Funding Standards: Comparison of the Position for Cross Border IORPS 2 June 2006

1. Funding Standards: Comparison of the Position for Cross Border IORPS 2 June 2006 To protect the confidential and proprietary information included in this material, it may not be disclosed or provided to any third parties without the approval of Hewitt Associates Limited.Hewitt Associates Limited is regulated by the Financial Regulator as an Authorised Adviser.

2. Presenters • Rachael Ingle – Hewitt Ireland • Lorayne Lloyd-Evans – Hewitt UK (International Practice)

3. Agenda • Introduction • Irish Funding Standard • Funding Standards in other EU countries – UK, Netherlands • Comparison of standards for sample scheme • Pan European IORP – domicile of choice • Summary

4. Irish Funding Standard - background • Set out in Part IV of the Pensions Act 1990 • No substantial changes until 2003 • Not really a concern for schemes prior to 2001 • Relatively high interest rates and “cheap” annuities • Strong equity market performance • Immature schemes • Did not have to cover pre -1991 benefits until 2001 • Following stock market falls of early 2000’s, Pensions Board were given powers in 2003 to relax the requirements for funding proposals (recovery plans) in limited circumstances • Further flexibility introduced in 2005 • Approximately 30% of schemes failed the standard when last tested • Ongoing review by Pensions Board

5. Funding Standard – when is the test carried out? • To comply with EU Directive, period between certificates is 3 years (previously 3.5 years, but most schemes used 3 in practice) • Must be submitted to Pensions Board within 9 months of effective date • If the standard is satisfied, annual statement needed in 2 intervening years to confirm that the actuary is “reasonably satisfied” that the standard would be met as at the year end • If the standard is not met (or the actuary cannot give the required statement in an intervening year), a funding proposal must be submitted to Pensions Board • This must be designed to restore the position in 3 years (or longer period approved by the Pensions Board) and is also subject to an annual check by the actuary

6. Funding standard – basic principles • Reflects the position on winding up or discontinuance of the scheme at the effective date of the test • Assets are assumed to be realised, expenses met and benefits provided in accordance with statutory priority order • AVCs • Pensions in payment (including future guaranteed increases and any contingent pensions) • Preserved benefits for others (essentially their entitlements under the rules) including revaluation on post 1991 accrual • Revaluation on pre 1991 accrual for those who left after 1 June 2002 and actives on wind up date • If sufficient assets are available to meet the first 3 classes, the funding standard is satisfied (priority 4 must be funded by 2012)

7. Funding standard - liabilities • Pensions currently in payment must be valued by reference to market cost of buying annuities • Treat anybody over “normal pensionable age” as having retired on that date • Difficulty in matching “unusual” liabilities e.g. pay related pension increases • High cost of index linked annuities (shortage of matching assets for insurers) • Recent change to Pensions Act confirms that fixed increases can be substituted • Active and deferred members valued as transfer values • Minimum basis set out in actuarial guidance • Reviewed regularly (statutory requirement for Ministerial approval)

8. Funding Standard - assets • Realisable value • Bid price for units • Forced sale value for property etc • Venture capital? Private Equity? • Limit of 10% on concentration of assets e.g. single stock or property (does not apply to managed funds, unit trusts, insurance policies, cash deposits or government stocks) • Self investment must be excluded from assets taken into account • Shares or debt in sponsoring employer or related company • Property occupied by sponsoring employer or related company (unless let at full market value) • Loans to company or money due from the company e.g. unpaid contributions

9. How would the Irish funding standard apply in a cross border context? • If an IORP is established in Ireland, the requirements of the home country (Ireland) apply in relation to the calculation of technical provisions • The funding standard test is undertaken in the same way as for a domestic scheme but allowing appropriately for any differences • Annuities should reflect currency of host country e.g. sterling annuities for UK pensions • Transfer values should be calculated for actives and deferreds in a manner consistent with actuarial guidance issued by the Society of Actuaries in Ireland • Any requirements of social and labour law of host country must be taken into account in calculating the benefits to be valued e.g. revaluation and indexation required for UK members

10. Requirements for cross border schemes • Must satisfy the funding standard on application to operate cross border (existing Irish or “re-domiciled” scheme) or within 2 years (new scheme) • Must subsequently be “fully funded at all times” • no formal pensions Board guidance has yet been issued • the Pensions Board intend to interpret this as requiring the scheme to be funded on a basis which is “expected” to maintain fully funded status over the following 3 year period • If the scheme becomes underfunded during or at the end of the period, the Pensions Board intends to permit a recovery plan (what recovery period?) • The Commission may decide to tighten up its requirements if some states appear to be interpreting them “too liberally” and may ultimately look to harmonise across the EU……..

11. UK Funding Standard • Background • MFR introduced from April 1997, in response to Maxwell • Increasingly viewed as inadequate • EU IORP Directive • Pensions Act 2004 – MFR replaced by “statutory funding objective” from the end of 2005

12. UK Funding Standard - changes • “Scheme-specific” • Statutory funding objective – to hold sufficient assets to cover technical provisions • Technical provisions – measure of liabilities as determined by the Trustees • Statement of Funding principles – agreed principles adopted by scheme for meeting the statutory funding objective • Recovery plan – practical plan of action for correcting any shortfall • Schedule of contributions – agreed contributions which satisfy statement of funding principles and recovery plan

13. UK Funding Standard - changes • Full valuation every three years • Annual report to update position • Within 15 months of date of full valuation scheme must have finalised schedule of contributions, recovery plan, consultation with members on any proposed benefit changes • (In general) seek employer’s agreement • Obtain actuarial advice • Assumptions for calculating technical provisions - level of prudence should be consistent with the overall confidence the trustees want to have that benefits will be paid • Does not need to reflect insurance buyout cost

14. UK Funding Standard - changes • Recovery plan must be submitted to the Pensions Regulator • Trustees should aim for any shortfall to be eliminated as quickly as the employer can reasonably afford • What is possible and reasonable will depend on assessment of employer’s covenant • Target recovery period expected to be no more than 10 years • If the funding target and/or the recovery plan do not satisfy certain criteria, these will trigger further investigation by the Regulator

15. UK Funding Standard – cross-border schemes • Additional requirements for UK schemes operating cross-border within the EU • Full valuations must be carried out annually (rather than triennial) • Any shortfall must be eliminated within 2 years of the valuation date (no extended recovery period allowed) • Schemes applying to operate cross-border for the first time must be fully-funded at the time of application • Transitional arrangements apply for existing cross-border schemes – fully-funded by September 2008

16. Netherlands Funding Standard • Pension and Savings Funds Act – pension promises generally must be financed through pension funds or insurance contracts • Annual valuations for minimum funding • Valuation of defined benefit liabilities • Fixed interest rate of 4% per year (3% per year for more recent insurance contracts) or government bond yield if lower • Usually no explicit allowance for future salary increases, turnover rates or non-guaranteed indexation • Prior to 2001 most schemes exceeded minimum funding requirement - surplus used in part to index benefits

17. Netherlands Funding Standard - changes • In response to asset falls and worsening funding levels, Pensions and Insurance Chamber introduced a minimum solvency margin requirement • 105% funded within 1 year • Additional reserve within further 7 years so that scheme would remain fully funded if bond values and equity values fall by specified percentages • Additional changes to be implemented from 2007 • Interest rate for valuing liabilities will be market-linked, based on government bond yield curve according to duration of liabilities • 15 years (rather than 8 years) to fund additional reserve • Tests for additional funding reserve will be more comprehensive, and will also depend on duration of liabilities (compared with duration of bonds held)

18. Netherlands Funding Standard – cross-border schemes • Dutch schemes are already required to be “fully-funded at all times” • No additional minimum funding requirements for schemes operating cross-border within the EU

19. Comparison of standards • Difficult to compare standards • Prescriptive v scheme-specific • Differences in investment market conditions • Illustration - compare “technical provisions” in each jurisdiction for a sample scheme

20. Comparison of standards – sample scheme • “Sample” final salary scheme: • 100 actives aged 45 • 20 years past service • Current salary = 30,000 per year • Accrued pension = 20/60 x 30,000 = 10,000 per year • Payable from age 65 • Eventual pension based on final salary at date of leaving plus indexation to age 65 in line with CPI • Indexation in payment in line with CPI • 100 pensioners aged 70 • Pension in payment = 5,000 per year • Indexation in payment in line with CPI • What would be the "technical provisions" in each jurisdiction for this scheme at 1 May 2006?

21. Technical provision in each jurisdiction • Ireland • Prescribed assumptions • UK • Assumptions chosen by scheme • Netherlands • Prescribed assumptions • Must be 105% funded within 1 year • Plus additional reserve within 7 years • Lower provision if no guaranteed indexation in payment or deferment

22. Technical provision in each jurisdiction Netherlands with guaranteed indexation

23. Technical provision in each jurisdiction Netherlands with no guaranteed indexation

24. Pan European IORP – domicile of choice • Multinational employer with schemes in Netherlands, UK and Ireland, each with 100 active and 100 retired members as before, sets up a Pan European IORP • Technical provisions reflect the statutory requirements in the home state and social and labour law of host state • Ireland • Cash equivalent transfer values for active members (allowing for Irish, UK and Dutch revaluation and indexation) • Index linked annuities for retirees (reflecting Irish, UK and Dutch indexation) • Say 50 M to 55 M

25. Pan European IORP – domicile of choice • UK • Scheme-specific funding basis (allowing for Irish, UK and Dutch revaluation and indexation) • Say 55 M to 75 M • Netherlands • Prescribed basis (allowing for Irish, UK and Dutch revaluation and indexation) • Say 55 M (rising to 57 M after 1 year, and 65 M after 8 years)

26. Summary • Detailed requirements for calculation of technical provisions still unclear and regulators’ response untested • Considerable diversity may give scope for regulatory arbitrage • Other issues to consider as well – the home state which has the least onerous requirements in relation to funding may be inappropriate in other aspects e.g. investment restrictions, governance

27. Funding Standards: Comparison of the Position for Cross Border IORPS 2 June 2006 To protect the confidential and proprietary information included in this material, it may not be disclosed or provided to any third parties without the approval of Hewitt Associates Limited.Hewitt Associates Limited is regulated by the Financial Regulator as an Authorised Adviser.