2009 Annual Meeting ● Assemblée annuelle 2009 Halifax, Nova Scotia ● Halifax (Nouvelle-Écosse)

1. Canadian Institute of Actuaries L’Institutcanadien des actuaires 2009 Annual Meeting ●Assemblée annuelle 2009 Halifax, Nova Scotia ● Halifax (Nouvelle-Écosse)

2. 2009 Annual Meeting Assemblée annuelle 2009 Christian-Marc Panneton 2009-06-25 WS-30 LDI for Pension Plans: Moving from Theory to Practice AT-30 Les placements fondés sur les passifs pour les régimes de retraite: de la théorie à la pratique

3. Agenda Liabilities Interest Rate Risk Credit Spread Risk Risks Management Process Conclusion 2009 Annual Meeting Assembléeannuelle 2009 LDI for Pension Plans

4. Objective: Mitigate interest rate risk 1st Step: Determine risk exposure Duration is a simple metric A single number indicating sensitivity to interest rate changes Duration gap between assets and liabilities 2009 Annual Meeting Assembléeannuelle 2009 Interest Rate Risk

5. Need liability characteristics Typically monthly expected CF Must be updated regularly Adjust for actual vs expected Case Study: retirees 2009 Annual Meeting Assembléeannuelle 2009 Interest Rate Risk PV @ 4.50% = 106,63 millions Duration = 8.50

6. 2009 Annual Meeting Assemblée annuelle 2009 Interest Rate Risk • Duration – rule of thumb • Given a duration of D, a variation of y in yields will change the value by Dy • Duration = 8.5, y increases by 1% => decrease of 8.5% PV @ 4.50% = 106.63 millions PV @ 5.50% = 98.23 millions  = 7.88%

7. 2009 Annual Meeting Assemblée annuelle 2009 Interest Rate Risk • Duration metric is not precise • PV is not a linear function • Convexity • Indicates Duration sensitivity to interest rate changes Duration @ 4.50% = 8.50 Duration @ 5.50% = 7.92 Convexity @ 4.50% = 132.65 • Expected change in PV • with duration only: - 8.50% • With duration and convexity: - 7.83% • Actual change: - 7.88%

8. 2009 Annual Meeting Assemblée annuelle 2009 Case Study • Assumptions • Liability duration: 8.50 • Funded ratio: 100% • Traditional 60-40% Mix • Equities Duration: 0 • DEX Universe Duration: 6.57 (2007-12) • 60%-40% Mix Duration: 2.63 • Impact of a decrease in yield of +50bps • Assets increase by 1.32% • Liabilities increase by 4.25% • Funded ratio decreases to 97.07% Material interest rate risk with Traditional 60-40% Mix

9. 2009 Annual Meeting Assemblée annuelle 2009 Case Study • Using Long-Term Bonds • Equities Duration: 0 • DEX Long-term Duration: 12.61 (2007-12) • 33%-67% Mix Duration: 8.45 • Impact of a decrease in yield of +50bps • Assets increase by 4.23% • Liabilities increase by 4.25% • Funded ratio almost unchanged! (99.98%) Taking into account the liability’s CF duration in selecting assets can reduce exposure to interest rate changes.

10. 2009 Annual Meeting Assemblée annuelle 2009 Case Study • Not So Easy! • From Dec. 31, 2008 to March 31, 2009 • TSX Total return:  2.0% • DEX Universe: + 1.5% • DEX Long-term: + 0.3% • Solvency liability:  1.5% • Liability valued with Canada yield curve:  0.3% • CF Matching Liability (AA yield curve): + 4.4% • From Sep. 30, 2008 to Dec. 31, 2008 • TSX Total return:  22.7% • DEX Universe: + 4.5% • DEX Long-term: + 5.2% • Solvency liability: + 3.2% • Liability valued with Canada yield curve: + 8.9% • CF Matching Liability (AA yield curve):  4.8%

11. 2009 Annual Meeting Assemblée annuelle 2009 Case Study 60-40% Traditional Asset Mix 33-67% Alternative Asset Mix Assets (at market) Stocks TSX Total Return Bonds DEX Universe DEX Long-term Solvency Liability Funded Ratio Sep 30, ‘08 60.0 40.0 - 100.0 100.0 100.0% Dec 31 ‘08 46.4 41.8 - 88.2 103.2 85.4% Mar 31 ‘09 45.5 42.4 - 87.9 101.7 86.5% Sep 30, ‘08 33.0 - 67.0 100.0 100.0 100.0% Dec 31 ‘08 25.5 - 70.5 96.0 103.2 93.0% Mar 31 ‘09 25.0 - 70.7 95.7 101.7 94.1% Taking into account the liability’s CF duration in selecting assets did reduce exposure to interest rate changes!

12. Solvency Liability Based on a single rate: Canada over 10-years bond + spread Doesn’t capture full yield curve dynamic Better Approach to Risk Management Consider the complete yield curve Start with the Canada Bond yield curve Bootstrap to get spot curve… 2009 Annual Meeting Assembléeannuelle 2009 Case Study

13. Partial Duration Measure the sensitivity of change in yield for a given maturity Sums to duration (2008-12-31) 2009 Annual Meeting Assembléeannuelle 2009 Case Study Low sensitivity to short-term rates High sensitivity to long-term rates

14. Evolution Canada Yield Curve 2009 Annual Meeting Assembléeannuelle 2009 Case Study • From Dec 07 to Sep 08 • Large short-term rates decrease dominates => +0.3% • From Dec 08 to March 09 • Long-term rates increase dominates => 0.3%

15. Yield Curve for Liabilities Investment Policy: Assets allowed Based on Target or Benchmark portfolio Provincial spreads vs Canada Ontario spreads increased by 47bps in Q4 2008 2009 Annual Meeting Assembléeannuelle 2009 Case Study

16. Yield Curve for Liabilities Spreads on Corporate raised even more in 2008 Ontario spreads increased by 93 bps A-rated Corporate spreads increased by 305 bps 2009 Annual Meeting Assembléeannuelle 2009 Case Study

17. Credit Spread Risk Can be more material than interest rate risk From Sep ‘08 to Dec ’08 Canada curve decreased => + 8.9% Ontario curve decreased by smaller amount => + 4.2% A-rated Corp. curve increased =>  5.5% 2009 Annual Meeting Assembléeannuelle 2009 Case Study • Liability

18. Credit Spread Risk From Dec ‘08 to March ’09 Canada almost unchanged =>  0.3% Ontario stepped lightly =>  0.2 % A-rated Corp. curve decreased => + 5.8% 2009 Annual Meeting Assembléeannuelle 2009 Case Study • Liability Type of Bonds in portfolio can make a huge difference!

19. Financial Risks Interest rates Credit spread Liquidity Inflation Market risk … Non-financial Risks Mortality New entrants / Turnover … 2009 Annual Meeting Assembléeannuelle 2009 Risks

20. Optimization Development of an investment policy Portfolio construction Follow-up of matching Portfoliorebalancing Reports to clients LDI - ALM Process Analysis of client’s needs

21. Not “Active” in traditional sense, Not “Buy-and-Hold” either! Decision-making process Continuous process Close collaboration between Team members Assumption testing Portfolio Decision Validation 2009 Annual Meeting Assembléeannuelle 2009 Portfolio Management

22. Yield curve analysis and bond pricing Internal and External sources Securities allowed in portfolio: detached coupons, asset-backed securities, asset-backed mortgages, synthetic bonds, corporations (public and private), derivative products, RRB, … Buy and Sell decision Portfolio Rebalancing Opportunities Market Events 2009 Annual Meeting Assembléeannuelle 2009 Portfolio Management

23. Portfolio Construction Process Objective: Ensure matching of liabilities according to risk metrics defined in investment policy. Steps: Replication of the benchmark portfolio with a portfolio of zero coupons and/or bonds, Diversification of fixed income securities (issuers, activity sectors, geographic regions,…), Credit risk limited (e.g., maximum concentration rules by asset item class, sub-class, activity sector, issuer), Currency risk must be managed if allowed, Counterparty risk limited by concentration rules, Portfolio optimization, Final portfolio construction. 2009 Annual Meeting Assembléeannuelle 2009 Portfolio Management

24. Managing the Financial Risks associated with a Pension Liability Requires: A very good understanding of the liability financial characteristics. Risk tolerance limits which reflect the risk appetite of the Pension Plan. Tools to measure and assess current risk position. Portfolio managers which can generate added-value within pension plan risk appetite. 2009 Annual Meeting Assembléeannuelle 2009 Conclusion

25. 2009 Annual Meeting Assembléeannuelle 2009 Thank You!