Workshop on Investment Opportunities in Insurance-Linked Securities Returns from Pension Buy-outs Jonathan Bloomer Imperial College Business School

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3 Risk Management – Customised Solution Traditional buy-out Partial buy-out –Subset could be based on age, status or benefits Structured buy-out Insured solutions Longevity derivative solutions Risk management programme including liability management Complete Lower Limited Higher Risk Transfer Full Buy-out Potential Premium to Quoted Liability Structured Buy-out Initial Payment Payments toward full buy-out Partial Buy-out A range of pension de-risking strategies is available that can be customised to meet individual corporate requirements

4 Pensioner Buy-in Solutions Insurance for the pensioner liability as part of a wider risk management solution Buyout liabilities Equities Bonds £m BeforeAfter Insurance policies Bonds Equities Pensioner liabilities Residual buyout liabilities

5 Drivers of the Pension Buy-out Market Company Directors Defined benefit pension plan Pension fund trustees Pensions regulator Deficit volatility Improving longevity Increasing disclosure obligations Securing pension Promises “safe haven” Sponsor covenant Pension protection fund Employee/union pressures

6 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 (£ billions) 800 (2) (10) (20) Liabilities at end of year828 Source: Punter Southall “The End Game?”

7 Market Development Estimated 8bn in 2008 £m

8 Spread – cost of liabilities vs. return on assets Risks –Longevity –Interest rates –Credit –Inflation –Operational Economic Model

9 Liabilities Cannot Accelerate, but Longevity Risk.

10 Spread – cost of liabilities vs. return on assets Risks –Longevity –Interest rates –Credit –Inflation –Operational Economic Model

11 FSA Capital Requirements “ Pillar I” “Pillar II” Basic requirement (“rules- based”) The FSA requires a minimum level of capital on top of prudent reserves equal to 4% of reserves plus resilience capital based on the underlying assets 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.

12 Return on Equity= Return on Assets x (return on assets - pricing yield) = % + 10 x (6% - 5.1%) = 15% per annum Simplified Equity Returns 1 If capital required to support the business is 10% of statutory liabilities, i.e. gearing is 10 x 2 Assumed at 100bps over swap rates

13 Trustee driven transactions Sponsor goals for longer-term Fewer players Price increases Implications Sustainable, Growing Market