1. Teach-in Road to the End Game 17 September 2013
Road to the End Game: Terminal
Portfolios and Buy-In / Buy-out
1

2. Teach-in Road to the End Game 17 September 2013
The End Game
The End Game describes the position that a scheme aims to be in as it reaches maturity:
• This may mean targeting a “Terminal Portfolio” i.e. a low-risk asset allocation or;
• a buy-out or buy-in with an annuity provider
The path to the End Game for most schemes will be a dynamic process: whilst a less mature scheme with a large
deficit (and strong sponsor) may run a high-risk / high-return strategy, as the scheme’s funding position improves, it
makes sense to take de-risking opportunities where the scheme can afford to do so
This presentation is in two parts:
• Road to the End Game and Terminal Portfolios
• Buy-ins and Buy-outs with an annuity provider
2

3. Teach-in Road to the End Game 17 September 2013
Setting the Scene
Open
33%
Closed to
new
members
49%
Closed to
future
accruals
17%
Winding
up
1%
3
Source: Pension Protection Fund “Purple Book” 2012. Excludes hybrid schemes
Open
17%
Closed to
new
members
52%
Closed to
future
accruals
29%
Winding
up
2%
More schemes are closing to new members and to future accruals...
Distribution of Scheme Status (% of Schemes)
2012
Distribution of Scheme Status (% of Schemes)
2006

4. Teach-in Road to the End Game 17 September 2013
Setting the Scene
4
Overall, schemes are moving to lower risk asset allocations (lower equities, higher fixed interest)...
Equities
61%
Gilts &
fixed
interest
29%
Property
4%
Cash &
deposits
2%
Other
4%
Source: Pension Protection Fund “Purple Book” 2012. Excludes hybrid schemes
Equities
39%
Gilts &
fixed
interest
43%
Property
5%
Cash &
Deposits
5%
Other
8%
Average Asset Allocation in Total Assets
2006
Average Asset Allocation in Total Assets
2012

5. Teach-in Road to the End Game 17 September 2013
Setting the Scene
5
-0.6
0.0
0.6
1.2
1.8
3,000
4,000
5,000
6,000
7,000
FTSE 100 30yr Real Yield (%)
Source: Bloomberg (chart 1), PPF “Purple Book 2012 (chart 2)
60% 65% 62% 58%
68% 67%
60%
0%
20%
40%
60%
80%
2006 2007 2008 2009 2010 2011 2012 2013
Funding Ratio – Full Buy out basis
?
But most schemes are nowhere near fully funded on a buy-out basis

6. Teach-in Road to the End Game 17 September 2013
What do we mean by a Terminal Portfolio?
• A Terminal Portfolio is a portfolio that enables a scheme to continue paying out member benefits without any
deterioration to the funding level, until the very last benefit payment is made, or a buy-out occurs.
• A Terminal Portfolio assumes the Scheme is fully funded on a prudent valuation basis
• In addition, a Terminal Portfolio:
• No longer requires deficit-repair contributions from the Sponsor;
• Is fully interest rate and inflation hedged;
• Will likely have exposure to liquid and/or illiquid credit to:
• Fund the spread to Gilts (or Swaps) on the liability discount basis; and/or
• Provide a sufficient buffer to underpin the residual risks in the scheme, for example longevity risk
• The Terminal Portfolio is not implemented once the Scheme reaches full-funding. Rather, the Scheme’s current
investment strategy should converge towards this Terminal Portfolio as the Scheme approaches full funding
6

7. Teach-in Road to the End Game 17 September 2013
Why think about the End Game now?
7
150
175
200
225
250
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Liabilities Assets Liabilities have risen Assets (Required Return after liability rise)
1. Required Return to reach full
funding in 15yrs: Gilts + 2.50%
3. After liabilities have risen, Required
Return on Assets is Gilts + 3.25%
2. Liabilities have risen
• If liabilities rise, all else being equal, Required Return on Assets to meet full funding will rise; the closer the target full
funding date, the greater the impact on Required Returns
• It therefore makes sense to adopt an investment strategy that de-risks dynamically through time to give greater
certainty around the path to full funding as the scheme matures:
• As funding ratio improves, reduce reliance on less predictable sources of return e.g. equities, and allocate to
assets with more predictable and less risky cashflows that better match the liability cashflows
£m
Illustrative Flight Plan
Time Horizon

8. Teach-in Road to the End Game 17 September 2013
Objective Measurement Performance Indicators Performance (30 Jun 13) Status
Primary Funding
Objective
To reach full funding by [2025] based
on discount rate of Gilts + 1.00%
(Technical Provisions basis)
Expected Returns (ER) > Required
Returns (RR)
RR: Gilts + 275bps
ER: Gilts + 200bps
Difference: -75bps
Secondary
Funding Objective
To reach full funding on a buyout basis
by [2035] based on a Gilts Flat
discount rate
Expected Returns (ER) > Required
Returns (RR)
RR: Gilts + 250bps
ER: Gilts + 200bps
Difference: -50bps
Risk Budget
The investment strategy should not risk
the deficit worsening by [20%] of
liabilities over a 1 year period
VaR95 < [20%] of liabilities VaR95: 30.0%
Hedging Strategy
Nominal/Inflation hedge ratio should be
maintained within +/- 5% of the funding
ratio.
Funding Ratio (Gilts + 1.00%) 60%
Nominal Hedge Ratio (Gilts + 1.00%) 20%
Inflation Hedge Ratio (Gilts + 1.00%) 25%
Collateral
Maintain sufficient eligible for meeting
collateral requirements that may arise
from the Scheme’s current derivative
positions over a 1 year period.
Total available eligible collateral £300m
Remaining collateral after VaR95 event £200m
Road to the End Game: Setting Clear Goals and Objectives
8
Status Metric is at or above target Metric is within [10%] of target Metric is more than [10%] away
The first step is for all stakeholders to agree what the objectives are...

9. Teach-in Road to the End Game 17 September 2013
Constructing a Terminal Portfolio: What Required Returns should a Terminal Portfolio target?
9
1.Discount
Rate
2.Buffer
Target
Required
Returns
Once a Scheme has reached full funding, the Required Returns
needed to maintain this position will be:
• The liability discount rate on which the Scheme has reached
full-funding plus;
• A buffer/margin to cover risks, such as:
• Longevity Risk: the risk that members live longer
• Underperformance of credit portfolio: risk that the credit
allocation underperforms i.e. defaults
• Reinvestment Risk: credit spreads tighten over time so the
scheme can not achieve the same credit spreads in the future
• Deflation: where a scheme has a large proportion of LPI
floored liabilities, it is exposed to sustained periods of
deflation
• Other: expenses (advisors, legal, admin etc.)

10. Teach-in Road to the End Game 17 September 2013
Constructing a Terminal Portfolio
The asset allocation of a Terminal Portfolio will depend on what the scheme is trying to achieve e.g. how certain does the
scheme need to be that it will have no further need for sponsor contributions?
• The higher the discount rate, the higher the returns needed to maintain full-funding; this implies more risk
• The lower credit spreads are when the Scheme reaches full-funding, the higher the allocation to credit will need to
be to generate sufficient expected returns
• Note that these are not suggested portfolios. A Terminal Portfolio may also hold other (non-fixed income) assets
10
Liquid
credit
70%
Gilts /
Swaps
/ Cash
25%
Illiquid
credit
5%
Liquid
credit
15%
Gilts /
Swaps /
Cash
75%
Illiquid
credit
10%
Illustration 1
- Full funding by 2035
- Credit spreads = 100bps
- Discount basis = Gilts+50bps
Illustration 2
- Full funding by 2035
- Credit spreads = 200bps
- Discount basis = Gilts+25bps
Illustrative Terminal Portfolio 1 Illustrative Terminal Portfolio 2

11. Teach-in Road to the End Game 17 September 2013
The Role of Credit
11
The Role of Credit Within a Scheme’s Asset Allocation

12. Teach-in Road to the End Game 17 September 2013
Illiquid Asset Universe
12
ILS: Insurance linked securities
CTA: Commodity Trading Advisors
ABS: Asset backed securities
CRE: Commercial Real Estate Debt
Illiquid Asset Considerations
• Do incremental returns
contribute to expected returns
> required returns?
• Interest rate / inflation hedge?
• Impact on overall Scheme
risk?
• Is there still sufficient collateral
to cover scheme requirements?
• Do the returns compensate for
the investment’s level of risk,
illiquidity, complexity and
governance?
• Are there less complex
opportunities available?
• How is liquidity affected at the
Scheme level? Can the
Scheme afford to hold illiquid
assets?
• Scheme tolerance for
fluctuations in funding ratio
due to valuation of illiquid
assets?
Note: Above chart based on responses to a Redington survey

13. Teach-in Road to the End Game 17 September 2013
Further Considerations for a Terminal Portfolio
13
Why ? Further Considerations
Liquidity In the absence of sponsor contributions, a scheme may
rely largely on coupon payments, maturing assets and the
disposal of assets to pay benefits; it is therefore important
to manage the level of illiquid assets held that may be difficult
to sell in the short-term
However, long-dated illiquid
assets will typically provide an
attractive illiquidity premium
while reducing reinvestment risk
Collateral Collateral requirements will increase if the scheme uses
unfunded instruments, such as swaps to reduce risk;
emphasis should be on effectively managing these collateral
requirements
Reinvestment
Risk
As traditional credit is typically shorter-dated than scheme
liabilities, where a scheme relies on credit for returns, it will
be exposed to reinvestment risk (the risk that a scheme
can not reinvest at the same credit spreads as when the bond
was initially purchased); this may result in the scheme’s
Expected Returns being lower than its Required Returns
Allocation to long-dated credit
reduces this risk (subject to no
defaults) as it locks into current
returns for longer
Buy-Out
Compatibility
If a Scheme wishes to consider a buy-out in future, it should
consider which assets are preferable to an insurer in the
event of a buy-out

14. Teach-in Road to the End Game 17 September 2013
Ideally, a Scheme’s investment strategy should converge towards the Terminal Portfolio as the Scheme
approaches full funding; this can be achieved systematically within a dynamic de-risking framework, for example:
1. Reduce interest rate and inflation risk by increasing hedging
• Could be time-based i.e. level of hedge increased incrementally over time and/or;
• Trigger-based i.e. increase hedge ratio as funding ratio rises to “lock-in” funding ratio improvements
2. Reduce allocation to “return-seeking” assets (e.g. equities) as and when funding level improves:
• Where funding level improves, “Required Return” will fall, so the scheme can afford to reduce the level of
Expected Return (by reducing return-seeking assets) – see chart below
Dynamic De-Risking
14
0
100
200
300
400
500
60% 64% 68% 72% 76% 80% 84% 88% 92% 96% 100%
Required Return Expected Return
Spread over Gilts
Funding Ratio

15. Teach-in Road to the End Game 17 September 2013 15
Dynamic De-Risking Case Study: The Journey of a Small Scheme
Scheme 2008 2013 Comments
Clear Funding Objectives   Pension Risk Management Framework
Risk Budget   Reduced VaR from 30% to 15%
Monitoring   Missed Buy-Out opportunity in 2008
Allocation to Equities 90% 0% Dynamic asset allocation
Hedge Ratio 5% 90% Funding Level immunised to rates & inflation

16. Teach-in Road to the End Game 17 September 2013
Considerations for Terminal Portfolio vs. Partial Buy-in vs. Buy-out
• What are the residual risks in the scheme? e.g.:
• Longevity risk, credit risk, basis risks (e.g. discounting using a Gilts basis but hedging using swaps)
• Counterparty risk of the annuity provider
• What are relative costs of the solutions?
• Dependent on level of risk being run
• Market prices for solutions change over time
• Does the scheme have an appropriate governance framework for the solution?
• A dynamic de-risking strategy requires additional governance bandwidth
• Implementation of buy-in / buy-out / longevity swap will require trustee / investment committee time
16

17. Teach-in Road to the End Game 17 September 2013
13-15 Mallow Street London EC1Y 8RD Telephone : +44 (0) 20 7250 3331 www.redington.co.uk
Contacts
17
Disclaimer
For professional investors only. Not suitable for private
customers.
The information herein was obtained from various
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accuracy. The information is for your private information
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factors and assumptions may affect this analysis, and
this analysis does not reflect all possible loss scenarios.
There is no certainty that the parameters and
assumptions used in this analysis can be duplicated with
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subject to further due diligence .
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Direct Line: 0203 326 7134
karen.heaven@redington.co.uk

18. Teach-in Road to the End Game 17 September 2013
Building Pensions SuperTeams
18
About the event
What’s the difference between a SuperTeam and an average one? Why does creating the right team set the conditions to produce the best
outcomes? And how can understanding the success of the Rolling Stones help pension schemes to achieve their goals?
Pinsent Masons and Redington cordially invite you to learn the secrets of stellar performance from leadership and teamwork advisor, Khoi Tu, author
of ‘SuperTeams’.
We all work in teams, both within and across organisations, to solve complex issues such as repairing DB pension deficits or designing robust
investment strategies for DC members. With inspiration and insight from some of the greatest teams in the world, we hope to give you the
guidelines and protocols for success with your trustee board, your sponsor and your advisors.
Agenda:
4.00pm Registration and Refreshments
4.30pm Welcome Address (Pinsent Masons, Redington)
4.40pm Presentation, Q+A (Khoi Tu)
6.15pm Drinks and Canapes
http://www.redington.co.uk/Events-Seminars/Events/2013/Building-Pensions-SuperTeams.aspx
Building Pensions SuperTeams
Date: 14 Oct 2013
Time: 16:00
Venue: 30 Crown Place, Earl Street, London EC2A 4ES

19. 19
ROAD TO THE END GAME: TERMINAL
PORTFOLIOS AND BUY-IN / BUY-OUT –
AN INSURER’S VIEW
17 SEPTEMBER 2013
Michael Abramson – Co-Head of Business Development for Bulk
Annuities and Longevity Insurance

20. INSURER PRICING FOR BUY-IN AND BUY-
OUT.
20
20
Investment
strategy
Mortality
Inflation
expectations
Reserving
requirements
Shareholder
demands

21. ANNUITY INVESTMENT STRATEGY.
21
• Strategy varies from one insurer to the next
• Credit LDI
• Funding trade
• Legal & General approach
• Predominantly credit
• Average rating: A
• Currencies: GBP, USD, EUR
• Appropriate duration
• Diversification
• Actively managed
• Some gilt holdings for collateral
• Increasing allocation to direct investments, e.g. sale and
leaseback, infrastructure
• Rates, inflation and fx hedging to match liabilities

22. DETERMINING SCHEME PRIORITIES.
22
• Hedge vs. Outperform annuity pricing
• Hedge: Investing like an insurer
• Which insurer?
• Credit LDI strategy
• Default risk; exposure to illiquid assets
• Outperform
• Requires a good knowledge of true market price
• Timing is critical
• Possible approaches: price tracking, “toe in the water”, pre-
approval of contracts

23. MINIMISING TRANSACTION COSTS.
23
• In specie transfer generally based on overall insurer investment strategy
• Gilts are generally simplest
• Can transfer corporate bonds, although pooled funds may be tricky
• Illiquid assets will require insurer due diligence
• Swaps – can they be novated?
• A hedged strategy with low exit costs may be more effective than
focussing on in specie transfer

24. 24
APPENDIX

25. FSCS
Statutory reserves
(containing prudent margins
above best estimate liability)
Regulatory
Capital Requirements
Additional
shareholder
capital
Regulator
intervention
• UK insurers are required to hold
significant amounts of capital
– Life insurers hold statutory reserves,
which contain prudent margins above
best estimate liabilities
– Insurers must hold additional
Regulatory Capital Requirements
– Additional shareholder capital is held
above Regulatory Capital
Requirements
• Additional protections
– Regulator intervention to protect
policyholders’ benefits
– Financial Services Compensation
Scheme (the “FSCS”) protection
– FSCS covers at least 90% of benefits
• Layers of policyholder protections
Technical insolvency
(c. 110% of best
estimate)
Capital Resource Requirement
(c. 115% of best estimate)
UK INSURANCE REGULATORY REGIME.
25

26. Michael Abramson
Co-Head of Business Development,
Bulk Purchase Annuities and Longevity Insurance
direct: 020 3124 2978
mob: 07889 748927
email: michael.abramson@landg.com
CONTACT DETAILS.
26

27. This presentation contains confidential and proprietary information of Legal & General Group Plc (“L&G”). The presentation, and any opinions
on financial products it contains, may not be modified, sold, or otherwise provided, in whole or in part, to any other person or entity without
L&G's written permission.
L&G makes no representations as to the accuracy or completeness of any of the information in this presentation and any liability on the part
of L&G in relation to the inaccuracy or incompleteness of the information is excluded to the extent permitted by law. Nothing in this
presentation amounts to an offer or promise.