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The final assumptions will be agreed with each administering authority as part of the valuation process later in the summer.
LGPS Funds have seen strong investment performance over the three years to 31 March 2019, and we expect a typical LGPS Fund to have achieved returns of 20% to 30% over the inter-valuation period – well ahead of even the most optimistic actuarial projections. On the other side of the balance sheet, changes in market conditions over the three years are likely to have resulted (in most cases) in modest increases in the value of the liabilities since 2016.
Combining these expected movements in assets and liabilities since 2016, on methods and assumptions consistent with those we adopted for the 2016 actuarial valuation, we would expect to see the assets increase more than the liabilities which would lead to improved funding levels for most LGPS Funds.
However, the changes in market conditions – higher future inflation and potentially lower future investment returns - may have increased the cost of future benefits leading to higher “primary” rates for employers.
The actuarial valuation provides an opportunity to review the methods and assumptions used to calculate LGPS Funds’ funding positions and employer contribution rates. We summarise our proposed headline changes below.
What has stayed the same?
What has changed?
Our proposed discount rate model now considers global equity market indicators rather than those that are UK-specific, reflecting the global mandates that most Funds have.
We expect our proposed post-retirement mortality assumptions to be updated to reflect more recent mortality data and lower expectations for future longevity improvements, depending on the outcome of an analysis of each Fund’s own mortality experience.
More details of the changes are provided below.
The discount rate assumption (also referred to as the assumed future return on investments) will continue to be based on each Fund’s long-term investment strategy. A neutral (or best estimate) discount rate assumption is made for each asset class; this is the assumption that reflects neither a prudent nor optimistic view on the future return on that strategy. These returns are then combined along with an allowance for prudence based on the Fund’s risk appetite along with an adjustment for expenses.
We previously based our return assumption for equities on UK market indicators but we are concerned that these indicators are currently overstating the expected returns on equities, particularly over the longer-term. In addition, most Funds’ equity portfolios are global in nature and so we believe we should reflect this by using global market indicators in our equity return model.
Compared to the approach at the 2016 actuarial valuation, we anticipate lower discount rates and therefore a higher value of liabilities as a result of lower future assumed returns on investments. We will discuss with each Fund whether the current prudence allowance continues to be appropriate for the Fund’s risk appetite, and perhaps whether an additional prudence allowance needs to be made in order to reflect the current uncertainties surrounding the level of members’ LGPS benefits as per the Scheme Advisory Board’s guidance (see our recent note on McCloud judgement and the cost cap process).
The post-retirement mortality assumption remains one of the key assumptions at the actuarial valuation and the most likely to vary significantly between Funds. There are two aspects to consider in determining appropriate post retirement mortality assumptions:
Choosing an appropriate mortality base table assumption applicable today taking into account characteristics of the Fund’s members
Making an appropriate allowance for mortality to improve in future
Recent studies show that future levels of improvements in mortality are slowing and we anticipate reflecting this in the 2019 valuation basis. See our detailed note for more information. This would have the effect of reducing the value of liabilities compared to a 2016 consistent basis.
Deferred pension and pensions in payment in the LGPS continue to increase in line with Consumer Prices Index (CPI) inflation. In addition, active members’ Career Average Revalued Earnings (CARE) benefits also increase in line with CPI. We do not propose any fundamental changes to our approach for CPI although, similar to the recent change for the purpose of employer accounting disclosures, we anticipate moving to a marginally higher differential between the Retail Prices Index (RPI) assumption and the CPI assumption, which will reduce the value of the liabilities compared to a 2016 consistent basis.
Salary increases in the LGPS have remained low since the 2016 actuarial valuation. Last time we used a short-term overlay to reflect the low increases but we will be proposing a lower long-term salary increase assumption in order to reflect the continuing trends, again reducing the value of the liabilities although by a lower amount as it only affects benefits accrued prior to 2014 for active members.
Based on the above anticipated changes to the key assumptions, we are expecting most Funds to see an improved, or at least similar, funding position compared to 2016 as Funds’ asset performance have been strong over the three years but we are also anticipating lower returns in future which has an offsetting effect. We anticipate that primary rates (i.e. the amount to pay for ongoing accrual of benefits) will be higher, again reflecting the higher expectations for future inflation and lower anticipated returns, but we will be aiming for overall stability of total contribution levels where possible.
It should of course be noted that each Fund is different and therefore any expectations for an average Fund may not apply to every, or indeed any, Fund. The final results will depend on the experience of each Fund as well as any changes in the funding strategy and policies. Individual employer results will vary even more significantly as a result of member experience.
Your Fund’s assumptions will be agreed later in summer as part of the initial results stage of the 2019 actuarial valuation. However, we are aware that you may want to see more detail on the assumptions earlier in the valuation process, for example:
We would be happy to provide a paper setting out our proposed assumptions at this stage if required – please get in touch with your usual Barnett Waddingham contact. Alternatively, you can email email@example.com or call us on 0333 11 11 222.