Pensions Under Pressure: An Update for Global Organizations

Pensions Under Pressure
An Update for Global Organizations

October 22, 2009

© 2009 Towers Perrin you
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Today’s presenters

Marco Boschetti is a Principal in Towers Perrin’s London office, where
he serves as the U.K. Market Leader and leads the Mergers, Acquisitions
and Divestitures practice outside North America. He has experience on
all issues relating to international HR, including program design,
implementation, operation and monitoring. Marco has an honors degree
from the London School of Economics and is a Fellow of the U.K. Institute
of Actuaries. He is a frequent speaker at conferences, is part of the
international editorial board of the Journal of Pensions Management,
and regularly contributes articles to HR and M&A publications.

Steve Allan is a Principal in Towers Perrin’s Tokyo office and leads the
benefits and actuarial consulting practices across Japan, Korea, Hong Kong
and Malaysia. He has over 15 years of experience working with large global
organizations to ensure that their pension and benefit programs are
designed and implemented in accordance with global business objectives
and local market practices. Steve is a Fellow of both the Institute of
Actuaries in the U.K. and the Society of Actuaries in the U.S. He has a
bachelor’s and master’s degree from the University of Bristol, U.K.

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Today’s discussion

 The global context — accelerating pension change
 Close-up on two key markets
 United Kingdom
 Japan
 Q&A


The global context

 Retirement programs in countries around the world
face tremendous changes
 Many companies are moving away from providing
retirement security to reduce risk, volatility and/or cost
 This evolution poses near-term challenges for employers
 defining a sustainable “retirement deal” for the future
 managing/mitigating the cost and risk of legacy plans
 managing the change process

These challenges are especially complex for global organizations
because the underlying context, solutions and change process
are somewhat different in each country


U.K. pensions — the context

 All major companies have supplemental pension plans
because of relatively low levels of social security
pension provision
 basic state pension of about $8,000 a year
 target pension of 60% of basic salary is the norm
 Historically, most plans were defined benefit
 Key characteristics of company-provided plans
 indexation in deferment and payment
 plans are normally contributory
 trust law governs


The U.K.’s rapid transformation

 Most new plans now defined contribution
 Defined benefit plans mostly closed to new entrants,
but huge legacy issues remain
 inactives account for over two-thirds of plan liabilities
 many plans are heavily underfunded
 Wind-up is a big issue
 very expensive — longevity costs higher than in the U.S.
 debt on employer
 Pensions Protection Fund (like PBGC) introduced in 2005
 requires annual levy based on amount of underfunding
and probability of insolvency of sponsoring employer
The U.K. pension story:
A 20-year history of over-interference by the government

The latest example: The government’s 2009
budget introduced new pension tax changes

 Traditional pension provision for high-income (£150,000+)
individuals will become far less tax effective beginning 2011
 possibly even tax ineffective (benefit will be taxed twice)
 Companies are rethinking their compensation and
pension arrangements
 may give employees the choice of avoiding the new
pensions tax and/or explore other alternatives
 also likely to seek other opportunities to help employees
manage their tax bill
 Changes will impact broader reward strategies

The U.K. view is that “pensions are dead for
most high earners/executives”

The current U.K. pension landscape

Employer Summary of Change Effective Date
BP Closing DB pension plan to all new hires April 2010
Barclays Closing DB pension plan to both new and existing December
employees (employees will have choice of DC or hybrid plan) 2009
Fujitsu Closing DB pension plan to existing employees December
(closed to new hires in 2000) 2009
RBS Capping pensionable pay growth at CPI max 2% October 2009
Morrisons Closing DB final-salary pension plan to existing employees June 2009
(replaced by a “career average” DB plan and a DC
stakeholder plan open to all other employees)
Network Rail Announced its pension fund deficit nearly doubled (to almost June 2009
£664 million) within the last 12 months
Aon UK Proposed reduction in standard employer contribution April 2009
from 10% to 6% (age-related)
BAE Announced company will be forced to inject £500 million February 2009
Systems into the pension fund to serve a growing £2.2 billion deficit


Options being considered for defined
benefit plans presently under review

39%
35%

22%

9% 8%

Changing Move to career Move to DC Changing Move to
forward accrual average pension age mixed DB/DC
Sourc e: Assoc iation of Consulting Ac tuaries, September 2009

Recent trends
 Overall benefit accruals tend to be reduced by around 20%
 Some companies now more aggressive
 Defined contribution terms are improving

Finding the right solutions involves balancing
key workforce and financial goals

Benefit Strategy

Financial Strategies Related Reward Strategies Related
to Cost and Risk Management to Workforce Management

Addresses the cost Addresses whether
and risk implications future benefits are at
related to design, the right level and of
investment and other the right form, based
financing decisions Optimal Solution on competitiveness
and other workforce
considerations


Successfully managing the transition requires
a well-thought-out change plan…

1. Exploring the 2. Approval/ 5. Communicating 6. Education 7. Making Detailed
Options Decision
3. Announcement 4. Consultation Decision Campaign Choices

Timing
Month 1 Month 2 Mid-Month 3 Months 3 – 5 Month 6 Month 7 Months 8 – 9
(approx)
 Develop  Ensure  Explain  Understand  Brief leadership  Build  Campaign to
c onsultation stakeholder proposals and during 60-day  Brief unions and understanding keep awareness
strategy and support for business c onsultation trustees of pension  Drive
c ommunic ation proposals and rationale  how c hoic es and partic ipation
 Play bac k the
plan understanding  Build employees help people and use of tools
headlines from
 Educ ate of c hange plan understanding view the make dec isions
the c onsultation  Provide
stakeholders  Confirm design of the c hanges  Drive use of
proc ess targeted
proposals and c onsultation  the questions online tools
 Build data on  Announc e/c onfir ac tivities to
c ommunic ation proc ess they need
 likely m c hanges to respond to
plan answers to
employee  Explain the employee
 perc eptions of
Objectives reac tions differenc es by pension/benefit questions and
gains/losses
 employee employee plans inform their
 emotional hot
preferenc es groups pension c hoic es
spots  Clarify timeline
for c hange  Engage
 c redibility of for financ ial
 other programs employees in
c ase for educ ation and
 points of exploring the
c hange enrollment
sensitivity implic ations of
 Dec ide on
 Establish the c hanges
c hanges for
spec ific
implementation
employee
relations
objec tives


…and needs to educate plan participants
about different forms of investment risk


Tips for effective redesign

 Never a better time than now
 Thorough due diligence is a must
 Right judgment on ultimate endpoint
 Plan your journey
 Work in context of the overall employment package
 Keep it as simple as possible
 Employee choice allows individual optimization
 How you change has more impact than design fine points


A possible pensions journey

Current Identify objectives Future
state State
Cost savings and
simplification

Identify
major risks
Risk
management
Levers to pull objectives
met
Benefits

Investments

Liability
management


Don’t overlook the legacy issues


What to do next

Budget 2009 Changes
 Identify who is affected
 Brief the remuneration committee Briefing
 Ensure that HR can respond to queries
 Plan what to do about it

Benefit Design Changes
 Understand where you stand
Design Assessment
 Understand potential for change and financial implications
 Consider action

Benefit Risk Management
 Understand your risks
Risk Assessment
 Understand potential solutions
 Consider action


Japanese pensions — evolving legislative context…

1952: Retirement
Allowance Plans (Tax
Code incentives) End: March 31, 2012
(no new after 2002)
1962: Qualified
Pension Plans (Tax Act)

1966: Employee Pension
Fund Legislation

October 2001: Defined
Contribution Pension Act

April 2002: Defined Benefit
Corporate Pension Plan Act

1959: Small Enterprise Retirement
Allowance Legislation

Legend: Defined Benefit Legislation Defined Contribution Legislation Special Plans for Small Enterprises


…and a growing range of retirement
plan design options
3- to 5-year average Combination DB/DC
final salary plan (hybrid plans)

100% DC plan
Points system (with cashout option)

Traditional Modern

Career Core DC with
average salary top-up DB

Final salary plan with Cash balance Advance cash
heavily backloaded
benefits


Pension plan conversions continue
Dissolution
Dissolv ed Plans: 461 (as of Mar 31, 2009)
Future Dissolution Plans: 54 (as of Mar 31, 2009)
Employee Pension Fund
(EPF)
EPF
Daiko-henj o
Plans: 1,737 (as of Mar 31, 2002)
(Future Money) 869 Plans: 617 (as of Mar 31, 2009)
On Peak: 1,883 (as of Mar 31, 1997) (Past Money as w ell) 807 Participants: 4,740,000 (as of Mar 1, 2009)
(Mar 31, 2009)
Participants: 10,870,000 (as of Mar 31, 2002

On Peak: 12,250,000 (as of Mar 31, 1998)

232* New DB
(Feb 28, 2009)
Plans: 5,008 (as of Mar 31, 2009)
Participants: 6,000,000 (as of Mar 31, 2009)
6,363*
(Mar 31, 2009)

Qualified Pension Plan 5,229*
(Feb 28, 2009)
DC
(QPP)
Employ ers: 11,476 (as of Feb 28, 2009)
Plans: 12,979 (as of Feb 28, 2009)
(w ill be abolished on March 31, After Fiscal 2002 Participants: 3,100,000 (as of Jan 31, 2009)
2012) 16,080
(Feb 28, 2009)
Plans: 73,582 (as of Mar 31, 2002) Small Employer
25,441 (as of Mar 31, 2009) Retirement Allowance Plan
# of Decrease: 48,141 Plans: 374,869
Participants: 2,970,000 (as of Feb 28, 2009)

Participants: 9,170,000 (as of Mar 31, 2002)

3,480,000 (as of Mar 31, 2009) Dissolution
*The number of employer
# of Decrease: 5,690,000

Decline in defined benefit plans…

Qualified Pension Plans (QPPs) Employee Pension Funds (EPFs)
(Plans) (Participants: 000s) (Plans) (Participants: 000s)

120,000 12,000
2,500 14,000

100,000 10,000 12,000
2,000

10,000
80,000 8,000

1,500
8,000
60,000 6,000

6,000
1,000
40,000 4,000
4,000

500
20,000 2,000
2,000

- - - -
’92 ’94 ’96 ’98 ’00 ’02 ’04 ’06 ’08 ’92 ’94 ’96 ’98 ’00 ’02 ’04 ’06 ’08
Plans Participants Plans Participants


…and growth in new plans

Growth in New DB Plan Market Growth in New DC Plan Market
6,500 4,000

6,000 6,150 plans as of 3,095 plans as of
September 1, 2009 3,500 July 31, 2009
5,500
(11,896 employers,
5,000 3,000 3.3 million participants)
4,500

4,000 2,500

3,500
2,000
3,000

2,500 1,500
2,000
1,000
1,500

1,000
500
500

- -
Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun-
02 03 03 04 04 05 05 06 06 07 07 08 08 09 02 03 03 04 04 05 05 06 06 07 07 08 08 09

Number of New DB Plans Number of DC Plans


Key challenges in reviewing a defined benefit QPP

 Strong corporate preference for DC provision
 counter to historical Japanese practice
 difficult message given global and Japanese
investment records
 Low DC contribution ceilings (monthly limit of JPY 51,000
beginning January 2010; half this amount if funded DB
plan also sponsored)
 thus, hybrid designs are common
 Traditional plan provided immediate lump-sum benefits
 no access to DC benefits prior to age 60 (and no DC participation
for those over age 60)
 Employee consent required to change DB plans
 change based on prospective (i.e., total service) benefits
 two-thirds majority support required

Typical defined benefit plan review process

Phase (1) Phase (2) Phase (3) Phase (4)
Set Objectives
and Review Develop New Finalize New
Implementation
Current Design Framework Plan Design
Arrangements

 Business/HR  Plan options:  Design plan  Selection of DC
strategy revised DB, DC, parameters plan
 Leadership hybrid (cash  Cost and administrator
interviews balance), etc. funding (if DC plan is
 Funding assessments implemented)
 Retirement
plan policies structure  Scenario  Selection of DC
pros/cons testing funds (if DC plan
 Current plan
 Benefit level/ (winners/losers) is implemented)
analysis
accrual pattern  Transition  Employee
 Regulations and arrangements communication/
related legal education
constraints Employee
Consent
Required


DB governance and asset/liability management

 Local management becoming more proactive
 driven by Finance
— cash and accounting
 focus on sensitivities and risk factors
 focus is on risk identification
 risk mitigation is not yet standard practice
 growth of ALM and manager monitoring
 concern over funding levels
— lack of control of funding requirements
— lack of traction with trust banks
But active plan governance is still a minority practice in Japan


Other risk-reduction opportunities

 Multi-employer defined benefit plans common
 contributions and ongoing participation subject
to governing committee
 withdrawal may be difficult depending on financial
status of plan
 proactive monitoring of funding and contribution
requirements growing
 Growing interest in “buyout” options
 but limited local market for U.K.-style bulk buyouts
 individual cashouts of retirees possible
— often accompanied by review of retirement annuity
options for current active employees

DC environment poses other challenges

 Actual investment returns of DC participants are extremely low
 about 60% of DC assets concentrated in time deposits
 could spell future problems and participant complaints

 More discussion and emphasis on fiduciary duties of plan sponsors
 established philosophy on DC investment selection and ongoing monitoring
 robust employee education as part of consent process
 ongoing employee education and behavior monitoring Foreign Bond
Foreign Equity 3%
Time deposit
Distribution of Investment Returns— 2%
+GIC
Japan Bond
Assumed in Design Phase 3%
80%

Assumed Investment # %
Returns
0.0% 9 2.5%
Distribution of Investment Returns— Japan Equity
Actually Realized by Employees 17%
0.0% - 1.0% 19 5.3% 250

1.5% -
1.0% - 1.5% 28 7.8%
3.0% is 200

1.5% - 2.0% 105 29.4% popular, Mode
Mode 0.1% Balanced Fund.
5%
2.0% - 2.5% 137 38.4% and could 150
reasonably be
2.5% - 3.0% 37 10.4% pushed ev en
3.0% - 5.0% 20 5.6% higher 100
Source: MHLW
More than 5.0% 2 0.6%
50
None 127
No answer 164
0

All 957 100% -5.5% -3.5% -1.5% 0.5% 2.5% 4.5% 6.5% 8.5% 10.5% 12.5% 14.5% 16.5% 18.5%

Data source: Pension Fund Association Sourc e: Typic al Towers Perrin c lient — sample


What to do next

Current Situation
 What is the current benefit promise?
Understand current plan  Are there any legacy arrangements?
 Cash funding and expense position and projections
 Consistency with global benefit policy

Market Practice in Japan Is Changing
Comparison with local  Is the 2012 QPP deadline relevant to you?
market  Understand current market position and trends
 Reaction to recent and pending DC legislative changes

Communication Can Be a Key Challenge
 Employee consent requirements
 Corporate and local management may have different
Communication perspectives
 Consent and agreement may not equate to
understanding; ongoing communication and employee
education may be required


Key takeaways for global organizations

 As Japan and the U.K. illustrate, interventions and
solutions being pursued vary widely from country to country
 but, the drivers and ultimate direction of change are
much the same
 Companies need to be sensitive to the local nuances of the
change journey to ensure successful execution
 There’s an important role for corporate leaders to play
 leading companies paying more attention to global
governance of rewards and retirement program
 first step often involves rearticulating the reward
philosophy and governance structure with the local team


Questions?

 jp.provost@towersperrin.com
 marco.boschetti@towersperrin.com
 steve.allan@towersperrin.com


Pensions Under Pressure: An Update for Global Organizations

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