KICK-STARTING YOUR RISK MANAGEMENTPROGRAMMELDI WITHOUT THE TEARS

10 JULY 2014

Alan BakerHelen HopeJohn Finn

MERCER 2014 DB RISK WEBCAST SERIES

MERCER WEBCAST

Date Topic

6 March Risk transfer solutions – The beginning of the end …or the end of the beginning?

13 March Pension plan data – Why improving it benefits everyone

1 April Member options – More choice for members, less risk for schemes and sponsors

1 May Integrated solutions – Case studies in new approaches

15 May Investing for income – Using benefit cash flows in setting investment strategy

3 June Getting off the rollercoaster – How are pension schemes managing the volatility of their journey?

10 July Kick-starting your risk management programme – LDI without the tears

MERCER WEBCAST

Alan Baker John FinnHelen Hope

MERCER WEBCAST

• LDI is used to reduce the uncertainty of the present value of your liabilities– You know what pensions have been promised, however their present

value changes over time

• The key drivers of this present value are changes in bond yields andinflation

3

Bondyields

Liabilitypresentvalue

Inflationassumption

Liabilitypresentvalue

AND VICE VERSA!

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0% Hedged

LiabilitiesAssets

Deficit Liabilities

Assets

Deficit

Rates fall

100% Hedged

LiabilitiesAssets

Deficit LiabilitiesAssetsRates fall

Deficit

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Example Scheme

MERCER 6

Increase in interest ratesIncrease in interest rates

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How “much” tohedge

“When” to hedge

“What” tohedge with

Strategic objective

Need to consider the currentmarket environment and

how to capture opportunities

There are a wide range ofpotential hedging assets –

look to buy the “cheapest” toreduce the cost of hedgingand reduce risk relative to

the liabilities

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Yiel

d

A. Current strategy – current coverage

C. Agree how to achieve long-term target

Time

Pres

entV

alue

Time

Pres

entV

alue

Current coverageTime

Pres

entV

alue

Time

PAST FUTURE

Yield Trigger 1

Yield Trigger 2

Yield Trigger 3

B. Set long-term hedging target

Total liabilities

D. Extend the hedge towards long-term target

Fair value

Currently c.30%

Agree long-term targethedge ratio

MERCER 9

CorporateBonds

Gilt Repos Total ReturnSwaps

Fundedinstruments“Physicals”

Unfundedinstruments

“Derivatives”

Index-LinkedGilts

Fixed-InterestGilts

InterestRate/Inflation

Swaps

MERCER WEBCAST

Counterparty

• Default of counterparty bank may lead to losses

• Significantly mitigated through collateralisation

• Tested following Lehman default

Collateral

• To manage counterparty exposure collateral most paid/received to provide someadditional security

• Need to ensure collateral is adequate quality, paid/received regularly, clearlydocumented

Funding• Pension schemes obligation to pay a cash (LIBOR) rate with interest rate swaps

• LIBOR cannot be generated without taking risk

Liquidity• Liquidity can be low at times (particularly for inflation swaps) and transaction costs

have increased in both physical and synthetic markets

Leverage• Profits or losses will vary with changes in interest rates and inflation

• May require the transferring of assets from another portfolio to the hedging mandate sothat collateral can be posted by the pension scheme to the counterparty banks

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MERCER 11

MERCER WEBCAST 12

Real

Nominal

2022 - 2027 Maturity

c30yr Leveraged Duration

2032 – 2040 Maturity

c45yr Leveraged Duration

2050 - 2062 Maturity

c60yr Leveraged Duration

2052 - 2060 Maturity

c45yr Leveraged Duration

2040 Maturity

c45yr Leveraged Duration

2030 Maturity

c40yr Leveraged Duration

Short Medium Long

Short Medium Long

Credit

UK Credit

Better Credit investing –excl. Sub-ord & maximumsector exposures

c7.5yr duration

Global Buy & Maintain Credit

Better Credit Investing withfocus on lower turnover

c6.9yr duration

UK Global

2052 - 2068 Maturity

c45yr Duration

Over 5yr Index Linked Gilts

c21yr Duration

Longest Index

2060 - 2068 Maturity

c22yr Duration

Over 15yr Gilts

c16yr Duration

Note: Dashed boxes indicate leveraged funds, which will currently gain gilt-based exposure

Longest Index

MERCER WEBCAST

• For larger schemes with unique requirements, more bespoke de-risking and LDIstrategies can be implemented

• Example:– Move gradually from equities to a portfolio made up of corporate bonds and

LDI assets by 31 December 2016;– Interest rate & inflation coverage (LDI) increasing gradually over the journey

– Tailored solution to help implement and meet these requirements

2016 TargetLiability Hedging journey

13

MERCER WEBCAST 14

Source: Mercer 2014 European Asset Allocation Survey

MERCER WEBCAST

QUESTIONSPlease type your questions in the Q&A section of the toolbarand we will do our best to answer as many questions as wehave time for.

To submit a question while in full screen mode, use the Q&Abutton, on the floating panel, on the top of your screen.

CLICK HERE TO ASK A QUESTIONTO “ALL PANELISTS”

FEEDBACKPlease take the time to fill out thefeedback form at the end of this webcastso we can continue to improve. Thefeedback form will pop up in a newwindow when the session ends.

www.mercer.com/webcastsView past recordings and sign up forupcoming webcasts

Alan BakerPartner

alan.baker@mercer.com

John FinnPrincipal

john.finn@mercer.com

Helen HopePrincipal

helen,hope@mercer.com

MERCER WEBCAST

Reminder of webcasts in series

Date Topic

6 March Risk transfer solutions – The beginning of the end …or the end of the beginning?

13 March Pension plan data – Why improving it benefits everyone

1 April Member options – More choice for members, less risk for schemes and sponsors

1 May Integrated solutions – Case studies in new approaches

15 May Investing for income – Using benefit cash flows in setting investment strategy

3 June Getting off the rollercoaster – How are pension schemes managing the volatility of their journey?

10 July Kick-starting your risk management programme – LDI without the tears

MERCER WEBCAST

And finally… Meet our DB Risk Experts

www.uk.mercer.com/db-risk

18

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