Estimated reading time: 6 minutes
Barry McKay and Melanie Durrant explore what 2019 has in store for the LGPS.
2018 was another eventful year for pensions. In the LGPS we saw three new sets of regulations passed introducing exit credits, equalisation of survivor benefits and new powers for MHCLG to issue statutory guidance.
We also saw possible employer cost cap breaches, increased scrutiny from The Pensions Regulator (TPR) and Section 13 valuation reviews by the Government Actuary’s Department (GAD). In the wider pensions world we were also affected by GDPR and GMP reconciliations. In addition we saw GMP equalisation as a result of the Lloyd’s judgement, as well as plans for the go ahead of the Pensions Dashboard.
So what can we expect in 2019?
It’s still only January yet we have seen a flurry of excitement to start us off. There have been dramatic scenes in Westminster as the Government struggles to find its way through the Brexit negotiations. In LGPS news, the Fair Deal consultation was launched and the cost cap consultation is imminent (see below) with any potential benefit changes taking effect from 1 April 2019.
2019 funding valuations
Whatever happens, the English and Welsh LGPS funds and employers will be focussing on the 2019 valuations. In order to increase efficiencies, the valuation process is a continuous one. There is a lot of preparation that can be done in the next few months to spread the demands on resources at Administering Authorities.
Data . . . and lots of it!
As the number of employers participating in the LGPS continues to grow, so does the amount of data. To get a head start, funds can use our online data validation system to upload and query membership data as often as they like and at no cost. The unique “tell us once” function allows users to confirm or correct data items as of 31 March 2018. The benefit for you is that the 31 March 2018 data becomes the base data, and so when you upload the valuation data there will just be one year of changes to check rather than changes over the full inter-valuation period
Cash flow information
Employer cash flow data is also key to the valuation process. For several valuations now, we have adopted a pragmatic and proportionate approach to allocate and track employer assets using specific employer cash flows, as opposed to using complicated actuarial techniques. This approach is transparent, intuitive and simple for employers to understand and reduces the risk to the fund of employer challenge. Many of our funds have provided employer cash flows for the two years to 31 March 2018. This is yet another way to reduce the amount of work for the valuation when we are all in the thick of it.
At recent valuations there has been increasing emphasis on employer covenant. The valuation gives funds the opportunity to review their employers, any guarantees or security in place and the “riskiness” of different employers. This demonstrates good governance and risk management and also feeds into the valuation calculations.
There are different levels of assessment that can be carried out and each fund will have a view of the level of detail that is required. Most funds now carry out at least a qualitative assessment, which allows funds to categorise employers by their characteristics using a simple low/medium/high risk grouping. Many funds are building on this and using a quantitative assessment based on agreed risk factors, which produces a risk score. If a more detailed review is required for some employers, then a covenant expert can be used.
By providing information in an employer database, which is required for the valuation anyway, we can certainly help with both the qualitative and quantitative assessments and develop an employer risk framework prior to the valuation date.
As actuaries, the validity of our calculations depends on the accuracy of the data used. Small differences in data can have a large effect on liability values and, as a result, the contribution rates paid by employers. We are keen to work with you to spot any issues well in advance.
The 2019 valuation will receive increased scrutiny from GAD and TPR. Funds need to demonstrate that they understand their responsibilities and consider the risks relating to the different participating employers. Barnett Waddingham provides a range of risk management services. The valuation is a good opportunity to review some of these risks as follows:
- Longevity – analyse your membership to understand the risk and set bespoke longevity assumptions
- Risk benefits – set a policy to mitigate ill-health and DIS costs through pooling, self-insurance or external insurance. Watch out for more details on this shortly.
- ALM – review your investment strategy against the liability cash flows to assess the likelihood of meeting your fund objectives
- Employer covenant – develop a framework to categorise employers and set more tailored funding strategies
Please get in touch with your actuary to find out more.
As a reminder, there are two cost control mechanisms in place for the LGPS. One is calculated by the Treasury (HMT) and the other is calculated by the Scheme Advisory Board (SAB). The cost control mechanism is triggered if the absolute change in the cost of the Scheme is more than a pre-specified level. Under the SAB mechanism, the Scheme design may, or must, be changed to bring the total future service cost back to the target of 19.5% p.a. of pay. Under the HMT mechanism it is to bring the total employer cost back to 14.6% of pay.
The cost cap has been triggered and not in a good way. In summary, it seems likely that benefit improvements at a cost of around 0.5% of pay will be required to return the total (SAB) cost to the target cost of 19.5% of pay. The HMT cost mechanism will then apply allowing for any benefit changes proposed by SAB. There will also be a six week consultation period on the proposed benefit changes. This doesn’t leave a lot of time to make changes to benefits and/or member contributions before 31 March 2019.
The Fair Deal consultation runs until 4 April 2019. The objective is to strengthen the pension protections that apply when employees are outsourced from an LGPS employer (now known as a “Fair Deal employer” in this consultation). The consultation removes the option for service providers to put relevant employees into a broadly comparable pension scheme. The proposed approach in the consultation is that service providers can choose to classify themselves as deemed employers, rather than entering into an admission agreement. Being a deemed employer removes a lot of the risk the employer is taking on in order to remove the barriers of bidding for service providers. A deemed employer would participate in the LGPS in a form of risk-sharing arrangement, which would be commercially agreed between the Fair Deal employer and the service provider.
If this deal ahead, we would expect to see an increase in the number of pass-through arrangements. This will result in the Fair Deal employer retaining some of the funding risk. We will be responding to the consultation and would be keen to hear your thoughts, so please get in touch.
So what does 2019 hold?
The question we keep getting asked is “how will Brexit affect the LGPS?” We do know that the LGPS is currently in a good financial position. This means the LGPS can afford to take a long-term view in setting actuarial assumptions as part of the 2019 valuation and consequently setting contribution rates for employers from 1 April 2020. However, with Scheme valuations moving to a four yearly cycle, what does this mean for local fund valuations and setting contribution rates which currently run on a three year cycle?
We suspect 2019 has started as it means to go on – a lot of topics to consider as the scheme continues to evolve!