Agenda item

1.            That the Committee noted the updated funding and hedging position of the Fund and progress being made in the Risk Management Framework.

            Mr Middleman summarised the basics of funding a pension scheme:-

·         The benefits (i.e. the liabilities) are essentially inflation linked cashflows payable over a very long period.  This means that the level of inflation is a major factor in the cost e.g. higher inflation = higher liabilities = higher cost.

·         You finance the benefits paid through a balance of investment return (versus inflation) earned and contributions paid e.g. the higher the return versus inflation earned over the long term the less contributions are needed and vice versa.

            Essentially the Flighpath strategy is to give more certainty to the returns (over inflation) and also provide protection against changes in expected inflation levels. Central to this is the “hedging” strategy which essentially is investing in assets which more closely “match” changes in liabilities - therefore providing more stability in the level of deficit.  This leads to more certainty/stability of contributions for employers which is a key objective of the strategy.

            The key relationship is the investment return versus inflation and if inflation increases you want your investment return to increase also by at least the same amount to keep costs stable.

            Currently the hedging levels are still 20% in relation to interest rate and 40% in relation to inflation protection (with 100% being fully hedged). The funding level was significantly ahead of target at 91% (12% ahead) at 31 October 2017.

            Furthermore it is important to do this in the most efficient/timely manner in terms of the structure and financing of the strategy. This means the timing of any changes and the market level at which you do it is important as you want to do it in the most cost effective manner   The example of the restructuring of the hedging mandate in 2017 is an example of this where this is expected to deliver gains of £36.5m over the long term.  

            This detailed work is delegated to officers and is implemented on the advice provided by the Actuary and Investment Consultant via the Funding and Risk Management Group (FRMG).  The next key part of this is to revisit the equity protection element of the strategy before April 2018 when the current contract expires.  The outcome will be reported at a future committee.

            Taking into account all the above it has proved a successful strategy to date versus the cost of the governance which surrounds it.  Since inception in 2014 it has reduced deficit by c£140m all other things equal.

            Councillor Llewelyn-Jones had previously raised a question as to why the costs are so sensitive to changes in future investment returns as measured by the discount rate e.g., a 0.25% p.a. fall in investment return would reduce the funding level by 4% and increase the deficit by £91m. 

            Mr Middleman explained that it is due to the timeframe discussed.   The benefits are paid over relatively a long period, on average about 17-18 years across the total Fund for existing benefits.  A fall of 0.25% per year gives you a loss of about 4% over that period as there is a cumulative year on year compounding effect. 

            Mrs Fielder referred to a recent comment at a CIPFA event in Cardiff that if a Fund’s funding position has improved materially or it is 100% funded or over, thought should be given to protecting the position and taking risk off the table.  This is essentially the concept of the flightpath strategy.

            The Chairman highlighted that that the Budget had reaffirmed the potential removal of the public sector pay cap and asked what would happen to the Fund if it was removed?

            Mr Middleman noted at the last actuarial valuation the pay progression was assumed to be capped at 1% up to 2020 which was built into the contribution plan.

            If the cap is removed, the impact would depend on what was awarded and this can affect employers differently.  As an example if the average increase was now 2% p.a. up to the year 2020, the impact on funding would be an increase the deficit of £15-20 million across the Fund.   This could mean an increase in deficit contributions of c£1.5m per annum.    In addition what is often forgotten is that the ongoing benefit accrual costs (15.3% of pay for the Fund) also increase in £’s terms as payroll increases more than previously budgeted for.

            Mr Everett stated that no one had any protection against the pay cap removal in budgets so this would be need to be considered in the discussions moving into the next valuation.

            The Chair thanked Mr Middleman for the positive update on the progress and the background to the Flightpath strategy for Committee members.

RESOLVED:

1.            That the Committee noted the updated funding and hedging position of the Fund and progress being made in the Risk Management Framework.