For the first time in the working lives of many people, the 2022 LGPS valuations will likely show funding surpluses. Fund actuary Robbie McInroy gives the inside track on options for councils and the best way to engage with the fund and actuary to optimise pension costs.
Another Local Government Pension Scheme triennial valuation takes place as at 31 March 2022. The 2022 valuations across England and Wales will however be like no other. The days of section 151 officers being told their contribution rates, or simply accepting the figure as the lowest possible, are long gone.
For the first time in the working lives of many within local government, it is likely that most LGPS funds will have a funding surplus at the valuation date. This presents a different kind of challenge for funds and councils to the one faced over the last two decades. In the past, a large focus has (rightly) been on plugging deficits and reaching 100% funding. The challenge for senior officers now will be to understand and consider the contribution and investment options available to maximise the impact of the funding gains.
Today’s decisions will set the direction of a council’s pension costs and funding for years to come, so it is vital to have clear pension cost objectives and ensure preferences are acknowledged and met.
To meet the challenges, a different and more engaged approach is needed by all. LGPS fund officers, and their actuaries, are poised and ready to support senior officers make these decisions.
In the past, a large focus has (rightly) been on plugging deficits and reaching 100% funding. The challenge for senior officers now will be to understand and consider the contribution and investment options available to maximise the impact of the funding gains.
Setting pension cost objectives
While the overall objective of each fund is to pay members’ benefits, the cost of paying for the benefits falls mainly on the employers. The aim of the fund is to keep these pension costs stable and affordable. However, what “affordable and stable” actually means to the authority, the fund and neighbouring councils can be different. These varying interpretations could be widened even further when the fund makes decisions to solidify the strong funding position.
Understanding the options and setting pension cost objectives for each authority is therefore critical for taking on board individual preferences and successful outcomes. These individual authority objectives will likely boil down to a target contribution rate and the level of acceptable volatility. For example, would a contribution rate of 18% of pay be preferable, which could increase at future valuations by 3-5%, or a contribution rate of 21% of pay which is likely to remain more stable?
Individual authority pension cost objectives can mean setting a quite different funding direction from those of the fund or other councils. However, this can be readily accommodated with early engagement.
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Practical options
While I would suggest the first step is working with the fund to articulate and document the council’s pension cost objectives, senior officer time is stretched, and attention is also needed on the shorter-term practicalities and budgeting aspects.
I have therefore provided five key options likely to be available to the council and the fund/actuarial concerns to navigate (noting that I do not guarantee that all funds or actuaries will agree!).
- Contribution reductions – for large, secure employers such as councils, contribution strategies are normally characterised by small increases/decreases between years. However, if a temporary or one-off drop in contributions would provide some budgetary relief, then it is worth having the conversation with the fund and actuary. Despite the upward pressure on the cost of members’ new benefit accrual, a strong past service funding position may allow more flexibility. The key concern for funds when agreeing to a larger contribution reduction is ensuring that the council understands and can cope with a potentially larger contribution increase at a future valuation if funding deteriorates.
- Reprofiling contributions – as long as the total contributions over the three years remain the same, most funds will be comfortable with flexing the pattern of contributions over that period. For example, a s151 officer earlier in the month shared that 2023/24 will be tight to manage but their budget will be easier beyond that. In this example, it therefore made sense to reprofile contribution reductions to have a bigger saving next year followed by small increases, rather than smaller reductions spread equally over the three years.
- Monetary vs. percentage of pay contributions – monetary deficit recovery contributions were introduced as best practice in the late 2000s to ensure adequate sums were being paid if payrolls dropped due to redundancies, academisations or outsourcings. Today, most funds and actuaries are less concerned about having a monetary element. Other than CIPFA’s preference for a percentage of pay element for future benefit accrual, it is therefore very much up to the individual council as to how total contributions are split between monetary and percentage of pay.
- “Prepayment” of contributions – putting aside the accounting reasons for pre-paying contributions, there is an economic benefit to paying contributions sooner (assuming the fund’s future investment returns are above 0%). Nearly all funds and actuaries will be happy to accommodate some level of pre-payment and pass on the savings calculated on a level of expected investment returns. In addition, a recent legal opinion stated that there was no barrier in making pre-payment of future contributions. From a legal standpoint therefore, pre-payment is not limited to only secondary contributions (previously known as deficit recovery contributions). For LGPS funds, the main concern that needs to be navigated is giving adequate time to plan for the changes in cashflows. Timely discussion and agreement are therefore vital.
- Schools – where the council is a local education authority, it might also be worth giving some thought to how schools’ contributions will be presented. These can readily be separated from the council’s contribution rate – for example, if a contribution pre-payment is being made on behalf of only the council or if a different contribution pattern is desirable. The key concern for funds when agreeing to a larger contribution reduction is ensuring that the council understands and can cope with a potentially larger contribution increase at a future valuation if funding deteriorates.
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Next steps for councils
In our more virtual world, it is far easier to engage with the fund and actuary and involve wider stakeholders. For example, pension costs could be discussed at the audit/finance committee. The first step is to consider some of the above, discuss the support required with the fund and set a plan in place for making the required decisions.
All parties acknowledge the competing demands on senior officer time and the importance of timely and efficient decision-making. However, the 2022 valuations will set the direction of pension costs and funding for years to come. Investing time now on reviewing individual authority pension cost objectives and engaging early in the valuation process around the practical preferences will pay dividends in the future.
Robbie McInroy is a partner and LGPS fund actuary at Hymans Robertson.
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