Marketplace Update

Marketplace UpdateRecent Activity and Implications

A presentation to MAACby David Speier

September 13, 2012

© 2012 Towers Watson. All rights reserved.G:\Speier\PRESENTATIONS\P091312_MAAC Annual Mtg.pptx

© 2012 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.com 2

GM Announcement

On June 1st, GM announced that it intends to settle $26 billion in salaried retiree obligations by the end of 2012 Retirees who retired after 10/1/1997 would receive an offer for a lump-sum to be

paid by end of August, 2012 (approximately 55% of retiree obligations) Employees and terminated vested participants would be spun-off into a separate

plan Retiree-only plan would be put through a standard plan termination process Annuity would be purchased from Prudential on behalf of remaining retirees

Reported financial impact: Settle $26 billion in retiree obligations for $29 billion Additional contributions of $4 billion One-time P&L charge of $3 billion, and reduction in pension income of $200

million annually Increased financial flexibility

G:\Speier\PRESENTATIONS\P091312_MAAC Annual Mtg.pptx

© 2012 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.com

Current MarketplaceFord vs. GM: Comparison of De-Risking Action*

Type Action Ford GMPlan Design Plans Closed to New Entrants Yes Yes

Ongoing Benefit Accruals Frozen No Yes

Asset Based Liability Driven Investment (LDI) Strategy Yes Yes

Settlement Based Prospective Lump Sum Option Yes Yes

TV One-Time Lump Sum Offer Yes (~30,000) No

Retiree Lump Sum Offer Yes (~66,000) Yes (~42,000)

Retiree Annuity Purchase No Yes (~100,000)

Estimated Liabilities Settled $5B $26B

Settlement Date End of 2013 End of 2012

* Note: All data provided based on publically available information

3G:\Speier\PRESENTATIONS\P091312_MAAC Annual Mtg.pptx


Effective at managing active liability risk profile and long-term plan cost

Effective at managing size of plan and overall risk exposure

Effective only for short-term issues and cost recognition timing

Effective at managing short-term plan costand volatility

Effective at managing long-term plan costand volatility

Pension Risk Management Aligns All Key Levers

LIABILITY TRANSFER/

EXIT STRATEGY

BENEFIT STRATEGY

FUNDINGSTRATEGY

ASSUMPTIONS AND METHODS

INVESTMENTSTRATEGY



Lump Sum – Opportunity for 2012

Estimated Lump Sum Rates Payable in 2012

Look-back Month Terminated Vested Age 45 Retiree Age 65

August 2011 6.02% 4.66%

September 2011 5.80% 4.54%

October 2011 5.50% 4.54%

November 2011 5.26% 4.43%

December 2011 5.24% 4.42%

May 2012 Rates* 4.99 % 4.10%

* Estimated May segment rates based on April, 2012 segment rates and average yield change during May

Many plans reset interest rates on an annual basis, using a permitted “look-back” to a date up to 5 months prior to the start of the year

Due to declines in interest rates since August 2011, many companies can offer lump sums in 2012 on a favorable basis (i.e., relative to plan liabilities) TV lump sums could be 5% - 20% lower; retiree lump

sums could be 3-5% lower

Value of accelerated lump sum windows will vary with market rates, thus illustrating the impact of preparation and monitoring



If Not 2012, When?

Sponsors not moving forward are faced with at

least 2 more years of financial risk and operating

expense

Windows not opened in 2012 unlikely to be

opened in 2013 (unless rates rise in 2012)

Falling rates in 2012 suggest value in

accelerating lump sum window

The following would need to occur to imply waiting until 2014 (or beyond) is economically preferable to offering lump sums in 2012 Rates rise enough to get back to 2011 levels plus enough to cover 2 years of

operating cost and liability growth Depending on plan profile, this could require 50-200bps increase in rates

Plan sponsor would also need to be comfortable with the exposure to financial risk during the delay period Sponsors with moderate to high equity exposure (intended to outgrow assets) will

need to address annual volatility Sponsors with high fixed income exposure will be less likely to outearn obligations,

thus increasing expected cost of implementation



Retiree Lump Sum Offer – Why or Why Not In the absence of clear regulatory guidance on the permissibility of offering

lump sums to retirees, there are several questions that a sponsor can ask to determine if the option could add enough value to warrant further consideration

Why Explore Further? Why Not Explore Further?Plan is well funded Plan is not well funded and additional contributions are

not available

Large retiree population Relatively small obligations

Significant number of younger or recent retirees A majority of retirees are older

Concerns about pricing of annuity purchase alternative Concerns over anti-selection

Other risk management strategies have been addressed or implemented

Other risk management options have not yet been examined or implemented

Desire to provide increased retirement income flexibility to participants

Concerns over retiree relations issues and ability to make informed elections

Comfort with (or ability to get comfortable with) legal considerations

Limited resources to explore regulatory and legal considerations

Retirees were never previously offered a lump sum option Retirees were offered a choice of a lump sum at retirement, but elected an annuity



Potential Regulatory Impediments – Threshold Issues Current IRC § 401(a)(9) regulations appear to prohibit lump sums to retirees, at least for

those beyond the required beginning date (RBD), specifically due to the following: Potential issues with changing the annuity payment period, except in limited circumstances

such as plan termination or in the event of increased benefits that arise from a plan amendment

The table below highlights potential options to address these regulatory considerations:

Option Potential Approaches

Seek guidance or approval

• Seek legal review or opinion on the ability to offer lump sums to retirees• Seek regulatory guidance (e.g., PLR)

Work within current regulations to allow second election

• Increase benefits provided to retirees • Unclear what level of increase would be acceptable

• Execute a spin-off termination• Increased administrative cost and complexity, plus consideration of cost

of annuity purchase for spun-off retirees not electing a lump sum• Only provide offer to retirees under age 70 ½

• May have limited impact and present technical/interpretive and age discrimination issues



Other Regulatory Considerations

Lump sum determination Plan subsidies (e.g., ERFs) in payments being made to retirees may need to be included in the lump sum value Social Security supplements likely do not need to be included in the lump sum value, but may have a significant

impact on lump sum take rates if eliminated For many plans, the size of the retiree obligations will increase the importance of the interest rate basis (stability

period / look-back month) in terms of a sponsor’s ability to assess the economic, financial and liquidity implications of a retiree offer In general, there is only limited ability to change the stability period and look-back month

Structure of offer In addition to a lump sum option, single participants will likely need to be offered SLA and married participants will

likely need to receive option to elect QJSA / QOSA annuity forms Rules for converting lump sum value determined at second annuity starting date to annuity forms unclear

Valid QJSA waiver would be required for the current spouse and potentially any former spouse, if applicable Nondiscrimination issues may be more prevalent due to higher number of former HCEs in a retiree population

compared to TV population (especially if the offer is not provided to all retirees) Retiree offer may receive more attention from unions than TV offer and may require agreement/consultation

Issues with temporary offering Potential significant detriment issues may dictate offer consideration period (may be longer than TV offer) Retiree offers that are implemented on a phased approach may encounter “permanent feature” issues

Aside from the legal / regulatory considerations already discussed, offering lump sums to retirees may present additional issues that differ from those involved in a terminated vested offer



Financial Considerations

Accounting implications Increased likelihood / magnitude of one-time settlement accounting entries More pronounced ongoing P&L impact due to loss of “EROA arbitrage” on assets settled More significant impact on balance sheet funded status (especially for plans funded <100%) Remeasurement effect for residual plan liabilities (i.e., discount rate effect)

Funding implications Leveraging effect on plans funded below 100% could greatly accelerate required funding Assessment of plan amendment impact required for plans funded near 80% Restrictions on accelerated payments for plans funded below 80%

Investment implications Potential for significant liquidity requirements Impact on overall plan investment strategy / post-transaction investment re-allocation as duration could potentially

increase significantly Transaction hedging and other interim investment strategies (from date interest rates are locked to the date lump

sums are distributed to participants)

Compared to a terminated vested window offer, executing a lump sum offer has the potential to more significantly impact plan finances and liquidity needs if the acceptance rate is high



Implementation Considerations

Feasibility Due to more complex nature of retiree offer, more rigorous feasibility assessment may be required (including

adverse selection assessment) Significant uncertainty regarding retiree take rates (very little experience, potential for more variation by age) Greater opportunity for unintended consequences as retirees may have to receive the option to re-elect an annuity

in an alternative form of payment

Window design / execution timing Legal due diligence may require additional lead time (especially if pursuing PLR) Phased implementation may be required for larger population due to execution capacity constraints (especially

with respect to call center volumes) Inclusion of a financial education component may be more prevalent

Data preparedness Retiree data should generally be more complete than TV data (but may require more data elements than a TV

offer – e.g., survivor benefit amounts, Social Security supplements, pop-up amounts, etc.) Spousal information could be an issue for participants currently receiving an SLA (or with a non-spouse

beneficiary) if QJSA / QOSA options need to be provided

Calculator development Limited guidance regarding basis for determining QJSA / QOSA options (plan basis, 417e basis?)

Retiree lump sum windows generally have the same implementation workstreams as a terminated vested window offer; however, there are special considerations for a retiree offer



Annuity Purchase Pricing Considerations Historical View Marketplace for traditional buyouts has become smaller; number of major players has dropped from 12+ to about 5 to

7 Fewer are competitive as size of buyout increases (beyond $25-50M)

● Pricing remains competitive for certain structures of benefits (traditional annuity) Only half of the current players will quote on cash balance plans

Annuity purchase pricing typically fell somewhere between duration-matched Treasuries and high-quality corporate bonds Once adjusted for fully generational mortality and cohort-specific discount rate, led to a spread of 5-15% versus

accounting liabilities Competitiveness issues drove pricing by insurer

Recent lack of activity plus expectation of future market growth has led to more aggressive pricing, closer to 5-10% over liabilities

Annuity Purchase Considerations

Billion

s

-

Marketplace Activity

1.6 1.71.3

0.8

1.8

2.92.52.3

3.2

0.0

1.0

2.0

3.0

4.0

20002001 2002 200320042005 2006 2007 2008

DB Annuity Market Annuity Purchases 2000 – 2011 (estimated)

*Source: Estimated LIMRA

2009 2010

1.0 0.9

2011

0.8

Annuity Purchase Pricing – Economic

Components of Insurance Company Pricing

Impact of Operational Costs

Compliance With 95-1

Market Capacity and Financial Services Industry

Accounting Implications on Capital Requirements

Plan Value Transfer

Regret Risk and Market Timing

Data Quality and Administration



Annuity Purchase Pricing Considerations Emerging View

When annuity purchase activity begins to increase, there are concerns over the impact of capacity Capacity can be viewed in short-term versus long-term perspective,

covering financial and operational considerations

Marketplace StatisticsMarketplace Obligations$5.4T of public obligations, backed by $2.5T of assets – very little in long bonds$3.0T of private obligations, backed by $2.4T of assets – about $0.4T in long bonds

Marketplace Instruments$10.0T of Treasuries – about $1.3T is long$3.3T of high-quality Corporate bonds – about $1.0T is long

Private pensions currently hold 20% of available long corporate bond instruments and 15% of long Treasuries

Source: Barclays Capital, TWIS, Department of the Treasury, BlackRock, PIMCO



Components of Annuity Purchase PricingTraditional Retiree Pricing Approach

$0

$300

$600

$900

$1,200

$1,500

ABO ProvisionAdjustments

Credit/Default Mortality Demographic Operating Costs& Profit

TerminationCost

$20M

ABO$1,000 M

Traditional Annuity Purchase Cost

$1,120 M

$10M $50M $10M$30M

Risk Charges

Illustr

ative



Fiduciary Considerations – Retiree Annuity Purchase Implementing the decision to purchase annuities to cover plan benefits is

subject to fiduciary standards under ERISA DOL regulations outline criteria for selecting the annuity provider on behalf of

participants, but it not fully prescriptive Coordination with legal counsel is recommended to define process for selecting

“safest available” annuity prior to selecting insurers and reviewing insurer bids

Partial settlements raise the issue of whether the decision to purchase annuities for some participants (not all) may result in disparate treatment among participants Partial settlement results in separate financial backing for plan participants – the

insurer vs. plan assets Participant and PBGC concerns could be raised if the remaining plan’s funding levels

decline in the future The potential for this type of claim and the appropriate considerations of all

participants should be reviewed with counsel throughout the process



PBGC Considerations – Retiree Annuity Purchase PBGC has raised some concerns regarding the distribution of plan assets prior

to (but potentially in contemplation of) a broader plan termination Could result in additional claims on PBGC or loss of non-guaranteed benefits in the

eventual plan termination process Concern that termination notices and disclosures would not be provided to

participants for whom annuities were purchased No ability for PBGC to audit benefit calculation processes

Guidance suggests PBGC will review these situations on a case-by-case basis, considering: Length of period between annuity purchase and potential for full plan termination Likelihood that distress termination would eventually occur Inclusion of affected participants in termination notices and disclosures


Documents

Marketplace Update