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Risk Management Solutions: Liability Driven Investment and Beyond

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Fiduciary responsibilities' The ultimate solutions to de-risk a pension fund are: ... of Assets and Liability and also takes on all the fiduciary responsibilities ... – PowerPoint PPT presentation

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Title: Risk Management Solutions: Liability Driven Investment and Beyond


1
Risk Management SolutionsLiability Driven
Investment and Beyond
National Bank Financial Group Strictly Private
Confidential
2
Agenda
  • Pension plan as a portfolio of risks
  • Dealing with Investment Risks
  • Identify objectives
  • Risk Budget
  • Optimization
  • Minimum Risk Portfolio and Return Portfolio
  • Case study
  • Dealing with Non-Investment risk
  • Conclusion

3
Pension plan as a portfolio of risks
Risk
Impact
Funding volatility, Could be diversified
Rewarded Investment Risks
Equity, Credit, Alternatives (Real estate,
Private equity, Infrastructure, Hedge funds,)
Non-Rewarded Investment Risks
Exposure to Interest Rates and Inflation created
by liability specifics
Funding volatility, Could be hedged
Funding volatility, Could be hedged
Non-Investment Risks
Longevity, Legal, Fiduciary, Database
inaccuracies
4
Dealing with Investment risks - Identify and
understand objectives
  • Frequent objectives
  • Pension expense volatility
  • Contribution level
  • Contribution volatility
  • Minimum Solvency/Going Concern Ratio,
  • This leads to the Dual Objective Approach

Objectives
Driver
Solutions
  • Contribution volatility
  • Minimum Funding ratio

Reduce volatility
Increase correlation between assets and
liabilities
  • Reduce contribution
  • Generate surplus

Increase return
Get the long term risk premium (alpha) of
equities, credit and alternatives
5
Dealing with Investment risks - Determine Risk
Budget
  • Quantify risks faced by the Pension Plan in terms
    of the predefined objectives with the current
    investment strategy
  • Probability of reaching the objectives
  • Identify adverse scenarios
  • Quantify severity of the loss when objectives are
    not met
  • Establish risk limits
  • Define acceptable volatility level
  • Establish maximum probability of failure
  • Identify minimum or maximum contribution level
    and/or surplus level

6
Dealing with Investment risks - Optimization
  • Minimum Risk Portfolio and Return Portfolio
  • Minimum Risk Portfolio (MRP)
  • Minimise the undesired and unrewarded risks of
    the assets relative to the liabilities
  • Hedge interest rate and/or inflation (more
    difficult!) risk
  • Consisting of physical assets (bonds, strips) and
    synthetic assets (swap, futures)
  • Helps to achieve the first set of objectives
  • Return Portfolio
  • Improves long term funding levels
  • Used to cover pension fund fees and reduce the
    plans long term contribution level
  • Consisting of a diversified range of asset
    classes (traditional and non-traditional)
  • Maximize return within risk budget
  • Helps to achieve the second set of objectives
  • Need to find the proportion X such that
  • Overall Portfolio X x MRP (1-X) x Return
    Portfolio

7
Dealing with Investment risks - Optimization
  • All of the MRP, the Return Portfolio and the
    proportion X will be driven by many factors,
    including
  • Long term vs. short term objectives
  • Plan dispositions
  • Financial situations
  • Demographics
  • Stakeholders objectives
  • Size of the Pension Plan vs. the Company
  • Risk tolerance
  • Sophistication
  • Level of comfort of the Board with derivatives

No one size fits all strategy
8
Dealing with Investment risks - Optimization
  • Very mature plan
  • Low risk tolerance
  • Average rated company

Young plan High risk tolerance Very strong
company
Liabilities
Liabilities
Minimum Risk Portfolio
Minimum Risk Portfolio
Return Portfolio
Return Portfolio
MRP Physical portion
MRP Synthetic portion
9
Dealing with Investment risks Case study
  • Plan Highlights
  • Mature DB plan
  • Pensioners represent more than 60 of the total
    liabilities
  • Initial solvency ratio of 90 (2 B in assets and
    2.2 B of liabilities)
  • Benchmark portfolio 55 Bonds and 45 Equities
  • Objectives and Risk Budget
  • Control the size of potential deficit
  • Control funding volatility
  • Keep annual contribution below 80 M
  • Limit surplus build up
  • Maximize probability of the solvency ratio being
    in the 95 105 range

10
Dealing with Investment risks Case study
11
Dealing with Non-Investment Risk
  • Even with a strong investment management process,
    difficult to remove all the risk and duties
  • Longevity risk
  • Legal risk (lawsuit, e.g. surplus ownership)
  • Fiduciary responsibilities'
  • The ultimate solutions to de-risk a pension fund
    are
  • Annuity purchase
  • Expensive
  • Limited liquidity in the marketplace
  • Partial Solution
  • Close the plan
  • Not so simple!
  • Sell operating business with plan
  • Must make business sense
  • Buyer may be no better equipped than seller to
    deal with legacy pension liabilities
  • Pension Buyout

12
Dealing with Non-Investment Risk
  • Pension buyout
  • Transfer sponsorship to a third party
  • A third party takes control of Assets and
    Liability and also takes on all the fiduciary
    responsibilities
  • Plan is not terminated, but remains ongoing with
    all legal protections in place
  • Removes all the risk
  • Investment related
  • Non-investment related
  • Type of pension plan buyer
  • Asset management firm
  • Global investment and commercial banks
  • Insurance companies
  • Nothing yet in North-America but some in Europe
    (UK)

13
Dealing with Non-Investment Risk
  • Issues concerning Pension Buyout
  • Not clear if Pension buyout will be allowed in
    Canada
  • Employee/employer relationship?
  • Is-it in the participants best interest?
  • No clear direction from OSFI, FISCO and RRQ with
    respect to this
  • Similar concerns in the US
  • JPMorganChase, Citi, Cerberus, and Morgan Stanley
    are among the firms lobbying Washington to let
    them take over and run corporate pension funds
  • Recent discussions indicate that legislators
    dont want to change the law
  • NBC Solution Virtual Buyout

14
Conclusion
  • Liability-Driven Investing is not a new
    theoretical concept, just a different approach
  • The current environment requires that pension
    plan sponsors improve their risk management
  • National Bank offers customized investment
    strategies based on a pension plans unique
    liability profile
  • Customized, risk based solutions tailored to the
    individual needs of the client
  • Reduced or eliminated pension risk
  • Reduced corporate risk exposure and financial
    statement volatility
  • More time to focus on running the business
  • Comprehensive solution utilizing the vast
    capabilities of National Bank
  • Risk identification and measurement, investment
    management, structuring, balance sheet
    capabilities, actuarial expertise
  • Capture the value added of comprehensive, market
    leading risk management platform
  • Optimization technology, pension expertise,
    capital markets experience
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