Workshop on Investment Opportunities in Insurance-Linked

Securities

Returns from Pension Buy-outs

Jonathan BloomerImperial College

Business School

2

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

FullBuy-out

Potential Premium to Quoted Liability

Structured Buy-outInitial

Payment

Pay

me

nts

tow

ard

full b

uy

-ou

t

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 SolutionsInsurance for the pensioner liability as part of a wider risk management solution

Buyout liabilities

Equities

Bonds

£m

Before After

Insurancepolicies

Bonds

Equities

Pensioner liabilities

Residual buyout

liabilities

5

Drivers of the Pension Buy-out Market

Company Directors

Definedbenefit

pension plan

Pension fundtrustees

Pensionsregulator

Deficit volatility

Improving longevity

Increasing disclosureobligations

Securing pension Promises “safe haven”

Sponsor covenant

Pensionprotection

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)

40

20

Liabilities at end of year 828

Source: Punter Southall “The End Game?”

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Market Development

Estimated 8bn in 2008

£m

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2007Q1

2007Q2

2007Q3

2007Q4

2008Q1

2008Q2

2008Q3

2008Q4*

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• Spread – cost of liabilities vs. return on assets

• Risks– Longevity

– Interest rates

– Credit

– Inflation

– Operational

Economic Model

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Liabilities Cannot Accelerate, but Longevity Risk.

Sample Pension Scheme - Cashflows (nominal terms)

0

10

20

30

40

50

60

70

80

0 5 10 15 20 25 30 35 40 45

Year

Ben

efit

pay

men

ts (

£m's

)

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.

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Return on Equity = Return on Assets + 101 x (return on assets - pricing yield)

= 6.02% + 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

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• Trustee driven transactions

• Sponsor goals for longer-term

• Fewer players

• Price increases

Implications

Sustainable, Growing Market