DCLG has recently published detailed March 2017 data on the 88 English and Welsh LGPS funds gathered using the annual SF3 forms. The headlines will be caught by the 21% rise in asset valuations but there is some interesting data on the trend to negative cashflow.
The data shows expenditure of £9.5bn on pension payments, excluding transfers, across the scheme, and administrative and investment costs of a further £1.0bn. Income from contributions, again excluding transfers, was £9.5bn. Before investment income is included, there is therefore a shortfall of about £1.0bn, or about 0.4% of the overall scheme assets. Investment income at £3.9bn (or 1.5%) covers this gap in aggregate but the margin for error, even at scheme level, is not huge.
These numbers are not markedly different from the 2016 numbers, when there was a similar £1.0bn shortfall, but show a considerable change from, for example, 2011. In that year there was a £1.2bn surplus of contributions over expenditure (0.8% of Scheme assets) and an additional £2.8bn (1.9%) of investment income. The direction of travel is unsurprising, but it is noteworthy that overall cashflow has declined from 2.7% of assets to 1.1% in six years. If the trend continues at the same rate, it will be negative by 2024.
The position of individual funds varies greatly, as we might expect. Looking first at the position without investment income, we see that only 27 of the 88 funds in England and Wales were still cashflow positive in the year to 2017. Of course, each fund’s position on this measure reflects how mature it is. Administering authorities have limited influence on this number, as they can only bear down on costs and set higher contribution levels.
If we then include investment income, most funds have a cushion, but 12 had negative cashflow over the year and a further six had a margin of less than 0.3%. Not all the funds are those you would expect. Some with low funding ratios come out OK on this measure of cashflow, while others with close to 100% come out badly.
Of the 18, about half are significantly more mature than the average fund, because they have a low ratio of active to deferred and pensioner members. These will deliberately be drawing down on assets in a manner more akin to private sector defined benefit funds. The transport authorities are the most obvious example, but there are a number of others, mainly in London, where the ratio of active to other members is less than 75% of the LGPS average.
I’d be the first to admit that the data should be viewed with considerable caution—there may be reasons why 2016/7 income was reduced, different funds may take different approaches to accounting for costs and cashflow may not be categorised as income in DCLG’s data. But on the face of it, the remaining ten constitute funds which are not particularly mature compared to the average LGPS fund, but which are, or are close to being, cashflow negative even after taking into account income from investments.
This reliance on asset sales to supplement cashflow is a risky strategy. It may be fine when, as over the past few years, asset prices are buoyant, but it has the potential to damage pension fund solvency significantly if assets have to be sold at distressed price levels to fund pension payments.
One marked characteristic of these ten funds is that on average they generate less than half the 1.5% yield from investments which the LGPS obtains overall. They also, on average, have higher expenses at 0.56% compared to the average of 0.40%. While three of the ten refer to their cashflow position in their Investment Strategy Statements, demonstrating that they are aware of the issue, seven make no reference.
These seven, which cause me most concern, are evenly split between London, the shires and Wales. I would hope that they have made some forward projections of likely cashflow and planned how they will meet shortfalls on various market scenarios. If they have not, they cannot be sure of paying their pensions in the future without the risk of asset fire sales. It will be interesting to see whether the Scheme Advisory Board standardised 2016 valuation, due for publication shortly, puts red flags for sustainability on any of them.