Liability-side risk management modelling future DC fund liabilities

MATTHEW BURGESS, DIRECTOR, ACTUARIAL AND BENEFITS CONSULTING RUSSELL INVESTMENTS TONY MILLER, SENIOR CONSULTANT RUSSELL INVESTMENTS

V908

Agenda

1. Changed environment 2. Russell total fund evaluator 3. The model and the variables 4. Practical applications

Changed environment
Increased focus on liquidity management: GFC raised concerns with illiquid investments Cooper recommends liquidity projections taking into account cash flows APRA : only 6% of funds stress test liquidity Increased focus on governance: Cooper recommends increased governance requirements MySuper will result in fund re-structuring Potential for more fund mergers Funds will benefit from better liquidity and governance modelling

Environment originally
Employer contributions Member contributions Rollovers Transfers Benefit payments and rollovers from fund

members accounts

Contribution tax

Net investment returns

Fees and costs

Insurance premiums

Default option

Simple asset structures

Cash Fixed interest Property Aust equity O/seas equity

How things have changed

Liquidity management
Complex investments

Increased switching

Retained Members
Reserves management

Active members
More investment options

Spouse

More complex fees

Employer subgroups
Increased governance Cooper?

My Super?

Pensioners Increased regulator activity

Illiquid investments

Environment now
Employer contributions Member contributions Rollovers Transfers Benefit payments and rollovers from fund Pension Payments

Active members Group A Active members Group B

Spouse and other members

Retained and inactive members

Insurance premiums Insurance costs

Allocated pensioners
Fees and costs Net investment returns

Other contributions Contribution tax Net investment returns

Conservative

Fees and costs

Member switches
Balanced Growth High growth

Cash

Asset rebalancing
Cash Fixed interest Defensive alts Direct prop Liquids Listed prop Private equity Aust equity O/seas equity Growth alts

Illiquids

Management currency impact

Currency

Liquidity management

2.
Russell total fund evaluator

Russell total fund evaluator

Applies complex defined benefit actuarial techniques to build a whole of fund model for DC funds New tool providing enhanced insights Allows for the actual economic and demographic drivers of the fund realistic base assumptions Platform for time weighted scenario building

A revised approach example

Cash flow projections $ millions

Basic modelling of liabilities to-date reflected original simplicity of funds and weight of cash flow
800

600

400

200

0 0 -200 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Russell TFE "Simple" Approach

-400

The assumptions
Investment returns Inflation Expense deductions Insurance deductions Switching by age Transfers / rollovers Exit rates Mortality by age Pension payment rates Contributions Retention rates Currency treatment

Asset allocation strategy Disablement by age

Comprehensive information
Cash flow projections (by components) Contributions Benefits Deductions and costs Switches

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Summary cash flows sample fund

Cash flow projections
500,000,000 400,000,000 300,000,000 200,000,000 100,000,000 Pensions 0 1 -100,000,000 -200,000,000 -300,000,000 -400,000,000 -500,000,000 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Benefit Payments Net Contributions

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Comprehensive information
Cash flow projections (by components) Contributions Benefits Deductions and costs Switches Projected membership (by class) Active, retained, pensioners, other

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Pensioners sample mature fund

Membership projections Number of pensioners
12,000

10,000

8,000

6,000

4,000

2,000

0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19

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Comprehensive information
Cash flow projections (by components) Contributions Benefits Deductions and costs Switches Projected membership (by class) Active, retained, pensioners, other Projected assets (segmented) Member Investment option Asset classes or subclasses Liquid/illiquid
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Total assets by option

Projected asset values
9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Cash Stable Low Growth Balanced Growth

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Member options after 5 years

Projected asset allocations (by age group)
Projected Asset Allocations (by Age Group)
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 15-20 20-25 25-30 30-35 35-40 40-45 45-50 50-55 55-60 60-65 65-70 70-75 75-80 80+ Cash Stable Low Grow th Balance Grow th

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3.
The fund and the variables

The model in action

Collect the member data

Age | Category | Account balances across options

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The model in action

Roll forward 1 year: Membership and assets + + + o +
Investment earnings New contributions Fee deductions Insurance costs Exits (death, tpd, retirement, resignation) Retention Switching New member

Year 1

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The model in action

Continue over time: Tracking membership and assets + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o +

Year 5

Year 10

Year 15

Year 20

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The model in action

Collate over time: Aggregate and analyse results by year, age, category, option and asset class + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o + + + + o +

Year 5

Year 10

Year 15

Year 20

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4.
Practical applications

Multiple applications of the Russell total fund evaluator

A Stress testing B Satisfy regulator - APRA C Cash flow prediction D Strategic decision making E Budgeting change F Building a MySuper product G Benefit of a fund merger H Managing operating risk reserve
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Apply illiquid investment strategy

Illiquidity ratio (default option)

45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Year Illiquidity Ratio Target Upper Range

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Stress test current strategy utilising scenarios

Investment market shocks Currency settlements Member switching Loss of membership Other OK or modify?

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Scenario: Year 6 25% fall in listed assets, member switches to cash, currency depreciation
Illiquidity ratio (default option)

45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Year Illiquidity Ratio Target Upper Range

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Scenario cash flow impact: Year 6 25% fall in listed assets, member switches to cash, currency depreciation
Total cash flows available for reinvestment

800 600 400 200 0 -200 -400 -600 -800 -1,000 -1,200 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Liquids Illiquids

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Scenario test: Reduced illiquid investment program

Illiquidity ratio (default option)

45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Year Illiquidity Ratio Target Upper Range

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Multiple applications of the Russell total fund evaluator

A Stress testing B Satisfy regulator - APRA C Cash flow prediction D Strategic decision making E Budgeting change F Building a MySuper product G Benefit of a fund merger H Managing operating risk reserve
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Multiple applications of the Russell total fund evaluator

A Stress testing B Satisfy regulator - APRA C Cash flow prediction D Strategic decision making E Budgeting change F Building a MySuper product G Benefit of a fund merger H Managing operating risk reserve
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Evaluator output sample only

Comparison of projected cash flows mature fund vs average fund Base, $ millions
300 200 100 0 0 -100 -200 -300 -400 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Average Mature

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Multiple applications of the Russell total fund evaluator

A Stress testing B Satisfy regulator - APRA C Cash flow prediction D Strategic decision making E Budgeting change F Building a MySuper product G Benefit of a fund merger H Managing operating risk reserve
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Strategic planning - mature fund

Projected cash flows base vs increased retention vs lower retention vs increased volume contributions $ millions
200 150 100 50 0 0 -50 Base -100 -150 -200 90% Retention 60% Retention 25% Extra Contributions (above 45) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

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Fund statistics
Projected asset values SG from 9.0% to 12.0% for average fund $ millions

12,000 10,000 8,000 6,000 4,000 2,000 0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 SG 9% SG 12%

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Fund statistics net cash flow impact

Projected cash flows SG from 9.0% to 12.0% for average fund $ millions
200

150

100

SG 9% SG 12%

50

0 0 -50 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

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Multiple applications of the Russell total fund evaluator

A Stress testing B Satisfy regulator - APRA C Cash flow prediction D Strategic decision making E Budgeting change F Building a MySuper product G Benefit of a fund merger H Managing operating risk reserve
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Evaluator testing fee deductions

Comparison of cost deductions Base vs increased retention vs increased volume contributions $ millions

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Base

10

Higher Retention 10% More Contributions

0 0 1 2 3 4
Year

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Multiple applications of the Russell total fund evaluator

A Stress testing B Satisfy regulator - APRA C Cash flow prediction D Strategic decision making E Budgeting change F Building a MySuper product G Benefit of a fund merger H Managing operating risk reserve
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Multiple applications of the Russell total fund evaluator

A Stress testing B Satisfy regulator - APRA C Cash flow prediction D Strategic decision making E Budgeting change F Building a MySuper product G Benefit of a fund merger H Managing operating risk reserve
39

Multiple applications of the Russell total fund evaluator

A Stress testing B Satisfy regulator - APRA C Cash flow prediction D Strategic decision making E Budgeting change F Building a MySuper product G Benefit of a fund merger H Managing operating risk reserve
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DC liability modelling
New interactive models Enhanced insights from realistic analysis Tailored to fund circumstances Apply annually with updated data Part of good governance processes

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Russell Investments
Issued by Russell Investment Management Ltd ABN 53 068 338 974, AFS Licence 247185 (RIM). This document provides general information only and was not prepared having regard to your objectives, financial situation or needs. Before making an investment decision, you need to consider whether this information is appropriate to your objectives, financial situation or needs. This information has been compiled from sources considered to be reliable, but is not guaranteed. Copyright 2010 Russell Investments. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments.

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