Agenda item

The Local Government Pension Scheme (LGPS) regulations require each administering authority to prepare and publish a Funding Strategy Statement (FSS). The FSS sets out the key assumptions which the Fund’s Actuary has used in preparing the actuarial valuation and the policies adopted by the Administering Authority. 

The Group Manager for Funding, Investment & Risk introduced the report. She explained that a review of the Statement takes place every 3 years to coincide with the completion of a full statutory actuarial valuation. She added that the report reflects the workshop discussion that took place earlier in the month.

Paul Middleman, Mercer, addressed the Committee and highlighted the following points to them.

In the draft Funding Strategy Statement 2025 the following changes are being incorporated:

·  Discount Rate basis for past service liabilities (funding target) - The key assumption which drives the value of the pension Fund liabilities (the future benefit payments) and therefore deficit or surplus is the discount rate. This is set by the Fund, based on advice from the Actuary, to reflect the overall investment return which we expect to achieve on the Fund’s assets (within reasonable risk parameters) over the long term with a suitable and necessary allowance for prudence to support contribution sustainability.

·  The discount rate reflects the “real” expected asset return above the CPI baseline assumption when assessing the long-term solvency target. Increases in inflation will increase the liabilities as the benefits are inflation linked and potentially it can also reduce the real return on assets. A judgement is needed as to expected future inflation, with the risk that understating inflation and its persistency in this valuation will transpire into higher contributions at the next valuation in 2028.

·  The Actuary is proposing to increase the expected level of real return above CPI by 1.80% from the 2022 valuation to CPI+3.30% per annum, which includes an appropriate level of prudence to support contribution sustainability (as in the probability of achieving the discount rate) taking into account a range of factors/assumptions including the economic and geopolitical environment. The level of prudence includes judgement for the Actuary on the level of uncertainty of these factors in the context of the current global environment.

·  Future service rate (FSR) discount rate basis - The future service liabilities are calculated using the same assumptions as the funding target except that a different financial assumption for the discount rate is used. A critical aspect here is that the Regulations state the desirability of keeping the “Primary Rate” (which is the future service rate) as stable as possible so this needs to be taken into account when setting the assumptions.

·  As future service contributions are paid in respect of benefits built up in the future, the FSR should take account of the uncertainty in market conditions applying at future dates, not just the date of the valuation, it is justifiable to use a lower expected return from the investment strategy compared to the past service discount rate.

·  The Actuary’s view is that the real return applied in 2022 can be increased by 0.25% to CPI +2.25% per annum. As a result, there will be a reduction in FSR (all other things equal).

·  Mortality assumption - The baseline and short-term trend in mortality will be adjusted to reflect the Fund’s experience since 2022. The full demographic analysis has yet to be completed. However, the initial demographic analysis indicates that life expectancy has in general fallen (the exception being amongst female pensioners) which will reduce the baseline liabilities. The longevity assumption used to date is in line with current Continuous Mortality Investigation (CMI) (2023) with a long-term improvement trend of 1.75% p.a. and this is set out within the FSS. This will be updated to use the 2024 CMI tables once they are available, and the Actuary will consider further the long-term improvement trend in light of the additional analysis that will follow.

·  Surplus Reserve Policy - The Fund is now in a stronger funding position than at recent previous valuations and some employers may have moved into surplus position, so an enduring surplus policy is required. The Fund’s objective is to maintain stability of contributions and in the 2025 valuation circumstances of worldwide financial market turmoil, there is a need for a surplus reserve to protect against adverse experience leading to unsustainable contribution levels.

·  Relatively small surpluses are also fragile in the context of the daily variations in funding level and so the introduction of a sustainability reserve aims to provide a cushion against adverse experience to support the sustainability of contributions rates.

·  The FSS sets out differing surplus reserves by employer characteristics, given that some employers’ funding positions will be more sensitive to changes in market conditions, for example, than others, and at future valuations as the circumstances require the surplus reserve could be nil.

·  A critical consideration for committee is whether the reserves should vary by employer type (linked to the sensitivity of funding position to changes in assumptions) or maintain a constant reserve for employers and accept the potential lower likelihood of sustainable contributions. The draft policy shows provisional surplus reserves for the different categories of employer e.g. a 5% reserve for Councils/public bodies to allow for this variability in a practical way, along with circumstances where they would be considered on a case by case basis.

William Liew commented that he felt that it was right for the Fund to build in prudency, that he felt that employers value the certainty and therefore a 5% reserve was reasonable.

Jackie Peel queried whether the reserves should vary by employer type as it seemed like a level of complexity that wasn’t really needed.

Paul Middleman replied that he was content to keep it simplistic and that the Committee could consider having one reserve level. He said that this would be consistent and easier to understand for all. He added that an employer could always choose to contribute more if they wish.

Jackie Peel asked if she could send in further comments in writing.

The Group Manager for Funding, Investment & Risk replied that officers would be able to receive comments over the next couple of weeks.

The Committee RESOLVED to;

i) Approve the draft Funding Strategy Statement as set out in Appendix 1 for wider consultation, subject to the insertion of information which can only be included when the actuarial valuation and consultation processes are complete.

ii) Delegate power to officers, having taken advice from the Actuary, to amend the draft FSS for technical updates and updated information as appropriate.