Pension Plan Risk Management Phil Kivarkis, FSA, EA, CFA, Director of Investment Policy Services Hewitt EnnisKnupp

Pension Funded Status – A Wild Ride US Debt Rating Downgrade 2008 Credit Crisis S&P 500 aggregate pension funded status shows considerable volatility, and two extreme events in three years

Our Survey Shows Broad Risk Management Focus 3% 2% 0% 13% 10% 38% 65% 78% 68% 69% 84% 58% 31% 20% 21% 21% 14% 4% What changes have you made to your target investment strategy? Source – Aon Hewitt Pension Risk Survey

Integrated Risk Management Toolkit Investment Policy Funding Strategy Plan Design Assumptions and Methods Glide Path Hedge path Credit path Return-seeking portfolio Hedging portfolio Synthetics/Collars Pre-funding Borrow to fund Fund equity Stabilizer Close Freeze Cash Balance/ Career Average Lump Sums Asset smoothing Rate averaging Conservatism Aggressiveness 3

Current Interest Rate Environment is Challenging Yields are below historic levels… Maturity Source: Citigroup Pension Discount Curve

Some Opportunities Exist Very steep yield curve… CMT = Constant Maturity Treasury Favorable credit spreads… Source: Barclays Capital

Pension Plans Have Already Begun to De-Risk As Seen in Actual Allocations Note: S&P 500, US plans only. Source: Goldman Sachs Global Markets Institute; Capital IQ; company reports.

Dynamic Investment Policy Components

Improving Your Odds These probabilities represent the chance of various return-seeking portfolios outperforming long government/credit bonds over the next three years, using our current (1Q 2011) capital markets modeling assumptions. The expected return on long gov’t/credit bonds is 4.75%. Typical Return-Seeking Portfolio (Expected Return = 7.4%) Allocations: 75% Broad U.S. Equity / 25% Non-U.S. Equity (Dev & Emg) Diversify Globally (Expected Return = 8.4%) Allocations: Market Weight Global Equity (45% Broad U.S. Equity / 55% Non-U.S. Equity (Dev & Emg)) Increased Active/Credit Risk (Expected Return = 8.7%) Allocations: 60% Market Weight Global Equity / 30% Hedge Funds (median manager, not “buylist” – reflects credit basket allocation) / 10% Private Equity (9.2% return assumption, reflects distressed debt allocation) Assumes 25bp value added on total return-seeking portfolio from medium term views (reflecting some use of MTV in structuring credit portfolio) Add Alternatives (Expected Return = 8.8%) Allocations: 50% Market Weight Global Equity / 30% Hedge Funds / 10% Real Estate / 10% Private Equity Assumes 25bp value added on total return-seeking portfolio from medium term views Source: Hewitt EnnisKnupp capital markets expectations 8

Structural Surplus Risk Why Customize? Improved Performance and More Effective Risk Management. Structural Surplus Risk More Effective Hedge Custom Mandate Long Credit – 80% STRIPS 20+ yrs – 20% Source: Hewitt EnnisKnupp Illustrative Example

Alternative to Immediate Extension: Two-Dimensional Glide Paths Two-Dimensional Glide Paths offer a way to manage a pension plan out of the current low interest rate environment. First Dimension Funded Ratio Return Needs Return-Seeking Allocation Second Dimension Dynamic investment policies may be designed to incorporate Return Needs and Hedging Needs along two related, yet separate dimensions – Funded Ratio and Interest Rate Level. Interest Rate Level Desired Duration Hedge Ratio

Liability Hedging Path Design The glide path implies a certain liability hedging path… Glide Path Hedge Ratio

Liability Hedging Path Design: Hedge Path Corridor …but liabilities and interest rate views also imply certain liability hedging possibilities. Max Hedge Ratio Using Physical Bonds Floor at 80% Need funded ratio to go from 80% to 100% when rates rise 2.5%. Liability Duration is 12 years. If rates rise 2.5%, then liabilities will fall by 30% to $70 ($100 to $70). Assets are $80 (80% FR). $48 LHP – ($48 LHP X 8.3 year duration X 2.5%) = $38 $38 + $32 = $70 total assets Ceiling at 80% $48 in LHP (60% LHP X 80% Funded Ratio) Max allocation to 20+ year bucket is $21 based on liability profile. $21 invested in 20+ year STRIPS at duration of 27 years + $27 invested in Long Credit at duration of 12 years = 18 year duration. Max Rewarded Upside from Rising Rates

Integration of Hedge Path and the Glide Path - Illustrative   Funded Ratio 80% 85% 90% 95% 100% Discount Rate Level LHP % 53% 67% 79% Significantly High (+200 bps) 72% 86% High (+100 bps) 58% 83% 93% Fair Value 43% 57% 71% Moderately Low (-50 bps) 35% 48% 65% 82% Low (-100 bps) 27% 38% 59% Very Low (-150 bps) 19% 29% 77% Significantly Low (-200 bps) 18% 24% 47% 74% Key Characteristics Tailored to Plan glide path and funded ratio goals Incorporates Client’s interest rate views (and ours) Provides guidance while leaving flexibility to execute Market opportunities (medium term views) Available instruments

Hedge Path Development Steps Design Glide Path (if one doesn’t exist already) Review Risk Budget and Investment Horizon Develop a Hedge Path to Complement Glide Path Develop an Execution Strategy Update Investment Policy Statement Consider Outsourcing Execution Update Reporting to Include Hedge Path Transition the Portfolio to Target Hedge Ratio on Hedge Path Credit vs Government Yield Curve Positioning Use of Physicals and Synthetics

Key Takeaways Current Environment Duration Extension Steep curve, spreads favorable Asset return risk meaningful De-risking and defeasance trends persist Duration Extension Two-dimensional paths provide framework for change Ultimately, risk management drives hedge ratio Customized Portfolios Customization can improve hedging characteristics Relative importance increases with hedge ratio Diversification improves odds of success