1. 2008 Annual Meeting ● Assemblée annuelle 2008 Québec 2008 Annual Meeting ● Assemblée annuelle 2008 Québec Canadian Institute of Actuaries Canadian Institute of Actuaries L’Institut canadien des actuaires L’Institut canadien des actuaires

2. PD-27 Assumption Setting for Pension Plans What is a Reasonable Going Concern Discount Rate? Chris Vanden Haak Mercer 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

3. Assumption Setting for Pension Plans: What is Reasonable? Current challenges Mercer’s process for setting reasonable assumptions Going-concern Expected Return on Assets under CICA Future Challenges Wrap-up 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

4. Current Challenges Pension costs matter Plans have matured Aging workforce / increase in retiree liabilities Now a significant part of a corporation’s financial statements / cash flows Relative to the size of the active operations Sharp rise in costs in recent years due to decreasing interest rates Changes to accounting standards 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

5. Current Challenges Heightened Scrutiny Plan sponsor Pension and corporate governance Finance area Auditors Regulators Business community 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

6. Current Challenges Increased litigation Class actions Court decisions Fiduciary concerns What is the role of the actuary? 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

7. Current Challenges Lower Bond Yields 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

8. Current Challenges Financial Pressure + Heightened Scrutiny + Increased Litigation + Lower bond yields 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008 = Challenging Environment for Pension Actuaries Actuaries must be able to justify their assumptions

9. Setting Reasonable Assumptions Going Concern Discount Rate Context The goal is not necessarily to construct an economically sound measure of the pension promise The goal is to estimate whether the pension fund will be sufficient to satisfy the pension promise 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

10. Setting Reasonable Assumptions Going Concern Discount Rate What rate of return can we reasonably expect the pension fund to earn over the long-term? Not a prediction But as much as possible, a reading of the market 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

11. Setting Reasonable Assumptions Going Concern Discount Rate Historically, the typical approach for a Mercer actuary was: Stable long term economic views Based largely on empirical / historical evidence Little emphasis placed on market rates 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

12. Setting Reasonable Assumptions Going Concern Discount Rate Mercer’s current approach Provide actuaries with a market based model to assist in determining the going concern discount rate – and impose limits on the maximum permissible discount rate The actuary must assess the appropriateness of the assumptions for each valuation in the context of the particular case and the prevailing economic environment 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

13. Setting Reasonable Assumptions Going Concern Discount Rate First Step: Establish long-term expected return for each asset class Bonds – Based on current market yields in effect on valuation date – Split by Universe, Long and Real Return Bonds 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

14. Setting Reasonable Assumptions Going Concern Discount Rate Equities Long bond yields plus equity risk premium Equity risk premium considers expected GDP, dividend yield, growth in corporate earnings Model provides 3 equity risk premium scenarios Combine expected returns based on target policy mix 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

15. Setting Reasonable Assumptions Going Concern Discount Rate Adjustments to expected return Provision for active management Based on portion of fund that is actively managed Provision for expenses Expenses charged to the fund not already explicitly included in the current service cost 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

16. Setting Reasonable Assumptions Going Concern Discount Rate Adjustments to expected return Margin for adverse deviations Based on portion of fund that is invested in equities and underlying equity risk premium Consider any margins (positive or negative) inherent in other actuarial assumptions 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

17. Setting Reasonable Assumptions Going Concern Discount Rate An example, Expected Return 6.98% Active Management 0.30% Expenses(0.50%) Margin for adverse deviation (0.68%) Going Concern Discount Rate 6.10% 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

18. Setting Reasonable Assumptions Other Going Concern Assumptions Other assumptions Economic assumptions (inflation, YMPE, salary scale) Based on market yields Demographic assumptions Best estimate Future mortality improvements 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008 Otherwise, further adjustments to the margin in the discount rate

19. Setting Reasonable Assumptions Is 6.5% still reasonable for a plan that is invested 40% in bonds and 60% in equities? Let’s assume, Discount rate is before expenses Margin for adverse deviations = 0.5% Yield on universe bonds = 4.8% Roughly speaking, Implies equity return of 8.5% [(6.50% + 0.50%) - (40% times 4.8%)]/60% Implies an equity risk premium of 4.3% (Assuming government bonds are 4.2%) 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

20. Setting Reasonable Assumptions Expected Return on Assets (CICA) Actuaries often asked to provide input on accounting assumptions including the Expected Return on Assets (EROA) Same approach as setting the going concern discount rate No margin for adverse deviations since it is a best estimate assumption 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

21. Setting Reasonable Assumptions Future Challenges Alternative assets classes Margin for adverse deviations which considers the impact of alternative asset classes Margin for adverse deviations based on stochastic measure of the funded status 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

22. Setting Reasonable Assumptions Wrap-up Challenging times for pension actuaries Actuaries must be able to justify their assumptions Leads to assumptions that are largely driven by observed market conditions 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008