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Workshop on Investment Opportunities in Insurance-Linked Securities Returns from Pension Buy-outs Jonathan Bloomer Imperial College Business School 2 Risk Management Customised Solution A range of pension de-risking strategies is available that can be customised to meet individual corporate requirements Higher Full Buy-out Traditional buy-out Subset could be based on age, status or benefits Structured buy-out Potential

Premium to Quoted Liability Partial Buy-out Insured solutions Structured Buy-out Initial Payment Longevity derivative solutions Risk management programme including liability management Payments toward full buy-out Partial buy-out Lower

Limited Complete Risk Transfer 3 Pensioner Buy-in Solutions Insurance for the pensioner liability as part of a wider risk management solution m Equities Residual buyout liabilities Equities Buyout liabilities Bonds Bonds Insurance policies

Before Pensioner liabilities After 4 Drivers of the Pension Buy-out Market Pensions regulator Pension protection fund Deficit volatility Increasing disclosure obligations Defined benefit

pension plan Company Directors Improving longevity Securing pension Promises safe haven Pension fund trustees Employee/union pressures Sponsor covenant 5 Market Scale and Liability Growth Liabilities Liabilities at start of year Liabilities discharged through PPF Liabilities discharged through bulk buy-out market

Benefits paid Interest on liabilities Benefits Accrued Liabilities at end of year Source: Punter Southall The End Game? ( billions) 800 (2) (10) (20) 40 20 828 6 Market Development m 4,000 3,500 3,000 2,500

2,000 1,500 1,000 500 - 2007 Q1 Estimated 8bn in 2008 2007 Q2 2007 Q3 2007 Q4 2008 Q1 2008 Q2 2008 Q3

2008 Q4* 7 Economic Model Spread cost of liabilities vs. return on assets Risks Longevity Interest rates Credit Inflation Operational 8

Liabilities Cannot Accelerate, but Longevity Risk. Sample Pension Scheme - Cashflows (nominal terms) 80 70 Benefit payments (m's) 60 50 40 30 20 10 0 0 5 10

15 20 25 30 35 40 45 Year 9 Economic Model Spread cost of liabilities vs. return on assets Risks

Longevity Interest rates Credit Inflation Operational 10 FSA Capital Requirements Pillar I Basic requirement (rulesbased) The FSA requires a minimum level of capital on top of prudent reserves equal to Pillar II Economic requirement (1/200) The FSA requires realistic economic capital to be held that will ensure solvency on a realistic basis with 99.5% certainty.

4% of reserves plus resilience capital based on the underlying assets 11 Simplified Equity Returns Return on Equity = Return on Assets + 101 x (return on assets - pricing yield) = 6.02% + 10 x (6% - 5.1%) = 15% per annum 1 2 If capital required to support the business is 10% of statutory liabilities, i.e. gearing is 10 x Assumed at 100bps over swap rates 12 Implications Trustee driven transactions

Sponsor goals for longer-term Fewer players Price increases Sustainable, Growing Market 13