• Home
  • About
  • Subscribe
  • LATIF
  • Conferences
  • Dashboard
  • Edit My Profile
  • Log In
  • Logout
  • Register
  • Edit this post

Room 151

  • 151 BRIEF

    What's New?

  • Consultation opens on future of IFRS 9 statutory override

    August 12, 2022

  • EAPF criticised for water company investments

    August 10, 2022

  • Welsh pension fund confirms £50m investment in clean energy

    August 10, 2022

  • Inflation ‘disastrous’ for local services, warns LGA

    August 10, 2022

  • Consultation opens into care charging reforms

    August 9, 2022

  • ADASS survey: ‘worst fears confirmed for adult social care’

    August 5, 2022

  • Treasury
  • Technical
  • Funding
  • Resources
  • LGPS
  • Development
  • 151 News
  • Blogs
    • David Green
    • Agent 151
    • Dan Bates
    • Richard Harbord
    • Stephen Sheen
    • James Bevan
    • Steve Bishop
    • Cllr John Clancy
    • David Crum
    • Graham Liddell
    • Ian O’Donnell
    • Jackie Shute
  • Interviews
  • Briefs

LGPS: Valuations and the hard reality of contributions

1
  • by Guest
  • in LGPS
  • — 7 Nov, 2016

LGPS funds are waiting for the 2016 valuations. Urrffa Rafiq explores the best method for valuation and asks how the estimated aggregate deficit of £100bn will be managed.

LGPS

Valuations could mean facing “hard reality”. Document from Government Actuary’s Department.

We wait with bated breath for the results of the 2016 actuarial valuation of the Local Government Pension Scheme (LGPS) in England and Wales, especially as so much has changed over the three years since the last valuation – investment market conditions, regulations and the increased level of government scrutiny.

As a reminder, at a national level, the aggregate deficit at the 31 March 2013 actuarial valuation was £47bn which, based on KPMG estimates, has increased to around £70bn as at 31 March 2016 and is now over £100bn. These estimates use an approach where liabilities are pegged to gilt prices, which was used by the majority of LGPS funds back in 2013. As a consequence of gilt yields being so low, pension scheme liabilities have risen and have stepped up to all-time highs since the Brexit vote.

With limited evidence to suggest a reversal, the actuarial profession is scratching its collective head about what this means for the amount of cash needed by pension schemes. Is it still right to use a discount rate pegged to gilt yields and if so, should the expected return above gilts remain the same?  If not, what are the alternatives and are they any more appropriate?

Contributions crunch

It is about now that local authorities are being given an indication by their pension fund of the new level of contributions required for the three years from April 2017 . Perhaps surprisingly, we have heard that some funds are not asking for significantly higher contributions.  With a gilts-based deficit that has more than doubled and future service costs increasing by nearly 50%, this raises some clear questions about the approach the LGPS actuaries are choosing to take this time around. (Just after this article was submitted West Midlands requested an extra £100m in contributions this year).


NEW LGPS Quarterly Briefing REGISTER for our FREE quarterly email covering LGPS interviews, guest opinion pieces, investment analysis and news roundups. First edition coming January 2017.


The first point to note is that a lot of the increase in liabilities has happened since the actuarial valuation snapshot date of 31 March 2016, so it might be that some of the challenges are being deferred until the next valuation. Whilst markets might improve between now and 2019, you would be lucky if you were to bet on it and be proved right.

Secondly, unless they are simply concluding that deficits don’t need to be repaid in full, it follows that a rationale has been developed for higher discount rates (which give lower liabilities). And indeed, most LGPS funds are going to use a discount rate based on inflation (CPI) plus an assumption for the real return on assets.

This is neat and drives a stable future service cost because benefit increases are in line with CPI. However, the question is whether this provides any better indication of asset returns over the short and long-term. Finance theory would suggest that asset returns will reflect the level of risk over and above a risk-free rate, and although years of evidence does not suggest a significant level of correlation, the correlation between returns and price inflation is no better.

Where a pension fund is intending to sell its liabilities, there is broad consensus that funding should be tied to gilt yields – this is how insurance companies price pensions.  However, given that a sale is not on the cards, there is greater flexibility around how the liabilities can be measured.

Indeed, one might argue that funding doesn’t matter at all if the covenant from the employers is 100% — and some consider that there is, in effect, such a strong covenant in local government.

That said, given the legal uncertainty around the crown guarantee for the LGPS, and what would happen if a local authority were to fail, allowing too much flexibility could lead, in effect, to partial funding. It’s also important to remember that a quarter of all LGPS fund liabilities relate to employers that do not have tax raising powers and so this is not a “one-size-fits-all” issue.

Hard reality

So, is affordability the tail wagging actuarial dog? Whichever way you cut this actuarial valuation, if the results suggest that local authorities have to pay more, then it will simply not be affordable for most – so finding a presentable valuation approach has become the priority.

At the last actuarial valuation market conditions improved significantly between 31 March 2013 and the following September, and this was used to mitigate contribution increases. At this valuation, the new discount rate methodology will not reflect the increase in liabilities assessed using a gilts basis since 31 March 2016.

However, if presentation is put to one side, the harder reality comes to the fore. Across the LGPS we estimate there are around £1 trillion of earned pension payments, but only £250bn of assets to meet them. All extra contributions are welcome of course, but the key to the future of the LGPS is devising a long-term investment strategy which best finds a balance between risk and return.

Urrffa Rafiq

Urrffa Rafiq, is a director and public service pensions and local government lead at KPMG UK.

Get the Room151 Newsletter

 

Share

You may also like...

  • Ryan Boothroyd: Post-covid world holds opportunity for long-term LGPS investors 28th Apr, 2021
  • LGPS webinar finds built environment a “clear investment opportunity” 29th Apr, 2021
  • 2022 LGPS valuations: options, opportunities and objectives 31st Mar, 2022
  • The net-zero challenge for LGPS funds 7th Apr, 2022

1 Comment

  1. Sam Beckett says:
    2016/11/11 at 09:13

    The last paragraph is hokum, there are 89 funds in England & Wales each with assets and liabilities and within GMPF for example 450 employers with different contribution rates.

    Log in to Reply

Leave a Reply Cancel reply

You must be logged in to post a comment.

  • 151 BRIEFS – WHAT’s NEW?

    • Consultation opens on future of IFRS 9 statutory override
    • EAPF criticised for water company investments
    • Welsh pension fund confirms £50m investment in clean energy
    • Inflation ‘disastrous’ for local services, warns LGA
    • Consultation opens into care charging reforms
  • Room151’s LGPS Roundtables

    Biodiversity
    Valuations & Risk
    LGPS Women

  • Room151’s LGPS Roundtables

    Biodiversity
    LGPS Women
    Valuations & Risk
  • Latest tweets

    Room151 4 days ago

    LATIF/FDs’ Summit ‘on course to be biggest yet’: Room151’s flagship event – the Local Authority Treasurers Investment Forum (LATIF) and FDs’ Summit – is on course to be the biggest yet, with more than 200 delegates expected. Combining[...] dlvr.it/SWSDrL pic.twitter.com/f8FXzcAdWB

    Room151 4 days ago

    ‘Local government treated worse than any other part of public sector’: Clive Betts, chair of the Levelling Up, Housing and Communities Committee, talks to Mike Thatcher about lack of progress on levelling up, pork-barrel politics and why local government… dlvr.it/SWRk1L pic.twitter.com/Jpw0BsOsy3

    Room151 5 days ago

    Which LGPS pools and funds are attending the LGPS Investment Forum on Nov 2 & the LGPS Private Markets Forum on Nov 1st? Answer here: lnkd.in/eDHU8tuy pic.twitter.com/D3gd63Rh7F

    Room151 6 days ago

    LGPS and levelling up: nothing to fear but fear itself: There have been a number of objections to government plans for LGPS funds to invest 5% of their assets in local projects. But George Graham says these objections can be[...] dlvr.it/SWL7vt pic.twitter.com/ebwBEkZTy4

    Room151 6 days ago

    George Graham @SYpensions @bordertocoast channels his inner FDR in a call for local government pension funds to avoid the fear factor and embrace levelling up #LGPS #localgov room151.co.uk/local-governme…

    Room151 7 days ago

    Changes to rules on capital receipts raise wider questions: Stephen Kitching argues that DLUHC’s latest rule changes are part of a series following on from revisions to MRP guidance and the purchase of commercial property. He questions whether… dlvr.it/SWGqKC pic.twitter.com/Ycr5hWZDPk

    Room151 1 week ago

    ‘No ifs, no buts’: the Bank of England continues its battle with inflation: Partner Content: CCLA Investment Management’s Robert Evans discusses the MPC’s 0.5% increase in the Official Bank Rate and its ongoing commitment to the 2% inflation target… dlvr.it/SW7SNC pic.twitter.com/ryOzYRSNA9

    Room151 2 weeks ago

    DLUHC changes rules on flexible use of capital receipts: The levelling up secretary has written to all council leaders to amend the rules concerning the flexible use of capital receipts to fund transformation projects. In his letter, Greg Clark[...] dlvr.it/SW3jyX pic.twitter.com/KEhSSaMITl

    Room151 2 weeks ago

    Local audit and financial reporting: let’s take back control: Mazars’ Suresh Patel suggests three steps that auditors and council finance teams should take to help get financial reporting and local audit back on track. Following my recent appearance… dlvr.it/SW0PfV pic.twitter.com/miL7pjukce

  • Register to become a Room151 user

  • Previous story Council leader attacks investment managers and threatens to withhold £65m from pension fund
  • Next story James Bevan: Inflation and demographics

© Copyright 2022 Room 151. Typegrid Theme by WPBandit.

0 shares