CN Pension Plan

Managing Pension Risks: How We Work and Why

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CIA Pension Seminar - April 16, 2007Caroline Drouin

Table of Contents

Background 3 CN Pension Plan CN Railroad Railroad Industry

Managing Pension Risks 11 Plan Design Plan Governance Funding / Accounting Policy Investment Policy

Summary 20

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Background - CN Pension PlanDemography

Covers 16,200 active members at January 1, 2006

CN Pension Plan is large and very mature with 2.6 pensioners forevery active member

Pays monthly pensions to 42,500 pensioners at January 1, 2006

Retirees represent roughly 70% of the plan population and their liabilities are roughly 60% of the total plan liabilities

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Same rules apply to union and management employees within CN Pension Plan

New management employees hired from 2006 join DC Plan

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Comparison to Other Class I RailroadsPBO divided by service cost, fiscal year end 2004-2006

0 x

10 x

20 x

30 x

40 x

50 x

60 x

70 x

80 x

90 x

100 x

110 x

120 x

2004 2005 2006

10th - 25th 25th - 50th 50th - 75th 75th - 90th CN

Source: Mercer Human Resource Consulting

Background - CN Pension PlanFinancial Summary

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Financial position as of January 1, 2006

2006 Contributions 2006 Pension Expense

CN $85M -- CN $50M

Employee $50M

Going Concern

Assets (AV) $11.8B

Liabilities $11.6B

Surplus $0.2B

Solvency

Assets (MV) $14.1B

Liabilities $13.7B

Surplus $0.4B

Accounting

Assets (MV) $14.1B

Liabilities $13.4B

Surplus $0.7B

Background CN Pension PlanComparison to other Canadian Public Companies

Funding

Going Concern

Funding

SolvencyAccounting

Proportion of plans in deficit 59% 75 % 78%

Average ratio of assets to liabilitiesPlans in surplus 117% 128% 122%

Plans in deficit 90% 81% 82%All plans 101% 92% 90%

CN 102% 103% 105%

Based on most recent actuarial valuations (145 pension plans)

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Source: Mercer Pension Database

Background - CN Railroad Precision Railroading

Engaged in the rail and related transportation business

20,300 miles of track spanning across North America

2006 Financial Highlights

Total revenues : $7.716 B

Operating income: $3.030 B

Operating ratio: 60.7 %

Total Assets: $24.004 B

Free cash flow: $1.343 B

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Background - CN Railroad Managing Business and Financial Risks

CN faces normal business risks similar to any other transportation company. Those risks are understood and expected by investors

Freight revenues come from 7 commodity groups representing a diversified and balance portfolio of goods

This combined with our geographic diversity positions CN well to face economic fluctuations

CN also faces financial risks that can be mitigated in order to reduce variability of financial results

Interest Rate Risk

Pension Liability / Corporate Debt = $14B / $5.6B

Pension Liability / Company Assets = $14B / $24B

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Background - Railroad Industry

In the US, CN competes against 6 major class 1 railroads

US Railroad employees participate in the US Railroad Retirement Board

Uneven playing field US railroads do not report comparable pension liabilities or obligations on their books

At $14B, CN pension liabilities are comparable to CN corporate liabilities

Pension liabilities are approximately 10 times the level of our US peers

Explaining differences in pension systems & obligations

to CN investors is a communication challenge

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Comparison to Other Class I RailroadsPBO as a percentage of corporate liabilities, fiscal year 2004-2006

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

200

4

200

5

200

6

10th - 25th 25th - 50th 50th - 75th 75th - 90th CN

Source: Mercer Human Resource Consulting

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CNs Risk Management Approach

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Managing Pension Risks

Funding Investment

AccountingBenefits

GovernanceBusinessObjectives

ManagedPlan Costs

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Managing Pension Risks Benefits - Risk Reducing Design

Plan has unique & innovative experience gain (loss) sharing features that tie pension improvements to Plan capacity to pay

50/50 Investment experience sharing with actives and pensioners

50/50 mortality experience sharing with pensioners

Escalation Account (EA) was created in 1989 for pensioners

Improvement Accounts (IAs) were created in 1998 for both active unionized and non-unionized employees

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Managing Pension Risks Benefits - Risk Reducing Design

Gain/ Loss sharing approach has worked well

60% indexation paid every year

Benefits have been improved significantly since 1997 and Plan is in top quartile of Canadian private pension plans

At the same time, EA/IAs absorb part of the loss during the "rainydays Risk sharing with members

Pension improvements are discussed at the pension committee level

Preserves financial integrity of the plan & minimizes risk for plan members and for CN

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Managing Pension RisksAdopting and Adhering Good Governance Practices

Role and structure of CN Pension Committee revamped in 1998

Quarterly meetings

Composed of senior union leaders, company officials and retiree representatives

Oversees the administration of the Plan rules and can recommend plan improvements

CN Board of Directors Sub Committees

Human Resources and Compensation Committee (HRCC)

Audit Committee

Investment Committee

Finance Committee

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Managing Pension Risks Funding / Accounting Policy

Practice of filing actuarial valuations annually

Employer contributions continued to be paid even when Plan was in surplus position

Cash Contribution / Free Cash Flow: $85M / $1,343M

Pension expense under control

Expense as % of operating income is low compared to other class I Railroads

Comprehensive review of valuation basis conducted every 5-year in addition to annual review of economic assumptions

Self imposed discipline in order to better manage future demands for cash contributions

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Comparison to other Canadian Public companiesCash Contribution/Free Cash Flow

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

All Companies Transportation & Environmental ServicesCanadian National Railway Company MedianQuartiles

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Source: Watson Wyatt's Pension Finance Indicator Database

Managing Pension Risks Funding/Accounting Policy Actuarial Basis

Gradual reduction in funding discount rate from 1999 (7.5%) to 2006 (6.5%) to reflect decline in long-term interest rates

CN pensioner mortality experience shows significant mortalityimprovement Introduced generational mortality table to anticipate future improvement in mortality

Conservative asset method: Five-year smoothing of realized and unrealized gains/losses is used to calculate actuarial value of assets for funding and accounting purposes

Market value on 31.12.2005: $14,094MActuarial value on 31.12.2005: $11,794MDifference: $ 2,300M

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Proactive and conservative approach

in setting actuarial assumptions

Managing Pension Risks Investment Policy

CNs conservative policies on design (risk sharing features) and funding, combined with a good governance structure allows it to sustain volatility associated with an active investment policy

60% Equity / 40% Fixed Income

Strategic investments in attractive, diversified asset classes have added substantial value

Fund achieved annualized return of 11.1% over the last 36 yearsFund achieved annualized return of 11.1% over the last 36 years

Allows higher expected returns over the long-term

Within active investment policy, risk reducing measures are alsoimplemented

Diversification, etc.

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Summary

Plan is large and very mature; small changes in assets and liabilities have material impact on pension costs

Financial risk is mitigated through prudent financial management by adopting conservative benefit and funding policies combined with a robust governance structure

Funds long-term ownership oriented philosophy has been an integral part of its success

This has helped offset the impact of the reduction in long-term interest rates

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Table of ContentsBackground - CN Pension PlanDemographyBackground - CN Pension PlanFinancial SummaryBackground CN Pension PlanComparison to other Canadian Public Companies Background - CN Railroad Precision Railroading Background - CN Railroad Managing Business and Financial RisksBackground - Railroad IndustryCNs Risk Management ApproachManaging Pension Risks Benefits - Risk Reducing DesignManaging Pension Risks Benefits - Risk Reducing DesignManaging Pension RisksAdopting and Adhering Good Governance PracticesManaging Pension Risks Funding / Accounting PolicyComparison to other Canadian Public companiesCash Contribution/Free Cash Flow Managing Pension Risks Funding/Accounting Policy Actuarial BasisManaging Pension Risks Investment PolicySummary