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In mid-March we saw significant falls in gilt yields and equity values as a result of the Covid-19 pandemic and we raised some of the considerations with our funds at that time. Recently, markets have appeared to be settling slightly, but there is still significant daily volatility and this is likely to continue for some time.
This blog provides our view on the vital considerations for LGPS funds, principally in terms of how the market shockwaves may impact funding, employers and accounting.
New LGPS funding challenges
Market volatility is nothing new but we haven’t seen falls like this for a long time. We therefore recommend you take stock of the following:
- Pre-payments: some employers are due to pay all or part of their primary and/or secondary contributions in advance during April 2020. Employers should already be aware of the investment risk associated with paying a lump sum in advance; i.e. compared with just paying regular monthly contributions where they would generally benefit at the next valuation if markets (over the next three years) outperform expectations and lose out if markets underperform. We have no way of knowing how markets will perform, but the employer should be made aware of this risk in case they want to reconsider or take additional advice.
- Employer covenant and security: this may be a good time to review employer covenants and discuss the option of providing security to the fund where a weak covenant or affordability may be an issue.
- Deferral of employer contributions: funds may receive requests to defer payment of employer contributions. It is important that employers understand they will need to make up any deferred contributions later in the scheme year. We will be issuing a separate communication on this topic to our funds.
- Funding model: our funding model is designed to withstand short-term volatility in markets as we use smoothed assumptions over a six-month period with the ultimate aim of setting stable contributions for employers. Therefore, although the falls have been significant, the ongoing funding position under our model will not have fallen as significantly as markets, as the model helps to mitigate some of the impact of the extreme events. This will not be the case with some other funding models used in the LGPS. The longer markets stay as they are though, the more impact we will see. However, generally pension funding is a long term game so we would suggest focusing on your long-term funding strategy and avoiding any knee-jerk decisions. We will continue to monitor the situation. If you would like to know how the recent market volatility has affected your fund’s funding position, we would be happy to prepare a current monitoring report.
- Investment considerations: clearly, there are also lots of investment issues to consider with your investment consultant. Please keep us informed of any changes that you make to your strategy so we can feed them into the funding model as appropriate
- New employer reports: similar to the point above relating to our funding model, new employers may join under less favourable conditions but, in the short-term, our smoothing mechanism is designed to reduce the impact of market volatility. We will be keeping our funding model under review as the situation progresses.
- Ceasing and short term employers: the current environment is not favourable for ceasing employers, particularly those ceasing on a minimum-risk basis due to the low yields and much lower asset values pushing up any exit payments for ceasing employers. There is little we can do to resolve this situation if an employer ceases at an unfavourable time but funds will need to consider any messaging when providing cessation figures. Focus on those employers who may be exiting the fund within the next couple of years and ensure they are still on track to be fully funded to avoid any additional cash calls at that time. You could consider offering employers more flexible terms to repay the cessation debt if they can provide some additional security. We can provide an updated funding position and contribution rate for employers in our funds to help engagement and risk management.
- Transfers: any bulk transfers underway are going to be more sensitive to a particular market date, especially if the transfer is an asset transfer. If on the paying side, you may also wish to consider whether you have enough liquid assets to pay any significant bulk transfers due.
- Accounting: one of the more pressing issues is the 31 March 2020 IAS19 and FRS102 figures. In the interests of time, the usual approach of LGPS actuaries is to take the most recently available assets and make an estimate of market movements to 31 March when we estimate the notional asset value attributable to each employer. However, with current levels of volatility and the lower levels of estimation tolerance by auditors, we would urge you to consider whether this is still an appropriate approach or whether you should wait until you have the 31 March asset values before your actuary produces employer reports. This would of course delay the process and the delivery of reports, but it should avoid queries or having to rerun reports later down the line. Deadlines for local authorities have been extended, which should ease this pressure.
We are aware the situation is changing rapidly but our expertise is on hand to help you navigate the challenges ahead. For further guidance on any of these issues and what they mean specifically for you, get in touch with us to discuss your specific needs.
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