PD-22 Risk Management Outside the Insurance Industry

André Choquet, FSA, FCIA

General Meeting/Assemblée générale 2007, Montréal, Québec

PD-22 Risk Management Outside the Insurance Industry

André Choquet, FSA, FCIA

General Meeting/Assemblée générale 2007, Montréal, Québec

Canadian Institute

of Actuaries

Canadian Institute

of Actuaries

L’Institut canadien desactuaires

L’Institut canadien desactuaires

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From Pension Risk Management to Enterprise Risk Management

• Setting the Stage• Inside Pension Risk Management• Moving Toward Enterprise Risk Management

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Why do organizationshave pension plans?

Both workforce and organizational life cycles drive decisions about pension plans

!

•Optimize human capital investment

•Attract and retain labour

•Ensure orderly transition of workforce

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Value at Risk

Risk is relative to expectations

Risk measurement is evolving

Unipolar Risk

Risk Volatility Greater volatility equals greater risk

Evolution

Compliance with regulations brings no rewards; non-compliance results in penalties

Bipolar RiskResearch expenditures lead to high returns or loss of capital

Fair Price of Risk

Protection offered through use of hedges

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From Pension Risk Management (PRM) to Enterprise Risk Management (ERM)

Measure Tangible

Risk

Illustrate Intangible

Risk

Is risk appropriate?

Hedge or not?

How much risk?

ERM MonitorImplement

PRM

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Pension Risk Managementinvolves multiple parties

Financial Financial ManagementManagement

Portfolio Portfolio ManagementManagement

Benefit Benefit DeliveryDelivery

Benefit Benefit PolicyPolicy

ComplianceCompliance

Source: Watson Wyatt Worldwide

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How large is the plan toshareholders’ equity?

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

All Companies Financial Services (Banking) Sample Bank Median Quartiles

Pen

sio

n L

iab

ility

/Sh

arh

old

ers’

Eq

uit

y

Source: Watson Wyatt Worldwide

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Solvency ratio stayed flatdespite good returns

Solvency: Growth Portfolio, 50% Active Liabilities

50

70

90

110

130

150

170

190

Month

Ind

ex V

alu

e

Liability Index MV Asset Index Asset/Liability Index

Source: Watson Wyatt Worldwide

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Achieving 100% solvency…Solvency: Growth Portfolio, 50% Active Liabilities

75

80

85

90

95

100

105

Dec-0

5

Mar

-06

Jun-

06

Sep-0

6

Dec-0

6

Mar

-07

Jun-

07

Sep-0

7

Dec-0

7

Mar

-08

Jun-

08

Month

Ass

et/L

iab

ility

Ind

ex V

alu

e

Historical 15.6% equity return

1.00% long term interest rate increase, 2.5% equity return 0.60% long term interest rate increase, 8.0% equity return

Source: Watson Wyatt Worldwide

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…And remaining 100% Solvent

• With a new Bond Portfolio

• Using current portfolio with swaps and futures

• DB Buy-out, annuity purchase

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How a DB Buy-out could work in Canada

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GA71 GAM83 UP94 UP94(2015) UP94G9.5

10.0

10.5

11.0

11.5

12.0

12.5

Pen

sio

n V

alu

e a

t A

ge 6

0

Longevity risk difficult to hedge

Source: Watson Wyatt Worldwide

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Not all mature plans areshifting away from equities

Plan Maturity % Compared to Equity %

10%

20%

30%

40%

50%

60%

70%

80%

90%

0.0 20.0 40.0 60.0 80.0 100.0 120.0 140.0 160.0 180.0 200.0

Liability Maturity Index (Total Liability / Total Service Cost)

Eq

uit

y %

Data Liability Median Equity Median

Source: Watson Wyatt Worldwide

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Risk budgeting: A framework to allocate risk

Asset/Liability Stochastic Simulation

Setting risk budget

Decision 3

$205 $210 $215 $220 $225 $230 $235

PV of Contributions (10 Years) Plus Solvency Deficit ($ Million)50th Percentile

PV

of

Co

ntr

ibu

tio

ns

(10

Yea

rs)

Plu

sS

olv

ency

Def

icit

($

Mill

ion

)

VaR

95

55% equity, LB, +5% intl, +5% HY and alt structure

55% equity, LB, +5% intl,+5% HY and current

structure

55% equity, LB, +5% intl and current structure

55% equity, LB and current structure

Policy (65% equity) and current structure

$325

$330

$335

$340

$345

$350

$355

$360

Source: Watson Wyatt Worldwide

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Risk shifts from employer…

Balanced Fund

Present Value of Cumulative Net Expense ($M) - 2014

$0.0

$10.0

$20.0

$30.0

1.5% Non-Contrib DB 1.5% Contrib DB w 3% EE Contrib 1% DB + 3% DC 6% DC

5th-25th percentile 25th-50th 50th-75th 75th-95th Mean

Source: Watson Wyatt Worldwide

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…to members

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

1.6%

1.8%

2.0%

1.5% Non-Contrib DB 1.5% Contrib DB w 3% EEContrib

1% DB + 3% DC 6% DC

Plan

An

nu

al P

lan

Acc

rual

as

a P

erce

nta

ge

of

Pay

10% 25% 50% 75% 90% Mean

Risk for Employee at Age 40

Source: Watson Wyatt Worldwide

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Relative pension after 20 years of contributionsas a percentage of the best outcome (Based on UK market data)

Pension as % of maximum - with lifecycle strategy

Pension as % of maximum - without lifecycle strategy

Maximum pension assuming no lifecycle strategy

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

1967 1972 1977 1982 1987 1992 1997 2002

Defined contribution risks:Investment decisions and annuitization

Source: Watson Wyatt Worldwide

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Another looming mismatch?Labour needs vs benefit design

GDP(%)

LabourProductivity

(%)

RequiredLabour Input(%)

LabourSupply

(%)

EstimatedLabour

Shortages End ofPeriod(Mil)

2006–2015 2.7 1.5 1.2 0.7 1.0

2016–2025 2.6 1.5 1.1 0.1 2.9

2026–2035 2.4 1.5 0.9 0.2 4.4

2036–2045 2.2 1.5 0.7 0.2 5.7

Living Standards Improvement = 1.85%

Source: Watson Wyatt Worldwide

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Use qualitative methodsto assess other risks

Compliance Governance Benefit Delivery

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Risk WorkshopsRisk WorkshopsResolver*Ballot manages risk assessment workshops Resolver*Ballot manages risk assessment workshops

to build consensus and provide results in real-timeto build consensus and provide results in real-time

Risk workshop Risk workshop participants participants evaluate and evaluate and

prioritize risks prioritize risks (and controls). (and controls).

Results are Results are viewed and viewed and

discussed to discussed to provide clarity, provide clarity,

then re-evaluated.then re-evaluated.

Risk workshop Risk workshop results are reviewed results are reviewed

by all. by all.

Source: Resolver Inc.

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A holistic framework: Moving towardenterprise risk management

Measure Tangible

Risk

Illustrate Intangible

Risk

Is risk appropriate?

Hedge or not?

How much risk?

ERM MonitorImplement

PRM

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The ERM risk management process

Understand

Manage Measure

“Risk comes from not knowing what you are doing”

Warren Buffet

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Websites and references• PWC Saratoga Institute : 2006 Key Trends in Human capital Report

http://www.pwc.com/extweb/service.nsf/docid/623831886DE2BC6A85256EBA0058B5C4

• Mortality Derivatives and the Option to Annuitize: M. Milevski and D. Promislow http://papers.ssrn.com/sol3/papers.cfm?abstract_id=289551

• Revisiting CAPMBill Sharpe "Investors and Markets: Portfolio Choices, Asset Prices and Investment Advice,"

• DC Risks– DC - a ticking time bomb?

http://www.watsonwyatt.com/research/whitepapers/wprender.asp?id=RM-UK-32

– SEI surveys on DC member investment behaviour.– http://www.seic.com/institutions/cda/en/documents/

EN_Research_Report_1104.pdf– http://www.seic.com/institutions/cda/en/documents/

DC_Members_Suffer_Consequences_of_Overconfidence.pdf

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Websites and references• E&Y Study of risk: “Risk Management in Canada:

Moving Beyond Assessment”• Canadian Treasurer: “Pension Management: a job for

the CFO” Feb 2006• 2006 WW Conference Board of Canada survey:

http://www.watsonwyatt.com/canada-english/topics/htrender.asp?ID=15104

• WW study on labour shortages: http://www.watsonwyatt.com/canada-english/pubs/specialmemoranda/showarticle.asp?ArticleID=16466&pdfURL=pdf/sm06-05.pdf&articledate=9/25/2006&Component=Memorandum

• On DB Buy-out in the UK http://www.pensioninsurancecorp.com/default.asp