Agenda item

(a)          The Committee approved the proposed key actuarial assumptions and funding parameters, in paragraphs 1.05 to 1.10 of the report, which will be incorporated into the Funding Strategy Statement.

(b)          The Committee approved the draft Funding Strategy Statement for consultation with employers (noting some information can only be included when the actuarial valuation is complete) and note the provisional results in paragraph 1.16.

(c)           The Committee delegated the refinement and finalisation of the draft FSS to the Head of Clwyd Pension Fund, before formal consultation with employers, having regard to the advice of the Fund Actuary.

            Mr Middleman explained that the purpose of the Funding Strategy Statement (“FSS”) was to balance the affordability of employer contributions against long-term sustainability of contributions and the financial health of the Fund. He noted the following key points regarding the draft FSS:

-       The draft FSS will be included in the consultation with employers over their employer contribution rates effective from 1 April 2023.

-       He emphasised that whilst the FSS was a structure to support sustainable contributions, it is also the responsibility of employers to consider this in the context of their own budgets, now and in the future. The importance of communication with employers is therefore paramount on this issue as taking materially reduced contributions now, due to the improved funding positions, makes sustainable contributions in the future more difficult to achieve. Written communication and discussions would take place including at the AJCM in December 2022 and feedback from employers on various factors would be brought to the next Committee for final sign off of the FSS in February 2023.

-       A minimum contribution requirement for employers is set via the FSS parameters to target sustainability in the future, and the flexibility within these parameters exists for employers to pay more than the minimum depending on their circumstances.

            Regarding the key parameters for assumptions from paragraph 1.05 onwards, Mr Middleman noted the following:

-       Benefit payments are related to inflation and therefore liabilities are driven by inflation.  This was a key assumption as part of the 2022 valuation.

-       There were many viewpoints regarding the current high level of inflation and how long it would persist, and it is important that the Fund makes reasonable allowance for it over the next few years. It was proposed to increase the long-term average level of inflation from 2.4% p.a. to 3.1% p.a., which was a reflection of the expectation that inflation would stay high for the next few years and then tail off.

-       The other aspect regarding inflation is the fact that the pension increase awarded was based on inflation in the 12 months to September each year. So it is now expected that the 2023 pension increase is going to be 10.1%. Therefore, allowance for known inflation was built in to refine the Fund’s cashflows i.e. the liabilities.

-       Employer contributions are essentially driven by the relationship between the expected return on the assets (the discount rate) and the rate of inflation, as this determines the proportion of benefits paid for by asset returns in the long-term versus those paid for by employer contributions.

-       At the valuation date, Mr Middleman had a picture of what might be a reasonable assumption for the discount rate and inflation but from March 2022 onwards, there was a drastic change in interest rates, expectations and the global economic outlook. This was considered and it was concluded that the assumptions were still reasonable as they had anticipated the increased inflation/lower growth scenarios to a reasonable extent.

-       Mr Middleman proposed to reduce the discount rate above inflation from the previous valuation by 0.25% (from CPI +1.75% to CPI +1.50%). A similar reduction was proposed in relation to future service liabilities i.e. from CPI + 2.25% to CPI+ 2.0%.

-       The pre 2014 liabilities relating to McCloud costs were based on the member’s final salary at date of retirement or leaving the Fund and therefore from paragraph 1.08, Mr Middleman proposed to retain the same long-term assumptions (i.e. CPI +1.25%). An option was also built in for employers to adjust their own pay-growth assumption based on their own pay expectations in the short-term.

-          The demographic analysis outlined in paragraph 1.09 reflected that the improvement in life expectancy was slowing down. Compared to 2019, the 2022 analysis showed that pensioners currently aged 65 were expected to live for less time in retirement and therefore, this reduced the liabilities at the 2022 valuation. The other demographic factors considered had less of a financial impact e.g. ill-health and cash commutation. The analysis showed that less members on average were opting for cash, so this has been reflected in the assumptions.

-          Recovery periods depended on whether an employer was in deficit or surplus as highlighted from paragraph 1.10. Mr Middleman proposed that if an employer was in deficit at the 2022 valuation, they would be reduced by 3 years to achieve a funding level target of 100% as quick as possible. For those employers in surplus, they would aim to keep the same recovery period as the 2019 valuation, which slowed down the payback of surplus to the employer. Both of these proposals were trying to achieve sustainability of contributions and intergenerational fairness to tax payers.

-          McCloud costs were now included in the liabilities and therefore within the balance sheet, as instructed by the Government. It was noted McCloud costs ceased at 31 March 2022 so do not affect the future service rate.

Paragraph 1.16 highlighted the provisional valuation results at 31 March 2022.

Therefore, Mr Middleman summarised that the Fund is in a positive position with an average funding level of 105% compared to a funding level of 91% at the 2019 valuation. This was driven mainly by the strong investment performance between 2019 and 2022 plus the deficit contributions paid. However, this was offset by some of the actuarial assumptions i.e. the discount rate change and the rate of inflation, but the demographic assumptions slightly improved the position.

Future service rates were more sensitive to the reduction in discount rate versus inflation as there was no positive asset performance to offset these costs.  The future service rate increased on average from 17.3% to 18.7%.

Generally, when looking at individual employers, there were stronger funding levels across the Fund but higher future service costs, therefore overall for a number of employers, the proposed FSS results in a reduction in contributions to reflect this improvement. As noted earlier, the consultation with employers will focus on some of the risks for employers around inflation and the global economic outlook in the context of contribution sustainability, to encourage those employers who could afford it to pay more than the minimum contributions.

Mr Ferguson mentioned that the climate had changed for employers and their budgets, citing the difference in pay awards compared to nine months ago and was pleased that the Fund was in surplus given the current financial climate. He believed it was reasonable to allow employers to take some flexibility around future contributions and welcomed the flexibility proposed in the draft FSS.

Regarding the climate change funding level scenario analysis, Cllr Swash highlighted from page 207 that a section of the FSS was not finalised as the Actuary had not completed the analysis of the physical and climate transition risks. He noted that this was an important factor in considering the draft FSS. Mr Middleman confirmed the analysis was expected to be completed by the next Committee. Mr Middleman also explained that the long-term assumptions proposed in the FSS incorporated implicit allowance for these climate change risks even though the scenarios were not currently populated. It was noted these scenarios would be a snapshot of what could happen in specific circumstances around the transition.

RESOLVED:

(a)          The Committee approved the proposed key actuarial assumptions and funding parameters, in paragraphs 1.05 to 1.10 of the report, which will be incorporated into the Funding Strategy Statement.

(b)          The Committee approved the draft Funding Strategy Statement for consultation with employers (noting some information can only be included when the actuarial valuation is complete) and note the provisional results in paragraph 1.16.

(c)           The Committee delegated the refinement and finalisation of the draft FSS to the Head of Clwyd Pension Fund, before formal consultation with employers, having regard to the advice of the Fund Actuary.