LGPS: Getting the right balance

18 Oct 13

The Local Government Pension Scheme is undergoing a number of changes, including greater scrutiny of valuation assumptions. Chief finance officers need to ask the right questions to avoid any unwelcome surprises

2013 is set to be another challenging year for those involved in the administration of the Local Government Pension Scheme (LGPS).

Earlier this year, employer and employee representatives in local government agreed the shape of a new pension scheme due to be launched on 1 April 2014. Shortly thereafter the Public Service Pensions Act received Royal Assent, bringing with it major changes to the structure and governance of public service pension schemes, including the LGPS.

Throughout the summer, practitioners have been bombarded with a steady stream of consultations from the Department for Communities and Local Government on regulations for the new scheme, discussion papers on how to implement the requirements of the aforementioned Public Service Pensions Act and, most recently, a call for evidence on the future structure of the LGPS following months of debate on the pros and cons of pension fund mergers.

At the same time, leading pension funds have been actively working on developing new cost-saving initiatives such as National Framework Agreements for key LGPS support services and collective investment vehicles. Add to this the need to conduct ‘business as usual’, and the scale of the task is clear.

Alongside this already-packed agenda, LGPS funds in England and Wales are undertaking their triennial valuations as at 31 March 2013. Always a key event in the LGPS calendar, the 2013 valuation, and the subsequent recalibration of employer pension scheme contribution rates, comes at a time of extreme pressures in local government finances.

The revised contribution rates that will be set in the coming months will run through to April 2017, during which time local government is bracing itself for yet further reductions in central government funding. And, of course, there’s also the impact on employers from the removal of the national insurance contracting-out rebate (estimated by the Local Government Association to cost scheme employers around £700m per annum across the LGPS).

Whilst the final figures will not be available until next year, earlier indications are that the overall picture will show a slight worsening in scheme funding levels (from the average 77% reported at the last valuation in 2010) as financial markets struggle to return to their pre-crash highs. This, in turn, is expected to put more upward pressure on employer contribution levels.

It is at around this stage in the valuation process that chief finance officers will be sitting down with their actuaries to finalise the key assumptions that will underpin the valuation – discount rates, deficit recovery periods etc. In selecting these assumptions, the CFO will need to balance the pressure to minimise the impact upon employers with what is prudent for the long-term health of the fund. As set out in CIPFA’s 2008 publication, Guidance For Chief Finance Officers Administering LGPS Actuarial Valuations, regarding valuation assumptions:

'This is probably the most significant aspect of the valuation. The chief finance officer is under an obligation to understand and the actuary is under an obligation to explain the importance and inter-relationships of the assumptions which have been used. The actuary should also explain to which assumptions the results are most sensitive. The actuary should further state whether the assumptions used are more or less prudent than his/her “best estimate".'

This raises some key questions for the CFO. Such is the sensitivity of key assumptions, such as the discount rate, that minor adjustments can have significant implications when calculating scheme funding levels and subsequent employer contributions. For the CFO, understanding these consequences is essential and will prompt a series of questions:

• Is the rate of return on assets assumption prudent? What is the probability that this rate of return will actually be achieved? What are the downstream consequences if these returns do not materialise?

• Is our deficit recovery period credible? What are the consequences for the fund? What are the costs attached to deferring deficit recovery into the future? Is this affordable to employers and to the fund?

• Is our overall funding plan credible? Does it recognise the financial pressures on employers? Have we achieved the right balance between employer affordability and fund resilience?

Another consideration for CFOs is that with the coming of the Public Service Pensions Act, LGPS valuations will be under greater scrutiny than ever before.

The Act introduces a specific requirement for LGPS regulations to provide for the rate of employer contributions to be set at an appropriate level to ensure the solvency of the pension fund and the long-term cost-efficiency of the scheme, so far as relating to the pension fund. It also requires the DCLG, as the responsible authority for the LGPS, to assure itself, amongst other things, that ‘the valuation has been carried out in a way which is not inconsistent with other valuations’.

We have yet to see what this will mean in practice, but valuation assumptions judged to fall outside of this ‘consistency’ range might well in the future be challenged, with potential consequences for funding plans that have been years in the making. The potential for knock-on effects for employers are clear and, with local government funding set to be squeezed for the foreseeable future, CFOs will be keen to avoid any unwelcome surprises come the next valuation in 2016.

The time to lay the groundwork for this is now by asking the right questions and ensuring that the 2013 valuations are as robust as can be.

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