The LGPS Scheme Advisory Board, a body tasked with encouraging best practice and collaboration across the local government pension scheme has weighed in on the debate around reducing LGPS pension contributions, urging funds to remain careful.
With almost one in five councils at risk of a Section 114 notice, employers and some consultants are suggesting to reduce pension contribution levels to ease financial pressures on the employers.
Indeed, funding levels for the LGPS have improved significantly throughout 2023. Since 2019, average funding levels for the Scheme have risen from 98% to 107%, with most local authority funds now in surplus, the Board said.
This chimes with data produced by consultancy firm ISIO. Its latest Low Risk Funding Index for the LGPS released at the end of October 2023 sets the average funding position at 108%.
The improved funding position for the LGPS is largely driven by the stark rise in yields on long-dated gilts, which are used to calculate the discount rate for the value of long-dated liabilities. Higher long-dated bond yields have lead to a stark reduction of actuarial estimates of the present value of pension scheme liabilities.
Over the past 12 months, yields on 20 year UK government debt have increased by more than 18% leading to a sharp drop in actuarial estimates of the present value of defined benefit liabilities.
Steve Simkins, partner at ISIO has previously argued on Room151 that pension funds should be using some of this “financial upside” to alleviate financial pressures facing local authorities.
But the Board appears to caution against such measures. While it acknowledges the financial pressures facing local government, and reports “increased appetite from employers and their advisors” to reduce contribution rates, the Board emphasises the importance of stable employer contributions.
Having said, it does not advise against reducing pension contribution rates per se but emphasises that what it refers to as “tailored approaches” should fit with funds’ overall risk management approach. Reduced contribution rates could be appropriate if a critical mass of employers was considering to de-risk the Board said.
By de-risking, in other words shifting a considerable section of their portfolio into long-dated gilts or other long-dated fixed income assets, schemes could lock in some of the higher returns and effectively shield against future investment risks.
ISIO’s Simkins criticises the Board’s position, arguing that it underestimates the scale of market changes that took place over the past 18 months.
“By deferring a full investigation until the next triennial valuation the SAB is putting England and Wales employers into a two year time lock” he argued.
“It would appear that the SAB is understandably very concerned about the consequences of having to deal with significant change between valuations. However, the pressure from employers is likely to mean the two year time lock will break. In our view, it would be better to face the resourcing issue head on and the scheme has assets it can use to support this” Simkins added.
However, most LGPS funds remain predominantly invested in riskier higher return assets such as equities and the government is keen to attract further LGPS investment in private markets, investment returns are therefore far from de-risked at the time of writing.
Moreover, industry practitioners warn that LGPS funding rates could rapidly deteriorate if long-dated bond yields would decline again.
Markets are now pricing in multiple Bank of England rate cuts in 2024 which could reduce bond yields. In that case, defined benefit liability estimates could rise again.
The LGPS Scheme Advisory Board also cautioned against a “partial termination” proposed by some employers which would result in the employer exiting the fund for deferred and pensioner members but remaining a participating employer for active members. This measure aims to lock in current liability values for deferred and pensioner members.
But this also means that there is no recourse to that employer if those estimates prove too low in future. In that case, the extra costs could become the responsibility of all employers in the fund, the Board warned.
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