This Towers Perrin presentation examines alternative risk financing techniques being implemented by companies in Europe with defined benefit (DB) pension plans. These techniques offer insights into the future of financing global pensions, both in the U.S. and elsewhere.

1. The Future of U.S. Pension Financing
Lessons From Europe
April 2009
© 2009 Towers Perrin

2. Presenters
Mitchell Cole
Mitch is a Principal in Towers Perrin’s Retirement Risk
Solutions (RRS) practice in Stamford, CT. He directs the
firm’s work in Alternative Financing for Employee Benefits
and Pensions, which is part of the RRS. RRS combines
expertise in employee benefits and pensions with risk
expertise and transaction execution capabilities to provide
risk management and structured solutions worldwide.
Travis Winkels
Travis is a Principal in Towers Perrin’s RRS practice in St.
Louis, MO. In his nine years of global employee benefit
consulting experience, Travis has had the privilege of
working with some of the largest and most recognizable
companies in the world to mitigate their pension risk
exposure through the implementation of alternative pension
financing including the use of captive insurance companies,
liability driven investments, and other cutting-edge financial
products.
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© 2009 Towers Perrin

3. Presenters
Paul Kelly
Paul Kelly is a Principal in Towers Perrin’s Global
Consulting Group in London. Paul joined Towers Perrin
in 2004, following a number of years as a global Director
of Pensions. Prior to this, he worked for 20 years in
international employee benefits consulting and has dealt
with many mergers and acquisitions.
James Staveley-Wadham
James is a consultant in Towers Perrin’s Retirement
group in London. One of his areas of expertise is in
securing benefits arising from defined benefit
arrangements, which he has been involved in for over
seven years. This work covers full buyouts with the
corresponding winding up of the pension plan through to
buying in certain members’ benefits as part of an
investment of the pension trust.
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4. Agenda
Context for Emerging Solutions in Europe
Case Studies
U.K. Pension Buy-In
Cross-Border Pension Pooling
European Pension Captive
Ideas for Action
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5. Recent surveys show a similarity
between European and U.S.
executives’ views on pension risk
The Major Risks of a Pension Plan (as seen by corporate leadership)
Europe
(% respondents)
Regulatory changes 48
Mortality assumptions 47
Inflation 36
Accounting changes 26
Source: The Economist Intelligence Unit 2008 and Towers Perrin
U.S.
(% respondents)
Cash flow 38
Regulatory compliance 35
Income statement 27
Source: CFO Research Services in collaboration with Towers Perrin
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6. The economic crisis has adversely affected the
funded status of plans in Europe and the U.S.
PBO-Funded Ratio for Benchmark Plan
140%
140%
Europe
U.S. 130%
130%
120%
120%
77.9% as of
63.7% as of
110% 110%
3/31/2009
3/31/2009
100% 100%
90% 90%
80% 80%
70% 70%
60% 60%
Dec 99 Dec 00 Dec 01 Dec 02 Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Dec 08 Dec 99 Dec 00 Dec 01 Dec 02 Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Dec 08
60/40 Average Duration Fixed Income (FI)
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7. Credit spreads introduce a new element of risk into the
overall risk profile that is difficult to hedge using traditional
financial market instruments (including derivatives)
Key Bond Yields (at end of month)
9.00%
8.00%
7.00%
6.00%
5.00%
4.00%
3.00%
2.00%
Spread Between Corporates (ML 10+) and 30-year T-bonds (bps)
Dec 04 Dec 05 Dec 06 Dec 07 Dec 08
December 1998 – March 2009
30-Yr Swaps 30-Yr T-Bonds
ML 10+ HiQ
4
Credit derivatives are 3.5
costly and volatile 3
Traditional LDI 2.5
strategies hedge
2
general interest-rate
risk, but don’t capture 1.5
credit-spread risk
1
High-quality corporate
0.5
bonds are few in
number and fairly illiquid 0
Dec 98 Dec 99 Dec 00 Dec 01 Dec 02 Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Dec 08
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© 2009 Towers Perrin

8. Companies in the U.S. and Europe
face identical challenges
Mark-to-market accounting
Matching pension obligations with fixed income is
difficult:
Limited availability of long-duration bonds
Deviation in credit spreads
Historically low yields on government issues
Counterparty credit risk
New accounting rules and pension regulations
increase cost of DB plans
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© 2009 Towers Perrin

9. The alternatives, which are largely customized,
rely on insurance and reinsurance companies
Why Alternatives …and Why Insurers
Control Capacity
Cost savings Credit risk management
Cash flow Capability
Annuity
Traditional
purchase
asset
High
immunization
Buy-ins
Cashouts/
Custom
other exercise
insurance
of options
Interest-
Cost
rate overlay
strategy
Pension
CAP*
Cross-border
Control pension
pooling
Traditional offering Low
Alternative financing approaches Low High
Degree of Risk Assumption *Patent pending in the U.S.
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© 2009 Towers Perrin

10. European executives are turning to
alternative financing, versus traditional,
one-size-fits-all approaches
Operational Risk Plan administration
Plan governance
Regulatory Risk Risk from regulatory changes by IRS,
DOL, PBGC, FASB, IASB, etc.
Asymmetric risk of surplus rules
Demographic Risk Risk posed by participant longevity and
embedded-design options (e.g., lump
sums, early retirement subsidies)
Spread Risk Risk posed by changes in spreads,
yield-curve shapes and pension
Investment Strategies
Traditional Annuities
asset/liability mismatch
Interest-Rate Risk
Risk posed by inflation-rate changes,
changes in treasury yield-curve shapes
Alternatives
Market Risk Market risk posed by investments held
in pension trust (equity volatility, credit
risk, currency risk, etc.)
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11. Alternative 1: U.K. Pension Buy-In

12. Snapshot of the pension buy-in
marketplace, 2007-2008
Name GBP m Insurer Date Type
Telent 3,000 Pension Corporation Nov-07 UFB
Thorn 1,200 Pension Corporation Jun-07 UFB
Cable & Wireless 1,000 Prudential Sep-08 PPB
P&O 800 Paternoster Dec-07 PPB
Rank 700 Rothesay Life Feb-08 Full
Delta 452 Pension Corporation Jun-08 PPB
Powell Duffryn 400 Paternoster Mar-08 Full
Friends Provident 350 Norwich Union May-08 PPB
TI Group 259 Legal & General Mar-08 PPB
Weir Group 240 Legal & General Dec-07 PPB
Thomson Regional Newspaper 200 Citigroup Aug-07 UFB
DRG Pension Fund 180 Legal & General Jan-07 PPB
M-Real Corporation 180 Legal & General Mar-08 Full
Electricity Association Services 170 Legal & General Nov-07 Full
Emap 170 Paternoster Oct-07 Full
Morgan Crucible 160 Lucida Mar-08 PPB
Eni Lasmo 150 Paternoster Nov-07 Full
Hunting 110 Paternoster Jan-07 PPB
Threshers 100 Pension Corporation Jun-07 UFB
Lonmin 78 Paternoster May-08 Full
Book Club Associates 75 Legal & General Dec-07 Full
Ravenmount (Swan Hill) 72 Pension Corporation May-08 Full
Queens Moat Houses 60 Legal & General Dec-07 Full
UFB: Uninsured Full Buyout, PPB: Partial Buyout, Full: Full Insured Buyout Source: Pension Week, May 26, 2008
plus addition of recent transactions
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© 2009 Towers Perrin

13. What is a buy-in?
What is a Bulk Annuity? What Makes a Successful Transaction?
An insurance policy that addresses Trustees clear on what they want
Investment risk Clarity and support from the company
Inflation and interest-rate risks Effective process and project
management
Mortality risk
Appointment of a project sponsor
Policies can be owned by either the
trustees — a “buy-in” — or by the
individual — a “buyout”
What is a Buyout? What is a Buy-In?
Company and trustees transfer all An investment held by the pension trust
of their responsibilities to a third-party Covers specific groups (e.g., retirees)
insurer or insurers Future tranches could be secured
Insurers deal directly with members with the insurer
in the future, who will have their own Plan retains all administration
individual policies
Plan is exposed to counterparty risk
Future benefit accrual cannot be
bought out
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14. Example buyout and buy-in structures
Buyout Buy-In
Plan Plan
Sponsor
Sponsor Sponsor
Annuity
Annuity Premium
Premium
Pension
Pension
Pension
Pension Insurer
Insurer
Plan
Scheme
Plan
Scheme
Monthly
Payroll
Benefit
Benefit
Payments
Payments
Plan
Plan
Participants
Participants
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© 2009 Towers Perrin

15. Case study: U.K. pension buy-in
Context Objectives
With liabilities of £1bn, Company Significantly reduce the level
was concerned over pension risk of pension risk by transferring
within its overall risk budget to a third party
Trustees keen to “de-risk” pension Satisfy trustees’ concern over
investments counterparty risk
Issues to Consider Outcome
Surrender provisions The first transaction in the U.K. to fully
insure obligation within the plan while
Mark-to-market accounting/valuation
offering unique security features
of the plan asset
Surrender value payable, after certain
Participant security and residual claim
trigger points, equal to 98% of
on pension fund
statutory reserve value of insurer’s
Counterparty risk outstanding liabilities
Withholding of the premium, which
could be returned to the trustees at
90% of the outstanding liabilities
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© 2009 Towers Perrin

16. Advantages and considerations
of buyout and buy-in in the U.S.
Buyout Buy-In
Advantages Advantages
liabilities off balance sheet liabilities not removed, but
“matched”
no PBGC premiums
may lower funding under PPA
outsourced administration
requirements
Considerations
may avoid accounting settlement hit
accounting settlement charge
Considerations
under FAS 88
subject to PBGC premiums
PPA funding implications
continued administration
— benefit restrictions
counterparty risk
— quarterly contributions
terms for future plan windup
— use of credit balance
possible enhanced credit protection
options (may increase cost relative
to buyout)
review by auditors and attorneys
is recommended
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© 2009 Towers Perrin

17. 2. Cross-Border Pension Pooling

18. Optimizing financial and operational
effectiveness for pensions on a global basis
Defined Benefit
Defined Contribution
Country
A B C IMEs D E F G IMEs H
employee
group
Local Local Local Local Local Local
IME
country country country country country country
plan
DC plan DC plan DB plan DB plan DB plan DB plan
Cross-border Cross-border
DC platform DB platform
(e.g., IORP*) (e.g., CAP, IORP*)
Optimizes financial
and demographic
Optimizes fiduciary,
risks (in an enterprise
compliance and plan
context)
governance risks Cross-border asset pooling
vehicle (with subsections)
Optimizes asset
management arrangements
(governance, cost, return)
*Institution for Occupational Retirement Provision, under EU Directive
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© 2009 Towers Perrin

19. Concept of cross-border IORP
NL Multinational
Employees in NL, U.K., IRL
IORP located in B
Regulated in B — single license
B supervision, regulations, funding.
For taxation, assets split based on liabilities.
Single fund with sections.
U.K. Section IRL Section
NL Section
Respects U.K. tax, Respects Irish tax,
Respects NL tax,
labor, social law labor, social law
labor, social law
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20. Asset pooling vs. cross-border plan
Without Pooling
German French U.K.
pension plan pension plan pension plan
Asset Asset Asset Asset Asset Asset Asset Asset Asset
class class class class class class class class class
1 2 3 1 2 3 1 2 3
Asset Pooling Cross-Border Plan
German French U.K.
pension plan pension plan pension plan
Single pension plan
Single Legal Entity
Asset-Pooling Vehicle
Asset Asset Asset Asset Asset Asset
class class class class class class
1 2 3 1 2 3
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© 2009 Towers Perrin

21. U.S. multinational case
High-tech Fortune 500
Had legacy defined benefit and defined contribution
issues for internationally mobile employees
And needed future home for defined contribution
Mostly related to EMEA countries
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22. Cross-border pension plan
Ireland Section
Deferred members
Active members
U.K. Section
in Ireland
Deferred members in
Turkey
U.K. and elsewhere
Active members
Active members
in U.K.
IORP in Ireland
Poland section
Egypt
Active members
Active members
Russia Hungary section
Active members Active members
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© 2009 Towers Perrin

23. Summary of advantages and effort
related to cross-border pension plans
Advantages Effort
Improved governance Setup of cross-border plan,
including
Improved risk management
benefit design for each
Improved reporting country section
selection of plan domicile
Reduced internal management
time and cost selection of vendors
understanding of social and
Reduced administration
labor law for each country
and management cost
understanding of tax
Stronger sense of one firm
requirements for each country
among employees
Establish a clear governance
model for countries involved
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© 2009 Towers Perrin

24. 3. European Pension Captive

25. How a captive works
Benefit plan purchases premium
Benefit Plan
(or a single premium) for either
Life, Disability, Medical or
Pensions at a given cost (say
Claims or Benefits
the prevailing market cost from
Annuity
AA insurer)
premium
Insurer reinsures to captive
Insurer
and passes assets to captive
Thus employer has control
of assets and can liberate
any emerging surplus
Reinsurance
Captive
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26. Captive reduces the net cost of windup
by eliminating profit loads and providing access to
emerging surplus
How CAP Can Reduce the Cost of Windup
CAP
Reinsurance can be
Potential Adverse terminated, transitioning
Deviation
Buy-in / Buy-out to traditional windup at
Retail Price market prices
Up-Front Savings from
“no-load” annuity
Wholesale Price
Surplus recovery Realized return >
through profit annuity technical rate
distribution reduces net pension
cost over time
Cost
Years
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27. Case study: European pension captive
Context Objectives
Centralize investment control
Global company needed to externalize
final-average-pay pension due to local Achieve long-term cost savings
tax ceiling
Maintain (or improve) participant
Cost of externalization unacceptably security
high
Reduce cost of externalization
Support global pension governance
Issues to Consider Outcome
Pension and reinsurance regulations Investment strategy controlled
by Corporate Treasury function
IFRS and the early involvement of the
accountants Centralized decision-making authority
Acceptable fronting capacity NPV cost reduction of €100M relative
to traditional buyout
Captive; domicile, license
Participant security enhanced
Capital
Security
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© 2009 Towers Perrin

28. Ideas for action
3. Set a timetable for
2. Assess whether
1. Determine how much risk achieving the
refinancing is
the company is able and refinancing, possibly
necessary and how
willing to assume using alternatives in
combination
Cost
Cost
Annuity
Traditional
purchase
We should be asset
immunization
indifferent between x Interim financing
million loss in the plan Buy-ins
or in operating income Cashouts/
Custom
other exercise
insurance
We would prefer to of options
have losses of less Alternative financing
Interest-
than x in the plan approaches
rate overlay
strategy
Pension
CAP
Windup
Cross-border
Control pension
pooling
Time in Months/Years
Extent of Risk Aversion Degree of Risk Assumption
Traditional offering
Alternative financing approaches
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© 2009 Towers Perrin

29. Following a proven process can deliver
custom solutions that satisfy diverse needs
Key Needs
Risk assessment and gap analysis
Identification and feasibility review of custom solutions
Assessment of global partners available to deliver proposed solutions
Execution and implementation
Agile decision making and ongoing monitoring
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© 2009 Towers Perrin

30. Questions ?

31. Presenters
Mitchell Cole
mitchell.cole@towersperrin.com
Ph: (203) 326-5431
Paul Kelly
paul.kelly@towersperrin.com
44 (20) 7170-3693
Travis Winkels
travis.winkels@towersperrin.com
Ph: (314) 719-5920
James Staveley-Wadham
james.staveley-wadham@towersperrin.com
Ph: 44 (20) 7170-3449
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© 2009 Towers Perrin