood / magnitude of one-time settlement accounting entries More pronounced ongoing P&L impact due to loss of “EROA arbitrage” on assets settled More significant impact on balance sheet funded status (especially for plans funded <100%) Remeasurement effect for residual plan liabilities (i.e., discount rate effect)
Funding implications Leveraging effect on plans funded below 100% could greatly accelerate required funding Assessment of plan amendment impact required for plans funded near 80% Restrictions on accelerated payments for plans funded below 80%
Investment implications Potential for significant liquidity requirements Impact on overall plan investment strategy / post-transaction investment re-allocation as duration could potentially
increase significantly Transaction hedging and other interim investment strategies (from date interest rates are locked to the date lump
sums are distributed to participants)
Compared to a terminated vested window offer, executing a lump sum offer has the potential to more significantly impact plan finances and liquidity needs if the acceptance rate is high
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Implementation Considerations
Feasibility Due to more complex nature of retiree offer, more rigorous feasibility assessment may be required (including
adverse selection assessment) Significant uncertainty regarding retiree take rates (very little experience, potential for more variation by age) Greater opportunity for unintended consequences as retirees may have to receive the option to re-elect an annuity
in an alternative form of payment
Window design / execution timing Legal due diligence may require additional lead time (especially if pursuing PLR) Phased implementation may be required for larger population due to execution capacity constraints (especially
with respect to call center volumes) Inclusion of a financial education component may be more prevalent
Data preparedness Retiree data should generally be more complete than TV data (but may require more data elements than a TV
offer – e.g., survivor benefit amounts, Social Security supplements, pop-up amounts, etc.) Spousal information could be an issue for participants currently receiving an SLA (or with a non-spouse
beneficiary) if QJSA / QOSA options need to be provided
Calculator development Limited guidance regarding basis for determining QJSA / QOSA options (plan basis, 417e basis?)
Retiree lump sum windows generally have the same implementation workstreams as a terminated vested window offer; however, there are special considerations for a retiree offer
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Annuity Purchase Pricing Considerations Historical View Marketplace for traditional buyouts has become smaller; number of major players has dropped from 12+ to about 5 to
7 Fewer are competitive as size of buyout increases (beyond $25-50M)
● Pricing remains competitive for certain structures of benefits (traditional annuity) Only half of the current players will quote on cash balance plans
Annuity purchase pricing typically fell somewhere between duration-matched Treasuries and high-quality corporate bonds Once adjusted for fully generational mortality and cohort-specific discount rate, led to a spread of 5-15% versus
accounting liabilities Competitiveness issues drove pricing by insurer
Recent lack of activity plus expectation of future market growth has led to more aggressive pricing, closer to 5-10% over liabilities
Annuity Purchase Considerations
Billion
s
-
Marketplace Activity
1.6 1.71.3
0.8
1.8
2.92.52.3
3.2
0.0
1.0
2.0
3.0
4.0
20002001 2002 200320042005 2006 2007 2008
DB Annuity Market Annuity Purchases 2000 – 2011 (estimated)
*Source: Estimated LIMRA
2009 2010
1.0 0.9
2011
0.8
Annuity Purchase Pricing – Economic
Components of Insurance Company Pricing
Impact of Operational Costs
Compliance With 95-1
Market Capacity and Financial Services Industry
Accounting Implications on Capital Requirements
Plan Value Transfer
Regret Risk and Market Timing
Data Quality and Administration
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Annuity Purchase Pricing Considerations Emerging View
When annuity purchase activity begins to increase, there are concerns over the impact of capacity Capacity can be viewed in short-term versus long-term perspective,
covering financial and operational considerations
Marketplace StatisticsMarketplace Obligations$5.4T of public obligations, backed by $2.5T of assets – very little in long bonds$3.0T of private obligations, backed by $2.4T of assets – about $0.4T in long bonds
Marketplace Instruments$10.0T of Treasuries – about $1.3T is long$3.3T of high-quality Corporate bonds – about $1.0T is long
Private pensions currently hold 20% of available long corporate bond instruments and 15% of long Treasuries
Source: Barclays Capital, TWIS, Department of the Treasury, BlackRock, PIMCO
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Components of Annuity Purchase PricingTraditional Retiree Pricing Approach
$0
$300
$600
$900
$1,200
$1,500
ABO ProvisionAdjustments
Credit/Default Mortality Demographic Operating Costs& Profit
TerminationCost
$20M
ABO$1,000 M
Traditional Annuity Purchase Cost
$1,120 M
$10M $50M $10M$30M
Risk Charges
Illustr
ative
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Fiduciary Considerations – Retiree Annuity Purchase Implementing the decision to purchase annuities to cover plan benefits is
subject to fiduciary standards under ERISA DOL regulations outline criteria for selecting the annuity provider on behalf of
participants, but it not fully prescriptive Coordination with legal counsel is recommended to define process for selecting
“safest available” annuity prior to selecting insurers and reviewing insurer bids
Partial settlements raise the issue of whether the decision to purchase annuities for some participants (not all) may result in disparate treatment among participants Partial settlement results in separate financial backing for plan participants – the
insurer vs. plan assets Participant and PBGC concerns could be raised if the remaining plan’s funding levels
decline in the future The potential for this type of claim and the appropriate considerations of all
participants should be reviewed with counsel throughout the process
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PBGC Considerations – Retiree Annuity Purchase PBGC has raised some concerns regarding the distribution of plan assets prior
to (but potentially in contemplation of) a broader plan termination Could result in additional claims on PBGC or loss of non-guaranteed benefits in the
eventual plan termination process Concern that termination notices and disclosures would not be provided to
participants for whom annuities were purchased No ability for PBGC to audit benefit calculation processes
Guidance suggests PBGC will review these situations on a case-by-case basis, considering: Length of period between annuity purchase and potential for full plan termination Likelihood that distress termination would eventually occur Inclusion of affected participants in termination notices and disclosures
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