Robert Bilton, partner at Hymans Robertson examines the outlook for the 2025 triennial valuation and key challenges for the LGPS to consider.
We are now less than 12 months away from the next triennial valuation for the LGPS in England and Wales. As 31 March 2025 fast approaches, everyone is asking ‘what the 2025 valuations will have in store for the LGPS?’.
To answer this question, it’s first helpful to remember what happened at the 2022 valuations. Due to strong asset performance in recent years, the LGPS held more assets per £ of benefit due than ever before. Combining this with life expectancy staying broadly steady, it’s no surprise that the funding level for the LGPS rose to 107%. The highest it’s been for a very long time.
Given this improvement, it was also no surprise to see the average employer contribution rate in the LGPS reduce to 21.1% of pay (a reduction of 1.8% of pay). A very positive reflection on the hard work done by the LGPS over the last 15 years, especially when contribution rates are increasing in the other public service pension schemes.
Since the 2022 valuations, there has been little change in the fundamental funding position. Investment returns, pension increases and life expectancy have been broadly as expected at 2022. So, it would be tempting to think that the 2025 valuations will be a continuation of 2022 and relatively straightforward. However…
Since 2022 there has been a fundamental change in the economic environment within which LGPS funds participate. This change in environment matters because LGPS funding and investment strategies do not operate in a special bubble. Rather, LGPS funds are market investors.
There are all sorts of indicators to summarise this change in environment. For example, we’ve seen it in insurers’ pricing – changes in annuity rates mean that the amount of pension an individual can buy for a given amount has increased by around 50% between 2022 and now. For the LGPS, perhaps the most relevant indicator is the return on long-term government bonds which are currently sitting at 4.5% pa (compared to 1.7% pa at 2022). This is now higher than the average future investment return of 4.3% pa that was assumed by the LGPS at 2022.
For 2025, LGPS funds will need to take a step back and think about what the change in economic environment means for their funding and investment strategies.
Will a fund believe that, because the funding fundamentals haven’t changed since 2022, funding levels have not materially changed since 2022. This would mean that their assumed future investment return (discount rate) will be around the same as long-term government bonds (typically viewed as the market’s risk-free rate of return). Does this mean that the fund thinks its assets such as equities, property or infrastructure are not going to be able to outperform government bonds? If so, should they stop taking all that investment risk and start to mirror what’s been happening in the retail savings market where there’s been a move from equity-type investments to bonds returning 4-5% pa? Assuming this would lead to contribution rates staying broadly steady, how do they manage employer expectations given most LGPS employer advisors are being vocal about funding level improvements and contribution rate reductions?
Alternatively, will a fund believe that they should get extra return for the investment risk being taken to generate returns. In this case, the discount rate would be higher than at 2022, resulting in a much higher funding level at 2025, mirroring the funding level increases recently observed in private sector pension schemes. Does this provide any opportunities to reduce the risk in the investment strategy or invest in UK productive finance? Or slightly more nuanced, does the fund need all that investment risk for every employer in the fund? Higher funding levels will also likely see employers asking and/or expecting contribution rate reductions. How will the fund balance this against the opportunity to use some of the funding improvement to build up a rainy-day fund to deliver greater long-term stability in contribution rates?
The answer to all these questions will vary between each LGPS fund. What is certain for every fund is that in the coming months they will be concentrating on their overarching long-term strategy, to ensure they make the right decisions, manage risks and take opportunities. Having a strong long-term strategy in place will help to maintain focus and ensure funds achieve longer-term goals and deliver the best outcomes for all stakeholders.
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