Agenda item

(a)          The Committee approved the draft Funding Strategy Statement; and

(b)          The Committee delegated the refinement and finalisation of the draft Funding Strategy Statement to the officers before formal consultation with employers.

Mr Middleman presented the key factors to consider when developing a funding strategy. 

He emphasised the importance of the Funding Strategy Statement as part of the Actuarial Valuation as it balances out a number of key risks.

Mr Middleman explained that fundamentally it is the “plan” for the Fund to ensure it has sufficient monies to pay members' benefits when they retire for as long as they live. This is financed through employer and employee contributions, and investment returns, so the balance between the two elements is what the FSS determines.  The other critical aspect is an employer’s covenant.  The covenant of an employer is the ability and willingness that an employer can pay their contributions that we require from them.  This also affects the level and timing of contributions you would request from different types of employer.   For example, a Council would be expected to be able to fund its pension liabilities over a longer timeframe with more certainly than, say, an employer who is reliant on specific funding streams. Therefore, the funding strategy has to take into account these differences.

Mr Middleman noted key points about the proposed assumption changes on the Funding Strategy Statement which was contained in the separate presentation.   The key changes where:

·         A reduction in the discount rate/return outlook relative to CPI inflation.

·         A change in the life expectancy assumption resulting in a reduction in life expectancy for the Fund.

·         A change in the short term pay growth to a minimum of 2% p.a. for 4 years to 2023.

·         An average reduction in the recovery period of 3 years to target the same period to full funding.

Mrs McWilliam queried why there are two different discount rate assumptions; one for past and future. Mr Middleman confirmed that there are two elements for how contributions are set.  Past service is looking at the deficit relating to the benefits that have already been earned. Future service is based on members who are in the Fund continuing to earn benefits, and these have a much longer timeframe to earn returns than the liabilities already accrued as this includes pensions in payment already.

Secondly, Mrs McWilliam asked about the recent announcement of the merging of RPI and CPI. Mr Middleman said that the announcement would not affect the valuation position as this was determined prior to the announcement so assets and liabilities are consistently measured. Equally it is not absolutely certain that the change will happen (although likely) and how it will manifest itself.  Mr Middleman therefore recommended no change in the parameters at this valuation but consideration of this issue will be needed going forward.  However, there was a market reaction to the announcement which will need to be considered in the context of the flightpath and hedging strategy adopted.   Any impact will be reported at future Committee meetings where appropriate.

            Mr Everett said that even the Councils are in different places in terms of affordability so it has to cater for all circumstances and he felt it does that. Mr Middleman agreed Mr Everett’s important point and noted it is becoming more difficult to balance across all employers although it is easier when the positon is improving.

Cllr Rutherford queried the impact of the pay growth from the 2016 to 2019 valuation. Mr Middleman noted that at 2016 a 1% p.a. increase (including increments) was assumed.  The data had shown the average increase on salary from the membership data shows c2.5%-3% p.a. over that period.  This results in a bigger than expected increase in the final salary related liabilities (benefits earned up to 2014) hence a small increase in the deficit due to this factor.  In terms of the forward looking short term pay assumption this is a reflection of the planned general pay increases in the sector (2% for 2019 and 2020) but employers will be asked to consider if a higher figure should be used as otherwise the impact of higher increases would come through at the next valuation (as in 2019).  It is essentially a budget risk for employers to manage as they know better than the Actuary what the pay progression is likely to be in the next few years.

Mr Hibbert queried if the average deficit recovery period should be kept at 15 years.  Mr Middleman noted that there is an expectation under the Section 13 valuation performed by the GAD that recovery periods would reduce over time and typically to maintain the same end point.  Mr Middleman noted however that when the length becomes too short then it can cause contribution requirements to become too volatile.   Depending on the final period adopted at this valuation it is possible that the average period would not reduce again or by less than three years.  

            Mr Middleman ran through the current policy issues highlighting the McCloud age discrimination case in relation to the benefit changes made in 2014 (and the protections given to certain members within 10 years of retirement) which means that there will be additional McCloud costs for all public sector schemes.   Guidance has been issued from Government stating that the Fund policy in relation to the allowance for the potential McCloud remedy should be clear.

            Mr Middleman explained that the remedy required in the LGPS will not be known before contribution rates are signed off.  Whilst it cannot be costed with any certainty a cost can be assessed if the age criteria were removed in terms of the underpin. This provision will be communicated to employers based on their individual membership.

Mr Middleman proposed that employers should have the choice to make a provision for the potential costs in the valuation contribution rates for the McCloud judgment or to make provision in their budgets.  If they make provisions in the contributions, then there would be no review of contributions before the next valuation to allow for the McCloud costs, whereas if a provision was made in the budget then if the remedy is known before the next valuation contribution requirements will be increased and backdated from 1 April 2020.  Therefore, if an allowance is made in the contributions from 1 April 2020 to 31 March 2023 an employer will have budget certainty for this period.

Mr Middleman also added that this is the costing approach adopted for each employer in their annual accounts so is consistent.

Mr Middleman stated that on the basis of the proposed parameters the funding level at the 2019 valuation would be an increase to 91% resulting in a much lower deficit.  However, the future service rate would increase to 17.3% of pay per annum.  The McCloud provision across the Fund would be c0.5% of liabilities pay and 0.5% of pay per annum in relation to the future service rate.

He also confirmed the following key points regarding other policy issues;

·         Cost management will not be allowed for at the 2019 Actuarial Valuation as it has been paused.

·         The policy in relation to interim valuations and individual employer contribution rate reviews between valuations is being consulted on in terms of when the Fund would do that.   However, it is looking increasingly possible that these provisions will not be brought in before the FSS is signed off.   Even so it is his view the issues should be consulted on even if the policy was removed from this FSS and the FSS was updated again at a later date to introduce them again.

·         Exit credits are where an employer can receive monies back on exit if the funding position shows a surplus (typically on an insurance basis).  The policy was put in place in 2018 and Regulations are expected to be updated to close a loophole for some cases where another employer (e.g. a Council) guarantees the debt but does not receive the surplus back.   These Regulations were expected before the end of the year and the FSS needs to reflect it, so employers are being consulted on whether the existing policy is sufficient.

·         The policy in relation to when an employer would be allowed to become a “Deferred employer” e.g. where an employer to stay in the Fund with no active members. This would have limited application in the Fund given the employer base.

Mr Latham queried the timeline for taking the FSS for consultation. Mr Middleman said that the employer results and draft FSS will be issued before the AJCM in November so they can be discussed directly with employers.

Cllr Bateman raised the issue of the protection of employer default. Mr Middleman highlighted the importance that the policy is as comprehensive as possible because if one employer defaults then the guarantor or all other employers have to pick up their obligations. There are separate processes around general employer risk management and in particular covenant data is gathered on employer’s ability to pay contributions to make an assessment on the likelihood of employer default and actions are taken to minimise it e.g. higher contributions and/or security.

Cllr Bateman queried the number of employers in the Fund. Mrs Fielder confirmed that there are 43 employers.

The Committee agreed the main parameter changes and draft polices discussed.

RESOLVED:

(a)          The Committee approved the draft Funding Strategy Statement; and

(b)          The Committee delegated the refinement and finalisation of the draft Funding Strategy Statement to the officers before formal consultation with employers.