PD22 Risk Management Outside the Insurance Industry

1
Canadian Institute of Actuaries
LInstitut canadien des actuaires

• PD-22 Risk Management Outside the Insurance
  Industry
• André Choquet, FSA, FCIA
• General Meeting/Assemblée générale 2007,
  Montréal, Québec

2
From Pension Risk Management to Enterprise Risk
Management

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

3
Why do organizationshave pension plans?

• Optimize human capital investment
• Attract and retain labour
• Ensure orderly transition of workforce

!
Both workforce and organizational life cycles
drive decisions about pension plans
4
Risk measurement is evolving

• Unipolar Risk

Bipolar Risk
Research expenditures lead to high returns or
loss of capital
Compliance with regulations brings no rewards
non-compliance results in penalties
Risk Volatility Greater volatility equals
greater risk
Value at Risk Risk is relative to expectations

• Fair Price of Risk
• Protection offered through use of hedges

Evolution
5
From Pension Risk Management (PRM) to Enterprise
Risk Management (ERM)
PRM
ERM
6
Pension Risk Managementinvolves multiple parties
Finance
GOVERNANCE
Human Resources
Source Watson Wyatt Worldwide
7
How large is the plan toshareholders equity?
Pension Liability/Sharholders Equity
Source Watson Wyatt Worldwide
8
Solvency ratio stayed flatdespite good returns
Source Watson Wyatt Worldwide
9
Achieving 100 solvency
Source Watson Wyatt Worldwide
10
And remaining 100 Solvent

• With a new Bond Portfolio
• Using current portfolio with swaps and futures
• DB Buy-out, annuity purchase

11
How a DB Buy-out could work in Canada
Mature Corp
DB Plan
Mature Corp
New Corp
Entrepreneur Corp
DB Plan
12
Longevity risk difficult to hedge
Source Watson Wyatt Worldwide
13
Not all mature plans areshifting away from
equities
Plan Maturity Compared to Equity
Source Watson Wyatt Worldwide
14
Risk budgeting A framework to allocate risk
Asset/Liability Stochastic Simulation
360
Policy (65 equity) and current structure
355
350
Setting risk budget
345
55 equity, LB, 5 intl, 5 HY and
current structure
PV of Contributions (10 Years) Plus
Solvency Deficit ( Million)
VaR95
340
Decision 3
55 equity, LB and current structure
335
55 equity, LB, 5 intl and current structure
55 equity, LB, 5 intl, 5 HY and alt
structure
330
325
205
210
215
220
225
230
235
PV of Contributions (10 Years) Plus Solvency
Deficit ( Million)
50th Percentile
Source Watson Wyatt Worldwide
15
Risk shifts from employer
Source Watson Wyatt Worldwide
16
to members
2.0
1.8
Risk for Employee at Age 40
1.6
1.4
1.2
Annual Plan Accrual as a Percentage of Pay
1.0
0.8
0.6
0.4
0.2
0.0
1.5 Non-Contrib DB
1.5 Contrib DB w 3 EE
1 DB 3 DC
6 DC
Contrib
Plan
Source Watson Wyatt Worldwide
10
25
50
75
90
Mean
17
Defined contribution risks Investment decisions
and annuitization
Relative pension after 20 years of
contributions as a percentage of the best outcome
(Based on UK market data)
Source Watson Wyatt Worldwide
18
Another looming mismatch?Labour needs vs benefit
design
Living Standards Improvement 1.85
Source Watson Wyatt Worldwide
19
Use qualitative methodsto assess other risks


Benefit Delivery
Governance
Compliance
20
Risk Workshops
ResolverBallot manages risk assessment workshops
to build consensus and provide results in
real-time
Source Resolver Inc.
21
A holistic framework Moving towardenterprise
risk management
PRM
Measure Tangible Risk
Implement
Monitor
ERM
Illustrate Intangible Risk
22
The ERM risk management process
Risk comes from not knowing what you are
doing Warren Buffet
23
Websites and references

• PWC Saratoga Institute 2006 Key Trends in Human
  capital Report http//www.pwc.com/extweb/service.n
  sf/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 CAPM
• Bill Sharpe "Investors and Markets Portfolio
  Choices, Asset Prices and Investment Advice,"
• DC Risks
• DC - a ticking time bomb? http//www.watsonwyatt.c
  om/research/whitepapers/wprender.asp?idRM-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.p
  df

24
Websites and references

• EY 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/h
  trender.asp?ID15104
• WW study on labour shortages http//www.watsonwya
  tt.com/canada-english/pubs/specialmemoranda/showar
  ticle.asp?ArticleID16466pdfURLpdf/sm06-05.pdfa
  rticledate9/25/2006ComponentMemorandum
• On DB Buy-out in the UK http//www.pensioninsuranc
  ecorp.com/default.asp