2019 Valuations - Detailed Report

Triennial valuation 2019 in the LGPS (England & Wales) - Detailed Report

2019 valuation results - executive summary ¹

Overall, the 2019 valuation was a very good valuation for all Funds. All LGPS Funds saw an improvement in funding position, largely driven by strong asset performance in 2016/17 which carried through to 31 March 2019, and deficit contributions paid by employers over the inter-valuation period. As at 31 March 2019, the total funding level across the 86 Funds analysed was 98% which corresponded to a deficit of £5.9bn.

Introduction

On 31 March 2020, the 2019 actuarial valuations for 88 Funds participating in the England & Wales Local Government Pension Scheme (LGPS) were completed. The purpose of these valuations was to set employer contribution rates in each Fund for the period from 1 April 2020 to 31 March 2023. There were three fewer Funds in the 2019 analysis compared with 2016:

• The London Borough of Richmond Pension Fund and the London Borough of Wandsworth Fund were merged to form a single Fund;
• The South Yorkshire Passenger Transport Fund was merged into the Greater Manchester Pension Fund; and
• The West Midlands Transport Fund has been excluded from this analysis as it merged into the West Midlands Pension Fund in 2019 (although separate valuation reports were produced).

This report summarises the data collected from 86 of the 88 Funds in England & Wales that participate in the LGPS (the two Environment Agency Funds we have excluded for the purposes of this analysis). It compares the 2019 valuation results to the 2016 valuation results as well as looking at the assumptions used, the investment strategies and the ranges of recovery periods and recovery plans. The full list of Funds analysed is shown in Appendix 1.

In carrying out this research, the Scheme Advisory Board secretariat have reviewed the valuation reports for all Funds and received support from Barnett Waddingham.

This report explores some of the key findings from looking at all the valuation reports and is split into the following sections:

• Executive summary
• Data
• Financial assumptions
• Demographic assumptions
• Funding results

Please contact the Scheme Advisory Board secretariat for further information.

For the first time, a lot of the information contained in the local Fund’s valuation reports was summarised in a dashboard agreed between the Fund actuaries and the Government Actuary’s Department (GAD). This was implemented following the 2016 Section 13 review as it was felt that the dashboard would enable users to find key information more easily in each Fund’s valuation report.

Actuarial firms

The 2019 valuation reports were prepared by the Fund actuaries of each LGPS Fund. Although each Fund is subject to their own funding results and approach, there are similarities between Funds advised by the same actuarial adviser. The split of the LGPS Funds by actuarial firm is shown in the chart below:

Actuaries are seeing participating employers being under increasing cost pressures and on the whole, becoming more engaged with the valuation process. An increasing number of Funds undertook employer covenant reviews as part of the valuation process. This helps Funds to look at the appropriateness of the contributions being set and the integration of employer covenant risk, investment strategy risk and funding risk in a similar way to what we are seeing in the private sector.

Current issues

In addition, Funds were faced with various issues surrounding the valuation:

• The potential impact of GMP equalisation and indexation: (an interim solution has been put into place until 5 April 2021, but no approach has been agreed for after this date).
• The potential impact of the McCloud/Sargeant case: The McCloud and Sargeant court cases were brought against the Government in relation to possible discrimination in the implementation of transitional protections following the introduction of the reformed 2015 Judicial and Fire pension schemes. The court ruled against the Government and the denied the Government’s request for an appeal. Although these cases are not directly related to the LGPS, on 15 July 2019, the Government made a statement that it expects to have to amend all public sector pension schemes, including the LGPS. The consultation detailing the remedy was issued on 16 July 2020, after the valuations were completed. However, the Fund actuaries were required to include some form of allowance in the 2019 valuation results which would be detailed this in each Fund’s Funding Strategy Statement.
• The potential impact of the cost management process: a full Scheme valuation is carried out in order to assess against a benchmark the cost of providing benefits in public sector pension schemes. Following the initial results of the Scheme valuation, changes in benefits were expected in order to bring the value of benefits back up to the benchmark, however, the process was paused in light of the McCloud/Sargeant judgement. The process was unpaused from 16 July 2020 with confirmation that allowance of the McCloud remedy should be included. The process will also go under review in advance of the 2020 Scheme valuation.
• Potential change to the valuation cycle: the Government consulted on a change to the LGPS valuation cycle to move to a quadrennial cycle in line with the other public sector pension schemes and also the LGPS Scheme valuation. However, it was confirmed that a triennial valuation cycle would remain at least until the 2022 valuation and therefore as before, three years’ of contributions were to be certified at the 2019 valuation.

Experience since 31 March 2019

The 2019 valuation saw a significant improvement in funding levels compared to 2016 (increasing from 85% to 98%). This is a very positive outcome for the LGPS, although recent events, in particular the impact of COVID-19 on asset values, will bring challenges for the period to the next valuation.

Since the valuation date, the 2020/21 year has seen some very volatile investment returns, particularly in the months of February and March when equity returns fell sharply negative due to the COVID-19 crisis. For the year to 31 March 2020, it is expected that investment returns across the LGPS will have been less than that assumed at the 2019 valuation.

On the liability side, the movement will depend on the impact that changes in market conditions will have had on each Fund’s funding basis. In general, future expectations of inflation are lower which would reduce the value of liabilities. The impact on the discount rate may vary by Fund; for example, if a discount rate is set with reference to gilt yields, then liabilities may be expected to have increased following 31 March 2019 due to a fall in gilt yields since this date. Overall, as at 31 March 2020, the funding position of an average Fund is expected to have worsened since 31 March 2019.

Results of Analysis

Data

Membership data

The LGPS continues to increase in size with total membership increasing from 5.6 ²m members in 2016 to 6.2m in 2019. The split of membership is summarised in the charts below. Please note that individuals may have multiple membership records due to different contracts etc. The actuarial valuations consider benefits by record rather than by member and therefore this count may be higher than the number of individual LGPS members.The following table sets out a comparison of the key membership statistics at the 2016 and 2019 valuations:

Please note that the average ages disclosed in the 2019 valuation reports are weighted by pension or by liability depending on the Fund. The average age shown in the table above is a simple average of the disclosed average ages and so is representative of neither.

Investment strategy

The overall allocation of assets of the Funds analysed in this report is set out in the chart below. For some more specific asset classes an allocation has been made to a class which is believed to be appropriate.

This is roughly a 70/30 split between growth and protection assets (classing equities, pooled investment vehicles, property and infrastructure as growth assets). Compared to 2016:

• There has been a reduction in growth type assets (the equivalent ratio at 2016 was approximately 80/20).
• It appears that Funds are moving into more diversified strategies and into less conventional asset types; for example the Other allocation at 2016 was 1% but has now increased to 7%. This includes assets such as derivatives, unitised insurance policies and liability driven investments.

There has been a slight increase in allocation to infrastructure from 1% at 2016 to 4% at 2019.Financial assumptionsThis section outlines findings split between the different key assumptions which are:

• Discount rate
• Inflation
• Real discount rate (margin above inflation)
• Salary increases

Discount rate

The discount rate assumption is the key assumption driving the value of each Fund’s liabilities. To determine the value of accrued liabilities and future contribution requirements at any given point in time it is necessary to discount future payments to and from the Fund. There are a number of different approaches which can be adopted in deriving the discount rate to be used and the approach that is most appropriate will depend on the purpose of the valuation and the overall funding objectives and risk appetite of the Fund. Therefore each actuary and Fund will derive their assumptions in an appropriate way.

The discount rate sometimes varies between employers and employer groups in each Fund, reflecting covenant strength. It is important to note that analysis here is of the average discount rate for each Fund.

The average disclosed discount rate used in the valuation fell from 4.4% p.a. at 2016 to 4.2% p.a. at 2019 and spanned a larger range of 3.1% to 5.3% p.a. compared with 3.8% to 5.7% p.a. in 2016. All else being equal, a fall in the discount rate increases the value of the liabilities.The chart below illustrates the number of Funds adopting discount rates within each range shown (and includes 2016 for comparison):

There has been a general trend across Funds of a decrease in the discount rate assumption since the last valuation; more Funds are now adopting a lower discount rate assumption. This is largely driven by expectations of lower future investment returns on assets.

In addition, Funds where Hymans Robertson or Barnett Waddingham act as Fund actuary incorporated an extra prudence allowance within the discount rate assumption towards the effect of the McCloud/Sargeant judgement. Funds where Mercer or Aon act as Fund actuary had adjustments made to the contributions certified, further details of which are set out in the Funding section of this report and in each individual Fund’s Funding Strategy Statement.

Inflation

In the LGPS, the Consumer Prices Index (CPI) is the current inflation measure used to index pensions in payment and deferment, and to revalue members’ CARE benefits for service accrued after 31 March 2014. The increase is set out each year in the public service pensions increase order issued by HM Treasury.

The average disclosed CPI inflation assumption used increased from 2.2% p.a. in 2016 to 2.4% p.a. in 2019. All else being equal, this would have led to an increase in the value of the liabilities as benefits are assumed to increase at a faster rate.

Real discount rate

The relationship between the CPI inflation assumption and the discount rate assumption, the real discount rate, is arguably the most important financial assumption. For example, a 0.1% increase in the inflation assumption combined with a 0.1% increase in the discount rate assumption results in very little change to the estimated value of the liabilities, but a 0.1% increase in the inflation assumption combined with a 0.1% decrease in the discount rate assumption, i.e. a fall in the real discount rate of 0.2%, could lead to an increase in the value of the liabilities of around 4%.

The graph below shows the change in real discount rate assumptions between the 2016 and 2019 valuations:

Most Funds saw a decrease in the real discount rate assumption which, all else being equal, would have led to an increase in the value of the liabilities. This would offset at least some of the improvements in funding position brought by the strong 2016/17 asset performance. Five Funds saw no change in the real discount rate assumption whilst four saw an increase.

Salary increases

As the LGPS is now a CARE scheme, the benefits earned after 31 March 2014 are revalued with inflation rather than salary increases. This means that the overall effect on valuation results of the salary increase assumption is less significant than it has been previously (ignoring any effects of McCloud remedies) and would not affect the contribution calculations. However, it still affects all pre-2014 accrued active liabilities.

Actual salary increases in the public sector have generally been low over the past few years and at recent valuations, there has been more of a range of salary increase assumptions used to reflect the circumstances of the individual Fund.

The chart below shows the range of long-term salary increase assumptions used by Funds at this valuation and the previous valuation:

The average long-term salary increase assumption across the Funds at 2019 was relatively unchanged from the 2016 valuation, however, the range for the salary increase assumption did narrow slightly from 2.0% p.a. - 3.9% p.a. at 2016 to 2.3% p.a. – 3.9% p.a. at 2019.

At the 2016 valuation, both Barnett Waddingham and Mercer applied a short-term overlay which allowed for a lower salary increase assumption in the short term. Mercer continued this approach for most of their Funds at 2019, however, Barnett Waddingham removed the short-term overlay and instead applied a lower long-term assumption. Neither Hymans Robertson nor Aon applied a short-term overlay for 2019.

Please note that this analysis does not consider the use of promotional salary scales which have been used by some Funds.

Demographic assumptions

There are a number of demographic assumptions (also known as statistical assumptions) made as part of a valuation, such as post-retirement mortality, rates of retirement and rates of withdrawal from active service.

The key demographic assumption is the post-retirement mortality assumption as it influences how long each Fund expects pensions to be paid for. This is analysed further in this section.

Post retirement mortality

The post-retirement mortality assumption will generally vary from Fund to Fund as this may take into account the specific profile of each Fund and its members.There are two aspects to consider in determining appropriate post-retirement mortality assumptions:

1. choosing an appropriate mortality base table assumption applicable today taking into account characteristics of the Fund members; and
2. making an appropriate allowance for mortality to improve in future.

The base table (and any adjustments made to it) will generally vary between Funds but the allowance for mortality to improve in the future is a more subjective assumption which will tend to be consistent between Funds, although the different actuarial firms have taken different views on what this should be and which version of the CMI Model to use.

The average life expectancies assumed at age 65 as set out in the dashboard are detailed in the chart below:

The average life expectancy assumption has reduced at 2019 compared to 2016. This is largely driven by a fall in levels of improvements in life expectancy seen in recent years (they have plateaued) and therefore lower expectations of improvements in life expectancy in future years. All else being equal, this would reduce the value of liabilities as benefits are expected to be paid out over a shorter timeframe than previously assumed.

The assumptions used have resulted in a range of life expectancy assumptions across the LGPS as set out in the table below:

Funding results

Funding level

Based on the 86 reports analysed, the results of the 2019 valuation reported assets of £285.8bn and liabilities on local funding assumptions of £291.7bn, i.e. a deficit of £5.9bn and a funding level of 98%. This is an overall improvement compared to the position in 2016 which showed assets of £216.6bn and liabilities of £254.3bn, i.e. a deficit of £37.7bn and a funding level of 85%. The chart below shows the range of funding levels at 2019 and 2016:

As can be seen from the chart, there has been a significant improvement in funding levels across the LGPS since the 2016 valuation. Published funding levels ranged from 70% to 125% (an improvement from the range at 2016 of 55% to 103%), with an average of 96% ³ (compared to an average of 85% at 2016). 24 Funds were reported as more than fully funded (i.e. higher than 100% funding level) as at 31 March 2019.

All Funds analysed saw an improvement in funding level, however, this ranged from 2% for the London Borough of Lambeth Pension Fund to 27% for the London Borough of Camden Pension Fund. The Fund with the highest reported funding position was the Royal Borough of Kensington and Chelsea Pension Fund at 125% funded and the lowest reported funding level was the London Borough of Havering Pension Fund at 70% funded.

Tier 3 employers

Since the 2016 valuation, there has been an additional focus on understanding the potential funding, legal and administrative issues in the Scheme relating to Tier 3 employers. Tier 3 employers are largely admitted and scheduled bodies that do not benefit from local or national tax-payer backing. More information on Tier 3 employers can be found on the Board webpage, Admitted and other Scheduled Bodies (Tier 3 Employers) in the LGPS.

Based on the information set out in the GAD dashboard (included in all Funds’ valuation reports for the purpose of GAD’s section 13 valuation), 11% of the total liabilities as at 31 March 2019 for the 86 Funds analysed were in respect of Tier 3 employers.

SAB standardised basis

It should be noted that the funding positions above are calculated using local funding assumptions which will differ by Fund. Funds use different assumptions to reflect their individual circumstances and attitudes to risk. However, as part of the 2019 valuations, Funds were asked to submit results on the same set of agreed assumptions to the Scheme Advisory Board (SAB) standard basis. This revealed a total funding level of 110% which compares to the total funding level of 98% on the local funding bases.

The average funding level reported on the SAB basis was 108% which compares to the average reported funding level of 96% on the local funding bases. Please note that the average funding level is a simpler metric which does not take into account Fund size.

Further analysis is expected in the Section 13 report to be published by GAD.

Contributions

The purpose of the 2019 actuarial valuations was to set appropriate contribution rates for each employer in the Scheme for the period from 1 April 2020 to 31 March 2023. This is required under Regulation 62 of the LGPS Regulations. Regulation 62 specifies four requirements that the actuary “must have regard to” when setting contributions and these are detailed below:

• “the desirability of maintaining as nearly constant a primary rate as possible”;
• “the current version of the administering authority’s funding strategy statement”;
• “the requirement to secure the solvency of the pension fund”; and
• “the long-term cost efficiency of the Scheme (i.e. the LGPS for England and Wales as a whole), so far as relating to the pension fund”.

The primary rate is the employer’s share of the cost of benefits accruing in each of the three years beginning 1 April 2020. In addition, each employer pays a secondary contribution as required under Regulation 62(7) that when combined with the primary rate results in the minimum total contributions certified for each employer. This secondary rate is based on their particular circumstances and so individual adjustments are made for each employer.

Primary rate of contributions

The following chart shows the range of primary rates calculated at whole Fund level at 2016 and 2019:

Please note that the disclosed whole Fund level primary rate looks at the average rate payable by employers in the Fund. It may not be paid by any individual employer.

The average primary rate increased from 17.0% of payroll p.a. ⁴ at 2016 to 18.6% of payroll p.a. at 2019. As can be seen from the chart above, there has been a general trend of an increase in primary rates.

All but six Funds saw an increase in primary rate; one Fund saw no change in primary rate and five saw a decrease. The changes in primary rate ranged from a decrease of 2.3% of payroll p.a. for the Suffolk Pension Fund to an increase of 5.0% of payroll p.a. for the London Borough of Hounslow Pension Fund.

Please note that these are the average primary rates at whole Fund level; individual employer primary rates will exhibit greater variability.

Secondary rate of contributions

In terms of secondary contributions, the total amounts expected from employers are £1.3bn, £1.2bn and £1.2bn for the 2020/21, 2021/22 and 2022/23 Scheme years respectively. The higher amount in year one is likely due to some employers having a preference to front end load their contributions.

What has actually been paid in secondary contributions may also vary if employers have changed their minds about front end loading their contributions due to the COVID-19 crisis.

Most secondary contributions will be certified as an amount to recover any deficit over a specified period or may be an amount to reflect any surplus attributable to an employer. For Funds where Mercer or Aon act as Fund actuary, any adjustments for McCloud were made to the contributions certified. No explicit adjustment to the contributions were made for Funds where Hymans Robertson or Barnett Waddingham act as Fund actuary as allowance was most commonly incorporated through extra prudence in the discount rate assumption.

There is limited information in the valuation reports about the length of surplus/deficit recovery periods used by Funds and participating employers and more detail will be available in each Fund’s Funding Strategy Statement. Some Funds have reported an average recovery period and some have reported the longest agreed recovery period for their employers (and sometimes both). It is not necessarily appropriate to consider a recovery period at Fund level for a number of reasons including:

• each employer or group of employers could be given their own recovery period depending on their individual circumstances; and
• some employers are in surplus and the surplus is not allocated to other employers so may result in a misleading whole Fund rate if it were assumed that it was shared.

In addition, recovery periods are used by some Funds as a tool to reflect employer covenant and therefore different recovery periods are offered to different employers; this will be set out in the Funding Strategy Statement of the relevant Fund.

Based on the information set out in the GAD dashboard, less than 3% of the total liabilities as at 31 March 2019 were in respect of employers with a deficit recovery period greater than 20 years. There were only five Funds which had any employers with a deficit recovery period greater than 20 years.

Total contributions

Combining the primary rate of contributions with the secondary rate of contributions, as a percentage of payroll the average total contribution rate at whole Fund level for the certified three year inter-valuation period is lower at 2019 compared to 2016.

The total average contribution for the three years following the 2016 valuation was 23.6% of payroll p.a.; this has fallen to 22.9% of payroll p.a. for the three years following the 2019 valuation.

Across the analysed Funds, there is significant variation in this change in average total contribution rate (ranging from a drop in total equivalent contributions of 7.3% of payroll, to an increase in total equivalent contributions of 8.1% of payroll). The average change was a decrease of 0.7% of payroll, generally reflecting the reduction in secondary rates (due to strong asset performance helping to reduce deficits) balancing out the increase in primary contributions.

However, contributions are paid on an individual employer level rather than a whole Fund level, and we expect even more variation at the individual employer level.

Please contact the Scheme Advisory Board secretariat for further information on the results of this research.

Appendix 1

List of LGPS Fund reports analysed (the two Environment Agency Funds we have excluded for the purposes of this analysis)