As the short to long-term funding position for local authorities gets more and more bleak, is now the time for LGPS funds to look at reducing contribution rates to help relieve some of the pressure?
Over the past year, sticky inflation and rising interest rates have pushed local government to its limit, with multiple councils each month reporting that their finances are in a dire situation.
In comparison, 2023 seems to have been a good year for the Local Government Pension Scheme (LGPS) as its aggregate funding position has improved substantially. According to the latest statistics from Isio’s Low-Risk Funding Index, the LGPS’s position had increased to 107% in September 2023 from 67% in March 2022.
Despite the positive funding position, LGPS contribution rates remain high, with the 2022 valuation highlighting that on average they were 21.2% of payroll for the year.
With all this in mind, should contribution rates be reviewed now rather than in 2026 at the next actuarial valuation to help relieve the funding pressure on local authorities?
Invoking the inter-valuation review?
Speaking to Room151, Steve Simkins, partner at consultant Isio, argues that now is the right time for LGPS funds to have a conversation with local authorities about whether contribution rates should be lowered and potentially invoke the inter-valuation review.
An inter-valuation review on contributions rates can be done on a local authority by local authority basis according to the LGPS Scheme Advisory Board guidance on employer flexibilities.
In addition, according to sources close to Room151, the advisory board is currently considering the matter of lowering contribution rates, with the intention of issuing guidance to funds on the subject.
Simkins explains the dilemma: “On one hand you have got a council really struggling to balance its budget and using up all of its reserves. On the other hand, it has a share in a pension fund that has got way more than it needs and certainly more than it expected.
“So, the question I am asking is, is there a better way of working through this challenge? Could some of the pensions upside be used to support a council that is at rock bottom and having to cut services, which undermines value in the council.
“Is there a better fit to this position, where one part of the council had got much worse financially whilst the other part has got much better?”
There seems to be this “disconnect” between councils and their LGPS funds, but at the end of the day “the pension fund’s money is the council’s money, just not in a liquid form”. For example, my local council has £5bn of assets in one LGPS fund, which “in some ways” is a utilisable asset on its balance sheet, Simkins explains.
Hence, Simkins argues that “it is surely reasonable” for funds to engage in conversation with councils to consider reducing contribution rates. He also put forward the question of whether it “would be appropriate for there to be a wholesale LGPS review”.
Could some of the pensions upside be used to support a council that is at rock bottom and having to cut services, which undermines value in the council- Steve Simkins, partner, Isio.
Interim review not to react to ‘market movements’
However, George Graham, director at South Yorkshire Pensions Authority, “fundamentally” disagrees with the idea of looking to lower contribution rates due to local authority financial distress.
He argues that the statutory guidance for the provisions of interim valuations is “very clear” that it is not intended as a provision to react to market movements.
Graham told Room151 that the issuance of a section 114 notice is a “perfectly legitimate” reason for a review of contributions as it is a “fundamental change” in the circumstances of the council, which was done at Croydon. However, this was an “individual case” and didn’t react to market movements.
As a pension fund, we’re charged to achieve “affordability and stability” and if we review pension contributions now then we are forgetting about “stability” from a budgeting point of view, he states.
In addition, once rates are lowered, it will then be difficult for funds to increase rates again as it will cause issues in the councils’ long-term budgeting process, Graham explains.
“Most of us understand the difficulties that councils face and we’re not unsympathetic to those, but our duty is to protect the long-term viability of the fund and we can’t take decisions that undermine that,” Graham adds.
Another local government source tells Room151: “Such suggestions are not helpful. In view of market uncertainty and expected reduced performance levels it would not be right to take money out of the fund which otherwise helps cover such contingencies. Retaining such monies also provides more stable financial predictions for the future.”
Contributions ‘drop in the ocean’ in terms of scale of problem
Graham also states that, equally, pension funds shouldn’t be holding on to money that we don’t need to meet liabilities, but that is why they have negative secondary contributions.
In addition, Graham says that the idea of reviewing contribution rates as a way of solving the scale of the problems that individual local authorities are faced with is “for the birds”.
“LGPS contributions are not the answer, they’re a drop in the ocean compared to some of the numbers [budget gaps] we’re talking about,” he adds.
Most recently, Southampton, Leeds and Cardiff councils have all reported budget gaps of over £100m.
Most of us understand the difficulties that councils face and we’re not unsympathetic to those, but our duty is to protect the long-term viability of the fund and we can’t take decisions that undermine that- George Graham, director, South Yorkshire Pensions Authority.
‘Never in a million years’
Speaking to Room151, Phil Triggs, tri-borough director of pensions and treasury, explains that he would “never in a million years” consider looking to lower contributions rates.
Both Graham and Triggs highlight that the government allowed administering authorities to go down this route in the 1990s as it reduced the funding target for funds from 100% to 75%. This immediately created surpluses for funds and resulted in them reducing contributions, and in some cases, conducting contribution holidays.
“It was disastrous and took a generation (20 years plus) of hefty deficit contributions to get back to normal funding levels. Us old practitioners still bear the scars,” Triggs says.
Graham adds: “It’s taken us until this [2022] valuation to restore our funding position. We don’t want to go back to that position.
“We need to manage surpluses, but we need to manage surpluses in a way that doesn’t undermine delivering the long-term sustainability of the fund. Because our job is not to help local authorities with their budgets but pay pensions when they fall due.”
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