Paul T. Lai Fatt, FSA, FCIA Marta Kelly, CA, MBA

Principal, Morneau Shepell VP Finance & Administration, Saint John Energy

September 19, 2013

Shared Risk Pension Plans – A Case Study

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Introduction

• The theme of this year’s conference is Powering the Future of Pension and Benefit Plans - You’ve heard a lot about Shared Risk Pension plans (or SRP’s) over the last year

or so and the concepts behind SRP’s may be representative of the future of pension plans

• While there has been plenty of talk about the SRP concept, legislation, mechanics and actuarial theory, we wanted to take a more practical approach

• Today we wanted to share the perspective and experience of a plan sponsor (and a plan member) through their SRP conversion journey - It is difficult to tell the story in 45 minutes or less, so we’ll try to tell the “short

version”

- Anyone who wants the “long version” can feel free to contact either of us

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Agenda

• History

• Process - What alternatives were considered and what were the considerations

when examining each?

- How was the SRP designed?

• Reaction

• Lessons for others

History

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History

• Saint John Energy’s (SJE) defined benefit pension plan was established on January 1, 1933

• Historically well funded - January 1, 1991: 103.5%

- January 1, 1994: 118.2%

- January 1, 1997: 131.8%

- January 1, 2000: 144.9%

- January 1, 2003: 108.1%

- January 1, 2006: 113.3%

• Benefit improvements made between 1994 and 2008 totaled about $13M

• Contribution holidays taken between 1994 and 2008, both employees and the employer combined, totaled about $13M

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History

• Then came 2008 - Very poor year in investment markets

- Bond rates (which drive solvency funding) at very low levels

• In the January 1, 2009 actuarial valuation the going concern funded level had dropped to 83% from 113% as at January 1, 2006

• Minimum employer contributions went from nothing (for the past 18 years) to 22.3% of payroll and employees began contributing again at the rate of 8.3% of payroll - Consider the impact on an employer if payroll costs unexpectedly

jumped 22.3% from one year to the next

- Consider the impact on an employee of an unexpected pay cut of 8.3%

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History

• While markets have been up and down since 2008, interest rates have continued to drop - Resulting in increased solvency funding requirements

• Preliminary valuation results as at January 1, 2013 revealed a solvency deficit requiring minimum employer contributions of 54% of payroll over 5 years - Compared to the 22.3% the employer had been paying for 4 years

- Plus employees were paying 8.3% of payroll into the plan

- Total employee and employer minimum contribution requirements were 62% of payroll

Process

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Process The problem

• There are many problems inherent in traditional DB pension plans - Rising costs - Benefit risk - Accounting volatility - Intergenerational inequity - Etc.

• For SJE, the main problem that needed a solution was unsustainable contribution requirements - 54% of payroll for 5 years, with a risk that they actually

increase

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Process Alternatives Considered

1. Status quo 2. Maintain DB but reduce benefits 3. Wind-up the DB plan and create a DC plan 4. Consider conversion to a Shared Risk Plan

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Process Alternatives Considered

1. Status quo - Considerations

› Employer contribution requirement of 54% of payroll for 5 years with continued risk that this actually increases

› Compared to 22.3% of payroll from 2009 – 2012 › The impact on SJE’s business would have been some

combination of: – Staff layoffs – Power rate increase – Deferred capital projects – Etc.

- Decision › The Board of SJE decided that this level of contribution was not

affordable and that, therefore, the status quo was not sustainable

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Process Alternatives Considered

2. Maintain DB but reduce benefits - Considerations

› Even if all future benefits eliminated minimum employer funding would be 40.5% of payroll for 5 years with a risk that it increases – Practically speaking, employer contributions were limited to the

range of 40.5% and 54% under a traditional DB plan

› Issue with intergenerational inequity in that active members pay much more for much less than their predecessors

› Still have all DB risks

- Decision › The Board of SJE decided that “tweaking” the DB plan would still

result in a prohibitively high contribution requirement while not being a real long term solution to general DB problems

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Process Alternatives Considered

3. Wind-up the DB plan and create a DC - Considerations

› Immediate wind-up deficiency contribution requirement of $14M (about 2 x payroll)

› HR concerns regarding DC – Benefit adequacy – Too much individual risk – Recruiting and retention compared to other public utilities

- Decision › The Board of SJE decided that the financial and HR costs made

this not a viable option

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Process Alternatives Considered

4. Consider conversion to a Shared Risk Plan - Considerations

› Board could set an employer contribution level they felt they could afford

› Contributions would forever be stable within a pre-defined range – Compared to their DB which had gone from 0% for 18 years to 54%

over a 4 year period

› Members would still continue to pool risk (unlike the DC alternative) – Pensions still based on salary / service – Monthly life pensions continue to protect members against

longevity risk

- Decision › The Board of SJE decided that conversion to SRP was the best

alternative available

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Process SRP Design Process

• SJE wanted to engage our employees in designing the new SRP

• The Board set the employer contribution level SJE was comfortable with as an employer - 9% permanent contribution - 8.5% temporary contribution for 15 years

› So 17.5% total compared to the current 22.3% and the required 54% if they did nothing

- Set the range of possible future changes at +/- 2%

• Then commissioned an employee working group to recommend an SRP design for this contribution level

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Process SRP Design Process

• Employee working group met over two months and made recommendations for: - Employee contribution rate - Benefit accrual rate - Retirement age - Disability benefits (if any) - Bridge benefits (if any) - Forms of pension, both normal and optional - Etc.

• Working group made their recommendations to the Board that were accepted and implemented

Reaction

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Reaction

• The process was very open and transparent - Open education sessions

› October 2012 discussing SRP’s and general DB pension issues

› Early April 2013 discussing Jan 1, 2013 valuation results and the Board’s decision making process

› Late May 2013 to disclose the newly designed SRP

- The employee working group gave each subset of plan members representation in the design process › Union

› Non-bargaining

› Retirees

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Reaction

• While reaction wasn’t explicitly positive, there wasn’t nearly the negative reaction that some other plan sponsors have seen - People felt they were engaged in the process and had

opportunities to ask questions and get involved

- People generally understood why change was needed and that the status quo was not sustainable › Status quo contribution requirements were unaffordable

› Can’t rely on taking investment risks to pay benefits

› Can’t expect to contribute for 30 years and collect for 35

- People generally understood that of the available alternatives, SRP was the best choice › Today’s reality was different than the reality of the mid-90’s

Lessons for others

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Lessons for others

• Understand the problem you’re trying to solve before you try to solve it - Cash contribution problem?

- Accounting volatility problem?

- Intergenerational inequity problem?

- Risk problem?

- Recruiting / retention problem?

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Lessons for others

• Be as open and transparent with stakeholders as possible - Communicate the problem(s)

› You have to make stakeholders understand there is a real problem that needs to be solved before they’re going to entertain a solution

- Clearly identify who gets to make the final decisions › Helps set clear expectations for “collaboration” versus “negotiation”

- Communicate the options for solving the problem(s) and the pros/cons of each

- When communicating the decision / solution clearly explain why the decision was made and what it means for each group of stakeholders (employees, retirees, etc.)

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Lessons for others

• Try to focus on real long term sustainable solutions - Address the problems of today while designing a solution that

hopefully avoids a repeat of those problems in the future

- Finding ways to reduce contributions (solvency funding extensions / exemptions, aggressive actuarial assumptions, etc.) for an unchanged benefit promise / structure just makes the benefit less secure › True long term cost of the pension plan remains unchanged

- Think about a funding policy and a flexible benefit design that will allow the plan to adapt to future events without having to “go back to the drawing board” each time

- Consider the interests of current, past and future plan members when designing a solution › Current legislation in most jurisdictions protects the past members at the

expense of current and future members

Questions and Discussion

Contact Paul T. Lai Fatt, FCIA Principal, Morneau Shepell plaifatt@morneaushepell.com (902) 474-3236