LGPS actuarial valuations: which methodology works best?

Barry McKay is a Partner and Actuary at Hymans Robertson LLP

At Hymans, we view the valuation as an opportunity for a complete risk management review. The economic landscape has changed and technology has allowed significant advancements in many different
fields. The actuarial profession is no different. We can now use technology to deliver better solutions and
manage risk. Our valuation approach distinguishes between measurement of the funding position and management of contribution rates.

Measurement

The LGPS Regulations require the actuary to report the balance sheet position. To do this the actuary makes lots of assumptions. These assumptions do not change the benefits accrued by members and so do not affect the cost, but only the pace at which the assets are built up. In other words, pay less now, pay more later. The assets are measured at market value. It is therefore important to use a market based approach to value the liabilities to ensure consistency. Basing assumptions on market conditions is the “least bad” approach as the market offers the most objective view of future expected economic conditions.

Any other approach is more subjective and introduces inconsistency. Our approach is also more suitable for crystallization events – where a participating employer becomes insolvent and a deficit has to be repaid. However, regardless of what assumptions are adopted, the answer is based on a single set of assumptions. One thing is certain – these will be wrong. Clearly we don’t know how long everyone is going to live or what inflation will be over the next 20 years. If things turned out exactly in line with our assumptions then the fund would be fully funded.

However, life is not like that.

This has been particularly true recently when markets have been extremely volatile. If we ask:
If you pay the calculated contribution rate, how likely are we to meet our objective of being 100% funded
within an appropriate timescale? The traditional valuation approach cannot answer this question! In fact, there is no guarantee of being fully funded even if the certified contribution rate is paid every year – as we are all only too painfully aware from recent experience!

In fact, the real question is whether we will have enough assets to pay benefits as and when they fall due, rather than focussing on what assumptions are adopted.

Management

Our aim is to set contributions that are stable, affordable, prudent and help ensure the security of the fund. We recognise that contributions can vary significantly from one valuation to the next. This does not help employers plan ahead or set budgets. One of the key benefits of our approach is to manage contributions to allow greater stability for employers. Our model tests thousands of future economic scenarios, rather than a single set of assumptions. We can test different contribution strategies to answer a similar question to that above. If we pay a stabilised contribution, how likely are we to meet our objective of being 100% funded over the same timescale?

Our approach assesses the risk attached to adopting a particular contribution strategy rather than relying on a single set of assumptions on a particular day.

Summary

Our risk based approach is one that tPR encourages in the private sector, will be suited to future governance requirements and will stand external scrutiny. It provides administering authorities with an assessment of risk enabling them to make informed decisions and keep their funds safe.

Note from the Editor: If you would like to present an alternative methodology for LGPS actuarial valuations on Room151 please contact editor@room151.co.uk
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07 February 2013
2nd LAPF Strategic Investment Forum (The Landmark Hotel, London)
Strategic investment thinking for senior LGPS investment officers, their independent advisers and heads of LGPS investment committees. Jointly organised by AIConferences and LAPF Investments Magazine
Free places offered on a first-come-first-served basis to qualifying delegates
Email: register@aiconferences.com