John Raisin: Pension contributions – one size doesn’t fit all

John Raisin takes issue with a recent suggestion that the variety of actuarial assumptions needs to be eliminated.

In a recent Room 151 article, a finance director argued in favour of standardising actuarial assumptions across the LGPS to reduce pension costs and free up resources for other purposes.  As a former CFO of two local authorities (a London Borough and a County), I understand the budget pressures that councils are under, and can see how pensions may seem an obvious place to find savings.  However, pensions are long-term and complex. Seeking to standardise actuarial assumptions is not, in my view, the best way for LGPS employers to get good value from their pension contributions.

The director is correct that LGPS contributions can vary significantly for different employers, sometimes in counter-intuitive ways.  In the example he cited, one district council was paying lower contributions than another despite having a much larger deficit.  The suggestion was that the council with the bigger deficit was getting a better deal out of its LGPS Fund because it was paying £1m per year less in pension contributions which it could therefore “spend on local services”.

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This approach is somewhat one-dimensional and is certainly too simplistic. Whatever actuarial assumptions are used, employees’ benefits have to be paid for eventually. Paying less now simply means paying more later on. Worse, by missing out on investment returns on that £1m, the council is potentially passing on a bigger problem and more cuts to future taxpayers and a future CFO!

I do not know the details behind the example, and there may be very good reasons why the second fund in question can accept lower contributions. For example, it may be relying more on investment returns, or it may be giving the council more time to repay its deficit: either of these suggests a greater risk appetite, which will not be the case with all funds and councils.

Individual employer membership can also be very important, and factors such as age, service and pay profile could all affect contributions. The quality of data submitted by each individual employer will affect the actuary’s calculation of its liabilities and can therefore influence employer pension contributions. Councils who heavily outsource services will appear to have lower pension contributions as a percentage of their budget because the pension costs for the outsourced staff will be hidden in the fees paid to contractors. This could be misleading if in reality the council is still ultimately responsible for funding those benefits.

But what about the actuarial assumptions themselves? Is there an argument to standardise these?  The Government Actuary’s Department’s (GAD) recent review of the 2016 LGPS valuations recommended “greater clarity and consistency in actuarial assumptions, except where differences are justified by material local variations”.  However, for most assumptions there are quite clearly “material local variations”.  Some Councils have different service delivery models which affect pay levels. A shire county may see their members live much longer than some metropolitan or London boroughs, and investment returns vary significantly depending on how funds invest their assets.

The present situation where each actuarial firm has its own methodology for asset returns (for example setting a discount rate) means that when selecting their actuary this factor, along with a range of other issues, can be taken into account. This allows the fund to appoint an actuary it can work with to best reflect its circumstances, strategies and policies. Additionally, there is no such thing as a “correct” discount rate. Consequently, if a common discount rate was applied to all LGPS fund valuations it would just be the view of one organisation – most likely GAD.

Far from being a problem, the ability of each fund to use its own judgement and adapt to local circumstances is one of the LGPS’s greatest strengths. It is far more in the spirit of localism that each fund can choose its own actuary and come up with its own local approach, than be forced to adopt an inflexible standardised method formulated by central government. The four actuarial firms who work with the LGPS understand the scheme and work with the individual funds to apply solutions which are tailored to their local circumstances, strategies and policies.

Furthermore, the presence of four actuarial firms offering their services to the LGPS provides competition and means they continue to evolve and improve their approach and techniques in relation to the scheme. This leads to the LGPS obtaining both greater input and value from its actuarial advisors. If we move to GAD stipulated assumptions, then this would reduce both the ability and the incentive for the actuarial firms to innovate and respond to the ever-changing circumstances of both the LGPS and individual employers in the scheme.

Finally, in contrast to the LGPS, consider the unhappy position of the unfunded central government schemes (eg the NHS, teachers, and firefighters). Each of the unfunded schemes uses a single set of assumptions across the whole country, and all their employers pay the same contribution rate. Without any assets to help absorb the impact of changing assumptions, and without any flexibility to reflect differences between employers, the contributions required by these schemes can change wildly every time they are reviewed.

Employers of teachers across England and Wales are facing contribution increases of more than 40% from September this year and they are at the lower end of the increases among the unfunded schemes! Could LGPS employers as a whole afford increases of over 40% in their employer contributions at the 2019 actuarial valuation? Such a scenario is however most unlikely, due to the local discretion afforded by the present LGPS actuarial arrangements.

The LGPS is not perfect, and some funds could do a better job of explaining and consulting with employers at each valuation. It is, however, also essential that the finance directors of employers within each fund fully engage with the administering authority to understand and appreciate the unique characteristics of their circumstances. Surely, it is much better that conversations take place at a local level reflecting local differences, rather than relying on a one size fits all direction from central government!

John Raisin is presently Independent Advisor to three LGPS Funds and Independent Chair of the Merseyside LGPS Pension Board. Previously, he was Chief Finance Officer of both a London Borough and a County Council.

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