2011 senior executive forum final presentation

For Financial Professional Use Only.Confidential; not for further distribution.0194866-00007-01For Financial Professional Use Only.

Opening RemarksOpening RemarksPaul Rogers, EVP & COO, Pacific Resources

Managing Employee Benefits in a Challenging EnvironmentCharles Lowrey, EVP & COO, U.S. Businesses, Prudential

The Significance of 2/7/64 and the Implications of Pension De-risking in the U.S.Richard Farr, Head of Pensions Advisory, BDO

Healthcare Reform and the Use of Technology to Manage Employer CostsRohail Khan Executive Managing Director ACS Human Resource Services A Xerox CompanyRohail Khan, Executive Managing Director, ACS, Human Resource Services, A Xerox Company

Audience Q&APaul Rogers, EVP & COO, Pacific Resources

Cl i R kClosing RemarksPaul Rogers, EVP & COO, Pacific Resources

For Financial Professional Use Only.For Financial Professional Use Only.

Charles LowreyE ti Vi P id t &Executive Vice President &

Chief Operating Officer, U.S. BusinessesPrudential Financial, Inc.

M i E l B fitFor Financial Professional Use Only.Confidential; not for further distribution.

For Financial Professional Use Only.

Managing Employee Benefits in a Challenging Environment

Senior Executive Forum

What senior finance executives are saying about managing employee benefits

Playing more of a role in benefits decisions

Increased focus on pension benefits risk managementmanagement

Reliance on DC plans for employees’ retirement p ysavings and income

Increased focus on cost of b fit ti l lbenefits, particularly healthcare costs


Source: 2010 Prudential Financial survey of CFOs. Survey results shown are based on companies with DB plans with $5 billion or more in assets.

4


Increased Focus onIncreased Focus on Pension Benefits Risk

M tManagement


5


Increased focus on pension benefits risk management

D i f i d f I li ti f i

Funding• Stiffer funding requirements

Drivers of increased focus by finance executives

Implications for companies

• 54% of finance executives h h i i• Stiffer funding requirements

introduced by 2006 Pension Protection Act (PPA)

• Although conditions are improving, the financial crisis

report that their companies are either likely to increase, or have already increased, contributions to close a funding gap

improving, the financial crisis continues to have an impact on DB plans

Accounting • Increases in financial statement ff ’• Funding status appears on the

corporate balance sheet – no longer relegated to footnotes

• FASB is likely to reconsider

volatility affect a company’s:– Stock price – Beta – Cost of capital

pension smoothing rules in favor of mark-to-market accounting, which would increase income statement volatility

p

• Risk management strategies more important


Source: 2010 Prudential Financial survey of CFOs. Survey results shown are based on companies with DB plans with $5 billion or more in assets. 6


Current environment for pension risk transfer

You wouldn’t acquire a pension plan• Pensions are not a core business

for most companies • Rating agencies and equity analysts

The environment has changed• Balance sheet volatility is here • Income statement volatility is

inevitable • Rating agencies and equity analysts view pension underfunding as debt

• Company stock prices incorporate pension risk

• Financial leverage is better taken

inevitable• PPA funding rules shift focus to

short-term investment results• PPA allows employer to fully fund

plan on a tax deductible basis

Value is attractive

• Financial leverage is better taken elsewhere

Waiting entails risk

plan on a tax deductible basis

Value is attractive• First-mover pricing is available today• Attractive borrowing rates mitigate

concerns about Buy-In or Buy-Out costs in a low interest rate

Waiting entails risk• Waiting for the “right” interest rate

environment to execute a risk transfer strategy raises the challenge of how to invest assets in the meantimecosts in a low interest rate

environmentinvest assets in the meantime

• Capacity is available today, but may not be tomorrow

• The market is beginning to move


7


Range of solutions to mitigate or transfer risk in DB plans

Buy-out

Liability Driven Investing

Buy-in

• A guaranteed annuity asset with a market value

• Liability transferred to insurance company

• Settles a plan sponsor’s obligationLiability Driven Investing

(LDI)to match the value of a liability–Insurance contract

version of LDI–Does not disrupt current

p g–Does trigger

settlement accounting• An investor’s approach that correlates investments in a DB plan

Fundinginsulation

funded status–Liability remains on plan

sponsor's balance sheet–Revocable – does not

trigger settlement

to the liabilities in the plan–Imperfect hedge–Credit and duration risk

• Liability remains on plan ggaccounting

CostAnnual One time One time premium

+

Liability remains on plan sponsor's balance sheet


8

management fee premium +Settlement charge


Developing a long-term pension risk transfer strategy

• DB plan sponsors are monitoring the capital markets to determine when favorable pricing exists to implement a buy-in, possibly as a transition to a buy-out

• Pricing varies by plan population and is a function of mortality, interest rates,Pricing varies by plan population and is a function of mortality, interest rates, and investment spreads

• Liability tranches (portions of the plan population) should be selected in a strategic mannerstrategic manner

• Develop buy-in or buy-out strategy

• Identify tranches to

Work with

actuaries

• Price• Market rates

and spreads• Settlement

charge

Determine action

triggers

• Transition assets

• Identify insurer(s)

• Establish

Prepare to

transacttranches to transfer

• Prepare data

actuaries• Impact on

investment return

triggers terms• Monitor the

market

transact


9


CFO perspectives on pension risk management

Likelihood of adopting DB risk management strategies in next two years

Key factors that would drive companies to transfer DB risk


Source: 2010 Prudential Financial survey of CFOs. Survey results shown are based on companies with DB plans with $5 billion or more in assets.

10


Shift from DB to DC Plans


11


Shift from DB to DC plans

Solutions for creatingImplications of shift fromDB to DC plans

Guaranteed income trends in large plan market

Solutions for creating more DB-like outcomes

from DC plans

• For individuals:increasing responsibility for managing risks they are typically ill-equipped t h dl

• Accelerated demand to augment target date funds with income guarantees

• Several solutions have been firmly established in DC plans

– Automatic to handle

– Investment risk– Longevity risk

• Fewer portability concerns: critical mass of recordkeepers

enrollment and escalation

– Portfolio rebalancing

• For employers:responsibility to offer more robust DC plans to fill the DB void

pparticipating in industry initiative to accommodate income solutions

g– Investment defaults– Stable value

H t dfill the DB void• Additional safeguard

developed to address insolvency, replaceability, and continuity

• However, guaranteed lifetime income solutions are missing from most DC plans


y

12


CFO perspectives on guaranteed lifetime income

50% have already adopted or are likely to offer products that generate guaranteed lifetime income in the next two years

Key factors that would drive companies to adopt guaranteed lifetime income products


Source: 2010 Prudential Financial survey of CFOs. Survey results shown are based on companies with DB plans with $5 billion or more in assets. 13


Focus on Benefits Costs


14


CFO perspectives on managing benefits costs

Expected implicationsof healthcare legislation *

Planned approachesto control

healthcare costs *

Role of voluntary benefits in managing

Percentage of plan sponsors that rate as highly important

* Source: 2010 Prudential Financial survey of CFOs. Survey results shown are based on companies ith DB l ith $5 billi i t

benefits in managing benefits costs **

as highly important


with DB plans with $5 billion or more in assets.

** Source: Prudential’s “Fifth Annual Study of Employee Benefits: Today and Beyond,” 2010. Survey results shown are based on companies of all sizes. 15


Solutions for managing employee benefits offerings

• Finance executives face a number of challenges related to employee benefitsp y

• Employers express concerns about managing the rising cost of healthcare benefits, reducing DB risk, and ensuring employees are adequately prepared for retirementadequately prepared for retirement

• There is a wide range of solutions to help companies manage their employee benefits offerings, including the expansion of voluntary p y g g p ybenefits

• Many employers are poised to consider adopting DB risk management strategies and adding guaranteed lifetime income options to DC plansstrategies and adding guaranteed lifetime income options to DC plans


16

Richard FarrH d f P i Ad i BDOHead of Pensions Advisory, BDO

Th Si ifi f 2/7/64 d i li ti fFor Financial Professional Use Only.Confidential; not for further distribution.


The Significance of 2/7/64 and implications for Pension De-Risking in the U.S.

The Beatles bring a UK Pop explosion to the U.S.

• On February 7, 1964, the Beatles landed in NewY k f Th Ed S lli ShYork for an appearance on The Ed Sullivan Showand by 4 April 1964, the Beatles held twelvepositions on the Billboard Hot 100 singles chart,including the top five positions

• So started the British Pop explosion in the U.S.

• 40 years later the UK enacted a new pensions regulatory regime which aimed to give UKpension plans more control to maintain adequate fundingpension plans more control to maintain adequate funding

• Today that regime has created an environment of higher funding targets and more controlin the hands of the Pension Plan trustees, supported by a regulatory framework predicatedon the threat of action

• What started out as a well meaning attempt to protect ‘deferred pay’ has turned into aheadache for many UK CEOs and CFOs…and its arrival in the U.S. is as inevitable as theBeatles in 1964

The Employer’s position

• Focus on cash

• Liabilities matter as deficits consume cash that could be generate better returnon capital from internal projects or growth e g acquisitionson capital from internal projects or growth e.g. acquisitions

• The UK Pensions Regulator has dramatically improved the funding regime ofUK pension plans

The U S eq i alent PPA f nding r les hich strengthen f nding req irements in• The U.S. equivalent: PPA funding rules, which strengthen funding requirements inthe U.S., are fully phased-in beginning in 2011

• Forecasting cash requirements (amount and timing) is very difficult

Alt ti f it l t b d t b f l il bl• Alternative sources of capital cannot be assumed to be freely available now

• Under PPA, funding is essentially market-to-market, resulting in volatile,difficult to forecast contribution requirements

f f f f• Accounting deficit is not a true reflection of the Employer’s funding obligation

• IAS19 and FAS in the U.S. are at least regular and comparable

• What started out as a target has now become a minimum requirement……

Shareholders and other Stakeholders

• Short-termism

• Shareholders typically focused on prospects over the next two years at most and believe pensions is a long term issue and will not bite short term

• Demographic change (e.g. longevity) will be the greatest long term impact, but is little understood and is not currently an easily tradable risk

• Analysts

• Very few analysts focus on pricing in pensions risk, therefore “off radar” for shareholders…but this is changing, increasingly the pension deficit (on a g g, g y p (scheme funding, not an accounting basis) is treated as debt

• Banks/Debt Providers

• See pensions as a potential for profitable hedging business on a vast scale• See pensions as a potential for profitable hedging business on a vast scale

• Bank providers are starting to treat pension plans as competing debt providers

The investor’s position

• Increasing publicity of public pension deficits is increasing awareness

• Whether debt or equity, should ask:e e deb o equ y, s ou d as

• What is the pension deficit and on what basis (accounting, self sufficiency, buy-out)?

Wh t th h fl / i iti ?• What are the cash flow consequences/priorities?

• What risks are is the company exposed to?

• Can the risk be measured, managed or migrated?, g g

• IAS19 deficit is considered as debt, but is this the right number?

• Comparing total liability with market capitalisation indicates “pension l ” d iti it t h i i ldleverage” and so sensitivity to a change in yields

• Transparency is limited in current published information, it doesn’t help identify those companies that would benefit most from de-risking

The Gorilla in the Garden (data) shed

• Investors hate uncertainty

• Corporate activity (M&A restructuring) means the valuation basis shifts• Corporate activity (M&A, restructuring) means the valuation basis shifts to buy out pricing

• A peculiarly British problem!

• Solvency basis rarely assessed, even more rarely disclosed

IT’S A CASE OF MUSICAL CHAIRS –THE MUSIC WILL STOP AS SOON AS THE ANALYSTS WAKE UP

Pension Risk Quadrants© - A cash flow pipeline

Unrewarded Risks

• Interest rates• Longevity

Obligation Risk

• Shock factor of R l t h• Longevity

• InflationRegulator change

• Cost of compliance• Wide reaching

powers• Unintended

consequences

The most important risk

consequences

Rewarded Risks

MIGRATE UNDERSTAND

risk• Underwriting:

— Benefit promise— Asset

performance• Non pension risk

• Risk seeking• Duration matching• Liability Driven

Investing• Dynamic AssetNon pension risk

• Should determine prudency adopted by Actuary

• Mitigation = risk reduction

• Dynamic Asset Allocation

PENSION RISK INTEGRATION – JOINED UP DETERMINE MANAGE

PENSION RISK INTEGRATION JOINED UP APPROACH

Is the music stopping now?

• Latest regulatory pronouncements would point towards this.....

• Super priority for pension plans is the new reality….• e.g. Nortel: court judgement that the pension deficit ranks as an expense of the

administration not an unsecured claim

S l II i t i t B k d I ith DB i• Solvency II impacts e.g. impact on Banks and Insurers with DB pension plans

• When is the general market going to adopt the same approach for the same risk?

We can’t just do what we’ve always done

1. Understand liability cash flows

2. Ensure assumptions are fit for purpose

3. Forward planning – short, medium and long term strategiesg g

4. Reduce liabilities first

5. Long-term risk plan requires di ti f t d li bilitco-ordination of asset and liability

strategies

6. De-risking often requires cash, but th l b fitthere are clear benefits

7. Employer Covenant - risk or opportunity? – treat it as part of the PENSION RISK IS ASYMMETRIC – IGNORE IT

AT YOUR PERIL

investment strategyAT YOUR PERIL

A new paradigm

• The pension problem is a multi-faceted combination of long-term financial uncertainties and shorter term market sentiment

• Investment volatility arises from non-core operations managed inconsistently with wider ERM approaches

F i t bli h d i i k• Few companies were established as insurance risk carriers/asset managers

• Shareholder value will be created from stabilising cash flows – the “certainty premium”

• This requires a clear pension risk transfer planC i t d d t d• Communicated and executed

• There will never be a better time to start!

What can Pensions learn from The Beatles?

Do You Want to K S t?

Current accounting measures do not accurately represent the i lit f i

Current accounting measures do not accurately represent the i lit f iKnow a Secret? economic reality of pensionseconomic reality of pensions

Twist and Shout

Pension volatility is already impacting the balance sheet ofU.S. corporations, the income statement is nextPension volatility is already impacting the balance sheet ofU.S. corporations, the income statement is next

I Want to Hold Your Hand

A more robust regulatory framework, that embraces economic risk may be inevitableA more robust regulatory framework, that embraces economic risk may be inevitable

Boy you’re going to Pensions will weigh on the bottom line of companies who don’tPensions will weigh on the bottom line of companies who don’tBoy, you re going to“Carry That Weight”

Pensions will weigh on the bottom line of companies who don t thoughtfully address their pension riskPensions will weigh on the bottom line of companies who don t thoughtfully address their pension risk

We Can Work it Out By setting out a thoughtful plan, many companies can addvalue by de risking today A brighter future awaitsBy setting out a thoughtful plan, many companies can addvalue by de risking today A brighter future awaits

Employers should act now to prepare for a UK style pension explosion: De-risk unrewarded risks and manage rewarded risks to close the pension deficit

value by de-risking today. A brighter future awaitsvalue by de-risking today. A brighter future awaits

g p

Important notes

Whilst all reasonable care has been taken in the preparation of this presentationno liability is accepted under any circumstances by BDO LLP for any loss ord i lt f li t t t i idamage occurring as a result of reliance on any statement, opinion, or any error oromission contained herein. Any statement or opinion unless otherwise statedshould not be construed as independent research and reflects our understandingof current or proposed legislation and regulation which may change without noticeof current or proposed legislation and regulation which may change without notice.The content of this document should not be regarded as specific advice in relationto the matters addressed.

Rohail Khan E ti M i Di tExecutive Managing Director,

ACS Human Resource ServicesA Xerox Company

H lth R f d th U f T h l tFor Financial Professional Use Only.Confidential; not for further distribution.

Healthcare Reform and the Use of Technology to Manage Employer Costs

Paul RogersE ti Vi P id t &Executive Vice President &

Chief Operating Officer Pacific Resources

For Financial Professional Use Only.Confidential; not for further distribution.

Audience Q&A

Paul RogersE ti Vi P id t &Executive Vice President &

Chief Operating Officer Pacific Resources

For Financial Professional Use Only.Confidential; not for further distribution.

Closing Remarks

Prudential is not affiliated with ACS Human Resource Services, BDO or Pacific Resources.

P d ti l th P d ti l l d th R k b l i k f P d ti l Fi i l I d it l t d titiPrudential, the Prudential logo and the Rock symbol are service marks of Prudential Financial, Inc. and its related entities,registered in many jurisdictions worldwide.


2011 senior executive forum final presentation

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