1. Teach-in Balancing Risk, Return and Contributions 6 May 2014
Balancing Risk, Return and Contributions
1

2. Balancing Risk, Return and Contributions
© Sacker & Partners LLP 2014 www.sackers.com
Ian Cormican
Sacker & Partners LLP
6 May 2014

3. Draft Code – Funding Defined Benefits
Principal
Driver for
consultation
…to minimise
any adverse
impact on the
sustainable
growth of an
employer
New statutory
objective –
Pensions Bill
© Sacker & Partners LLP 2014
3
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4. © Sacker & Partners LLP 2014
Consultation Document
Defined Benefit Regulatory
Strategy
Defined Benefit Funding Policy
Draft Code of Practice
Consultation closed on 7 February
4
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Text
DB
Funding

5. © Sacker & Partners LLP 2014
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Principles
based
Scheme -
specific
Flexible
Moving away
from fixed
triggers

6. © Sacker & Partners LLP 2014
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Is it same old,
same old?
No. Possibly a
profound sea-change
Balanced
Funding
Outcome
(BFO)
Risk - bar
New
approach to
covenant -
Segmentation
Focus on
investment

7. © Sacker & Partners LLP 2014
7
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Risk Management is at heart of it
Financial Management Plan?
Contingency
planning
Covenant
risk
Funding
risk
Investment
risk
Governance

8. Covenant
Regulator’s key factors
Outlook / plans for
sustainable growth
Sector outlook
/ position of
employerr
Profitability / trends
Generation cash
/ application
Debt level /
servicing
Balance sheet vs
deficit
Reinvestment
Balance sheet
strength
Dividend
policy
© Sacker & Partners LLP 2014
8
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9. Covenant Gradings
Gradings
1.Strong
Very strong trading,
cash generation and
asset position relative
to size of scheme / deficit.
Low risk.
4. Weak
Concerns over potential
insolvency or where scheme
is so large that without
fundamental change to the
strength of the employer it is
unlikely ever to be able to
adequately support the
scheme
2. Tending to strong
Good trading, cash
generation and asset
position relative to size
of scheme / deficit.
Medium risk.
3. Tending to weak
Concerns over employer
strength relative to the size /
deficit and/or signs of significant
decline, weak profitability or
balance sheet concerns /
vulnerable for economic cycle.
No immediate insolvency
but longer terms concerns.
© Sacker & Partners LLP 2014
9
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10. Key
change
How realistic is that?
Trustees are now expected
to understand and assess
employer’s business plans
Not just backward
looking / performance
but prospects
as well
© Sacker & Partners LLP 2014
10
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11. © Sacker & Partners LLP 2014
Balanced Funding Outcome?
Expresses a level
of contributions
they think should
be payable by a
company within
that segment
Reviewed
annually
But say it is
not a
minimum
level of
funding
11
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12. Notional value of
assets such that no
further deficit
reduction
contributions
required
Compare with actual
contributions to see
if it meets
expectations
BFO – How do
they go about
assessing it?
Calculated on an
“objective liability”
basis (not scheme
specific)
Compare to actual
assets / determine
the notional annual
rate to repair deficit
© Sacker & Partners LLP 2014
12
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13. © Sacker & Partners LLP 2014
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RISK BAR - INDICATORS
How much scheme falls short of BFO
Reliance on
investment
outperformance
in Recovery Plan
Quality of
Governance
Weakening of
covenant eg
dividendsPPF
deficit
Avoidance
issues
Reductions in
deficit
contributions
Issues raised
by tPR in
previous
valuations /
previous
interaction
Back-end
loadings
Mortality
Investment
strategy
risk

14. © Sacker & Partners LLP 2014
Risk
Bar for
Intervention
Shortfall compared to the BFO
indicator
Size of the scheme’s liabilities
Impact of the interventions / value
tPR can add
Overall tPR resources
14
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15. © Sacker & Partners LLP 2014
15
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Spring 2014
Annual
Funding
Statement
Completing
valuations
now – bear
in mind
Pro-active
investigations
with 25 schemes
applying
these
principles
Transitional
BFO Indicator for September
2013 – 2014 valuations
Risk Bar for September
2012 - 2013 valuations

16. Teach-in Balancing Risk, Return and Contributions 6 May 2014
Balancing Risk, Return and Contributions
John Towner, Redington
16

17. Teach-in Balancing Risk, Return and Contributions 6 May 2014
600
650
700
750
800
850
900
950
1,000
in£Millions
Liabilities Assets
Stable Funding?
17
What is your funding objective?
Full funding and Scheme can transition
into terminal portfolio
Self Sufficiency?
Gilts/Swaps?
Buy-out?
…….. And how long will it take to get there?
Technical Provisions?

18. Teach-in Balancing Risk, Return and Contributions 6 May 2014
600
650
700
750
800
850
900
950
1,000
in£Millions
Liabilities Assets
18
What levers can you pull to reach your goal?
One Lever is Time
Time 2029
Contributions £10.0m p.a.
Required Rate of Return Gilts + 1.20%
Time 2024
Contributions £10.0m p.a.
Required Rate of Return Gilts + 1.61%
10-Year Recovery Plan
600
650
700
750
800
850
900
950
1,000
in£Millions
Liabilities Assets
15-Year Recovery Plan

19. Teach-in Balancing Risk, Return and Contributions 6 May 2014
600
650
700
750
800
850
900
950
1,000
in£Millions
Liabilities Assets
600
650
700
750
800
850
900
950
1,000
in£Millions
Liabilities Assets
19
What levers can you pull to reach your goal?
Another Level is Contributions from the Sponsor
Time 2024
Contributions £10.0m p.a.
Required Rate of Return Gilts + 1.61%
Base Model
Time 2024
Contributions £12.0m p.a.
Required Rate of Return Gilts + 1.44%
Higher Contributions

20. Teach-in Balancing Risk, Return and Contributions 6 May 2014
600
650
700
750
800
850
900
950
1,000
in£Millions
Liabilities Assets
20
What levers can you pull to reach your goal?
The Final Lever is Investment Return
Time 2024
Contributions £10.0m p.a.
Required Rate of Return Gilts + 1.61%
Base Model
600
650
700
750
800
850
900
950
1,000
in£Millions
Liabilities Assets
Time 2024
Contributions £7.1m p.a.
Required Rate of Return Gilts + 1.91%
Higher Investment Returns

21. Teach-in Balancing Risk, Return and Contributions 6 May 2014 21
How much should you pull each lever?
An Integrated Framework to Assess Impact on
Total Covenant Load
Scenario A: Highly dependent on asset returns
Scenario B: Increased sponsor costs
Scenario C: Win-win impact of de-risking
Contributions
Investment Risk /
Returns
Current
Funding and
Target Date
The Trade-Offs of Different Policy Levers
A B C

22. Teach-in Balancing Risk, Return and Contributions 6 May 2014
How do you agree on the right journey plan?
Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5
Liability valuation
Full funding Date
Contributions
Hedge Ratio
Required rate of return 2.40% 2.04% 2.04% 1.50% 1.07%
Return Seeking assets 81% 66% 66% 45% 28%
UK Credit 6% 10% 10% 16% 21%
Liability Matching 14% 24% 24% 39% 52%
Cash 0% 0% 0% 0% 0%
Total VaR 29.54% 24.51% 19.51% 26.89% 16.90%
1 Yr Assets Cash Generation £45 £39 £39 £30 £22
1 Year Cash Contributions £12 £20 £20 £20 £28
1 YR Contributions at Risk £83 £49 £41 £43 £27
£140.3 £108.3 £99.5 £92.8 £77.1Total Potential Cash Requirement
0
20
40
60
80
100
120
140
160
180
1 2 3 4 5
COVENANTLOAD,
£millions
1 YR Contributions at Risk 1 YR Cash Contributions 1 YR Assets Cash Generation
22
An interactive tool for Trustee and Sponsor collaboration:
Adjust
variable to
find
optimal
solution

23. Teach-in Balancing Risk, Return and Contributions 6 May 2014
Case study – how does it all work in practice?
23
Case Study
Situation
The Trustee board of a multi-billion pound UK defined benefit pension scheme wanted
to increase the level of interest rate and inflation hedging within its scheme.
Problem
Every time the Trustees discussed their plans with the corporate sponsor, all the
sponsor heard was "unaffordable, low rates, expensive, locking in deficit" and pushed
back.
Implication
A dysfunctional stalemate in which nothing got done and governance budget was
spent with no result.
Need
An integrated investment and funding framework with a resulting dynamic de-risking
plan that provides the clarity needed to discuss and agree de-risking, as well as
weighs Trustee risk management objectives against sponsor affordability concerns.

24. Teach-in Balancing Risk, Return and Contributions 6 May 2014
Integrated funding and investment in action
24
Sponsor Advisor
Trustee Sponsor
Clear consensus on long-term funding
objective
Collaboration
Trustee Sponsor
Sponsor AdvisorTrustee Advisor
Working in Isolation
Trustee Advisor
Stakeholder Preferred Approach Consequence
Trustees Lower Risk Higher costs
Sponsor Lower Contributions
Higher returns
required leading to
higher risk and
potentially higher
contributions

25. Teach-in Balancing Risk, Return and Contributions 6 May 2014
Austin Friars House, 2-6 Austin Friars,
London EC2N 2HD
Telephone : +44 (0) 20 7250 3331
www.redington.co.uk
Contacts & Disclaimer
John Towner
Director│Investment Consulting
Tel: 0203 326 7143
Email: john.towner@redington.co.uk
25
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customers.
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