Funding and actuarial matters
Funding and actuarial matters
As the Local Government Pension Scheme (LGPS) is a funded pension scheme, assets are held by each individual LGPS fund to meet future benefit payments to its members.
Each employer within Greater Manchester Pension Fund (GMPF) has a notional sub fund. The notional sub fund is the employer’s designated share of GMPF’s assets. From each employer’s sub fund, benefit payments for their scheme members flow out and contribution payments and investment returns flow in. GMPF’s actuary supports the management of these sub funds, adjusting their value each month as transactions occur. Often sub funds of related employers are aggregated together to create employer pools. Each employer in the pool pays the same contribution rate.
The LGPS Regulations state that an actuarial valuation of the fund must take place every three years to determine if a fund has enough assets to meet its liabilities and to adjust the contributions that employers pay accordingly. Each pension fund must appoint an actuary to do this work. The actuary will consider demographic risk and investment risk when carrying out a valuation.
One of the Pension Fund Management Panel’s key roles is to agree on an approach to funding matters and to document this approach in a Funding Strategy Statement. The Panel is responsible for agreeing to the actuarial assumptions to be used in funding calculations with the actuary, for deciding the level of risk GMPF should take (for example, how long should an employer be allowed to repay a deficit) and for putting risk reduction measures in place.
Since 2004 it has been a statutory requirement to have and publish a Funding Strategy Statement. Its purpose is to set out how GMPF has balanced the conflicting aims of affordability of contributions, transparency of the process, the stability of employer contributions and prudence. The Statement sets out GMPF’s approach to:
- target funding levels
- setting employer contribution rates
- solvency issues
- exiting employers
- early retirement costs
- bulk transfers.
- Step one is to collect scheme member data. This includes information such as a scheme member’s date of birth, pay and their pension amount built up so far.
- Step two is to determine the actuarial assumptions to be used. This includes assumptions around likely pay growth and life expectancy. Assumptions may differ between employers and members.
- Step three is to estimate (using the data collected and the assumptions agreed) the benefits that GMPF expects to pay to each member and to estimate the cost of providing these benefits.
- Step four is to work out the assets held in each employer’s sub fund and match these against the expected cost of paying the benefits earned to date for all of the employer’s members (this amount is often referred to as the past service liabilities or liabilities).
- Step five is to work out what each employer needs to pay for the next three years to ensure that going forward there will be enough assets to pay for the liabilities being built up.
Once step five has been completed, the actuary produces a rates and adjustments certificate specifying each employer’s primary and secondary contribution rate for the next three years.
You can split pension liabilities into two parts. The expected cost of the benefits that scheme members have already built up is often called the past service liability. The expected cost of the benefits that they are going to build up in the future is often called the future service cost.
The primary rate is the contribution rate that an employer must pay to meet the future service cost. It is based on the expected cost of providing future benefits as set out in the current scheme rules. The secondary rate is an adjustment to the primary rate based on the past service liabilities. The amount of adjustment will depend on how the amount of assets held in the employer’s sub fund compares to its past service liability. The secondary rate can be shown as a percentage of pay or a fixed amount cash payment.
Subsection 4 of section 13 of the Public Service Pensions Act 2013 requires the Government Actuary as the person appointed by Ministry for Housing, Communities and Local Government (MHCLG) to report on the following for each LGPS fund:
- Compliance: whether the fund’s valuation is in accordance with the scheme regulations.
- Consistency: whether the fund’s valuation has been carried out in a way which is not inconsistent with the other fund valuations within LGPS.
- Solvency: whether the rate of employer contributions is set at an appropriate level to ensure the solvency of the pension fund.
- Long term cost efficiency: whether the rate of employer contributions is set at an appropriate level to ensure the long term cost efficiency of the scheme, so far as relating to the pension fund.
Section 13 subsection (6) states that if any of the aims of subsection (4) are not achieved:
- the report may recommend remedial steps
- the scheme manager (so the Administering Authority) must:
- take such remedial steps as the scheme manager considers appropriate
- publish details of those steps and the reasons for taking them
- the responsible authority (so MHCLG) may:
- require the scheme manager to report on progress in taking remedial stepsdirect the scheme manager to take such remedial steps
- direct the scheme manager to take such remedial steps as the responsible authority considers appropriate.
The key funding risks can be grouped under the following five headings:
- Financial
- Demographic
- Regulatory
- Governance
- Environmental
Information of the individual risks and controls can be found in section 6 of the Funding Strategy Statement. Inflation is a financial risk. If all else remains equal and inflation is higher than the inflation assumption used to value liabilities, then the value of the liabilities will be higher than expected.
When an employer leaves a LGPS fund, it triggers an exit process. This can happen for several reasons, often because they cease to exist as an organisation or because their last contributing member leaves or dies. The type of exit process undertaken depends on what was agreed when the employer first joined the fund. In many cases, the terms of admission will state that all assets and liabilities will pass back to the employer who acts as a guarantor.
However, if the terms of the admission state that an exit valuation is to be undertaken, this requires the actuary to assess if there are enough assets in the notional sub fund to cover the estimated liabilities. If not, the employer needs to make an exit payment to cover the shortfall. If there are more assets than liabilities, then the administering authority has the discretion to make an exit credit and effectively refund some of the contributions previously made to the employer.
When carrying out an exit valuation, the actuary would typically use more prudent assumptions (for example a lower assumed future investment return), which would place a higher value on the liabilities. This is because the fund does not have any opportunity to increase contributions at future valuations should the cost of providing the benefits be higher than expected. The ultimate responsibility for determining whether an exit credit is paid lies with the administering authority.
More information about this can be found in section 4 of the Funding Strategy Statement.