What will standardised assumptions across LGPS reveal about its true deficit?
Plans to measure LGPS funding levels consistently from 2016 will give a more realistic picture of the scheme's health status with many funds expected to come out worse, writes Stephanie Baxter
- Lack of standardisation in LGPS makes it hard to get a true picture of deficits
- LGPS advisory board will use standardised assumptions from next year
- Early analysis shows half of funds will see funding levels deteriorate
Getting a true picture of the local government pension scheme (LGPS) deficit has always been a big challenge because of the lack of consistency in assumptions used for fund valuations.
The lack of standardised actuarial assumption for the LGPS means analysts compare apples with pears, which makes it hard to identify funds that are doing badly and need help.
Standardised assumptions
To tackle the issue, the LGPS Scheme Advisory Board (SAB) is planning to apply a standard set of assumptions to the 2016 local triennial valuations. The results, which will be made publically available and will form part of the board's work on combining the funds' valuation reports and annual reports, should give a truer reflection of the scheme's health status.
Local Government Association (LGA) head of pensions Jeff Houston says there have been concerns the SAB is interfering in local valuations – which is "not the case at all because this is about creating a measure to compare funds properly without affecting the local valuations". The data will be used to compare funds and identify those that need assistance, but not for decisions on funding and contribution setting, which will continue at a local level.
"Are there any obvious outliers – funds that are way, way apart from others – and should we take a closer look at them?" asks Houston.
Some funds will come out worse while others will see their funding levels improve. The SAB has proposed using consumer price index (CPI) +3%. To put this into context, the average net discount rate fell from CPI +3.2% in 2010 to CPI +2.5% in 2013, meaning bases were generally more prudent in 2013.
Mixed impact on funds
Analysis from Hymans Robertson based on the 2013 valuations indicates that around half of the 88 funds in England and Wales would see their funding levels drop if a factor of CPI +3% was used across the board, while the others will benefit from an improvement under the standardised assumptions. Funding levels for 2013 would have ranged from 95% down to 62%, whereas reported levels actually ranged from 55% to 105%.
By applying a standard set of assumptions using the long-term salary growth of 4.75% set by HM Treasury, the firm found around 44 funds – which it says includes the 37 LGPS clients it advises – would see their funding levels improve on average by 6.6% making their deficit appear more manageable. It projects a shift in the opposite direction for the other 44, whose funding levels would fall by around 6.6% on average, equating to an £8.7bn increase in their total deficit.
Hymans Robertson partner Barry McKay says: "They will need to consider their position more closely, and in some cases take steps to either implement stronger recovery plans or better articulate their approach relative to other funds."
However, he says it is not the case that these funds have taken inappropriate advice or made poor decisions. "It's inevitable that significant disparities will have arisen in the absence of credible and consistent national data," he says.
Overall, McKay says under the standardised assumptions the national picture is slightly more positive than many believe, indicating that the deficit is manageable. Similar calculations by PwC found that reported total deficits of £46.8bn at the 2013 valuation fell dramatically to £24.4bn when standardising at CPI +3%.
PP contacted other actuarial consultants that work with LGPS clients but they were unable to comment by the deadline for this article.
McKay explains why he believes half of the funds did worse under the standardised assumption: "Those funds are taking a bigger bet on assets performing higher –assuming assets will achieve higher returns in the future – which means they don't need as much in contributions. Whereas funds assuming lower returns have put in more contributions and so are better funded."
The SAB is expected to tell funds early next year what it wants to happen under the standardised assumptions. In its analysis it will be expected to look at a variety of other factors to judge whether a fund is in an ok place or not. These include how long it intends to take to plug the deficit, contribution levels, and local demographic experience which varies significantly across the country.
Concerns
There is concern that introducing standardised assumptions could alter behaviour in undesirable ways. Houston says it should prompt local committees to ask questions rather than drive behaviour. "It's important that expectations are managed going into the valuation process, because when these assumptions are published, we don't want local authorities saying ‘oh can we have that one?'"
Centre for Policy Studies research fellow Michael Johnson welcomes the move towards standardisation and better transparency but warns it is just the start of a long process.
"We can have lots of transparency but then people can be wilfully blind – they don't want to see what's in front of their eyes. There are many cultural challenges that need to be overcome other than simply becoming transparent. They're not even scratching the surface of what they need to do."
In the short term, the proposal should give a consistent picture of the LGPS funding status. Being able to compare underlying funds on a level playing field to identify ones that are struggling could also be extremely useful.
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