Posts by David

David Davison

David Davison

Specialist consultant on pensions strategy for corporate, public sector and not for profit employers
David Davison

A question in the recent policy consultation “Local Government Pension Scheme: Changes to the Local Valuation Cycle and the Management of Employer Risk” asking if schemes needed greater protections from admitted bodies, and some recent communication with a Fund, really highlighted a misconception held by Funds and those associated with them.

A constant frustration for me, and something which must be a huge irritation for charities participating in LGPS is to be accused by Funds of recklessly building up liabilities they can’t afford and then complaining about having to deal with them. This is a blatant distortion of the facts and admitted bodies would in my view have every right to feel aggrieved by the assertion. I’d just like to set out some facts so that if this assertion does rear its ugly head it can be swiftly returned to whence it came.

  • Most organisations participating in LGPS were encouraged to do so by Councils and Funds without being provided with any risk warnings about their participation. Charities therefore joined with the best of motives but often unaware of the future risks they’d be exposed to. Had these warnings been provided in a clear way I’m sure many Trustee Boards would have taken a decision not to participate.
  • Even today warnings are far from transparent and the key driver for organisations not participating is that they are not permitted to join without Government or Council protection.  Most Funding Strategy Statements outline the process for achieving this for potential participants however Funds have taken no steps to rectify the legacy position.
  • In a similar vein Funds have been happy to transfer liabilities built up by these public bodies to organisations without their knowledge, without any choice and on a basis which leaves the charity with a liability many times that of the public body. The inequity is enshrined in Regulation and Councils in my experience use it as an excuse to avoid dealing with liabilities accrued on their watch.  Should Funds not be looking to protect members interests to the maximum extent possible. Surely a public sector guarantee over historic liabilities does this?  Yet Funds have been reluctant to pursue this with conflicts of interest to the fore. Indeed from what I’ve seen Funds and government bodies have looked instead to seek every route possible to avoid their obligations.
  • Crucially then Regulation limits organisations ability to deal with the issue. While other UK DB schemes will allow employers to close to future accrual and continue to fund on an ‘on-going’ funding basis to manage down risk in LGPS Funds unilaterally trigger a cessation debt on a gilts basis. There is the constant insistence that this is the correct basis to value these liabilities even though that is not the way Fund themselves invest their assets or indeed usually the way assets are invested post a cessation. Councils are effectively using exiting charitable bodies to cross subsidise their funding. Even where professional advice has been provided to the Scheme Advisory Board recommending change this has been strategically ignored.
  • Even where some flexibility is offered this is on the repayment term, not on the closure basis. In addition Funds are using the negotiation around an exit to leverage additional security or extort higher contributions.
  • Funds usually have a one dimensional view of risk driven by what happens when an admitted body looks to exit the Fund. They are not however balancing this with the risk they are exposing participants to by allowing further accrual, particularly for those with weaker covenants. Funds are not assessing this risk to properly identify the overall position and better manage it.

Based on the above I think charities would have every right to question who needs protection from who?

David Davison

In a previous LGPS Bulletin I highlighted the consultation issued on the 8th May entitled “Local Government Pension Scheme: Changes to the Local Valuation Cycle and the Management of Employer Risk.” The consultation closes on the 31 July 2019 and a copy of our detailed response to the specific questions can be found here or click on the image below.

Our response highlights concerns over the quality of information provided by schemes, deficiencies with the proposals and existing Regulation, the calculation of cessation debts, the drive for security, legacy liabilities and the status of public bodies in the schemes, and makes proposals for a more equitable future framework.

Over the coming Bulletins I will be examining many of these issues in more detail.

PLEASE NOTE: Our response was updated on 12th August 2019 to include additional information.

David Davison

This article was originally published in Lexis Nexis on 4th April 2019

Pensions analysis: David Davison, director and owner of Spence & Partners who leads the public sector, charities and not-for-profit practice and heads a team advising third sector bodies on all aspects of pension provision, discusses the recent government consultation which intends to ensure that exit payments paid to public sector employees are ‘value for money for the taxpayer’.

Original news

HM Treasury opens consultation on restricting exit payments for public sector workers, LNB News 10/04/2019 90

HM Treasury has opened a consultation outlining how the government will introduce a £95,000 cap on exit payments for public sector workers. The policy will see UK civil service, local government, police forces, schools and the NHS taking part in the first stage of implementation. The consultation sets out proposed draft regulations, schedule to the regulations, accompanying guidance and directions. The deadline for responses is 11:59pm on 3 July 2019.

What is the background to HM Treasury’s consultation on draft regulations restricting exit payments in the public sector published on 10 April 2019?

There has been government concern for some time about the level of severance packages in the public sector. This issue dates back to May 2015, with the government announcing it would bring forward proposals to end six figure pay-outs, then running an initial consultation with proposals in February 2016 and implementing changes in the Small Business, Enterprise and Employment Act 2015 (SBEEA 2015) and amending in the Enterprise Act 2016.

SBEEA 2015 required secondary legislation which had a first reading in the House of Commons in September 2017, with them now consulting on the detail based upon the proposals issued on 10 April 2019. It’s been pretty slow progress, but I suppose no-one should be that surprised by the contents. When this was looked at initially, there seemed to be some high profile severances and a real concern about senior staff in the public service exiting for large severances and then returning to another similar job a short time later.

The proposals follow research they’d carried out which suggested that more than 1,600 highly paid workers received payments of more than £100,000 in 2016/17 costing a total of £198m. They estimate that the total cost of exit payments across the public sector in 2016/17 were £1.2bn. So, the proposed limit will impact less than 17% of total payments and any saving likely to be materially less than that as still some pay-out will be made. The focus is going to be very much limiting large payments at the top-end and not those for the vast majority.

What are the key proposals for change and why are they being implemented now? Are there any specific exclusions or exemptions under the proposals?

The proposals would implement a cap on the value of redundancy lump sums and pension top-up payments to £95,000 in total. Those organisations impacted are specified in the proposals, but it is the ultimate aim that the legislation will apply to all public sector employers at a future date so effectively we have a two-stage roll-out.

Payments made by devolved authorities are exempt, as are payments from secret intelligence service, the security service, the government communications HQ and the armed forces given their unique requirements. Payments from fire and rescue authorities are also proposed to be exempt as they do not increase the actuarial value of the pension payable.

As a general rule, accrued pension entitlements are exempt as they do not incur an additional cost to the public purse however payments which do involve an additional employer cost (such as ‘strain costs’ payable on redundancy) would be included. Other exemptions include death-in-service benefits, incapacity benefits, a payment in lieu of contractual leave not taken, payment in lieu of notice or any payment made by court order or a tribunal.

The proposals provide a standard legal underpin, however they do not prevent employers from applying alternatives.

How would the introduction of the proposals impact on public sector employees and employers?

It is the employer’s responsibility to ensure that a payment is not made in excess of the cap. This will place an additional administrative burden on employers. Clearly for employers it would reduce the overall cost of severance packages. It is also likely to make planning for these costs more certain. For employers there will be a requirement to consolidate all payments to ensure that the cap isn’t breached. This will mean ensuring that ‘strain costs’ are identified early in the process to allow these to be incorporated.

Employee payments will at the higher end be lower which may influence decisions about exiting as it may make them less attractive or indeed unaffordable. This may also make the option of restructuring senior roles more difficult for employers possibly trapping senior employees in roles they are not wholly committed to. That said it may promote greater transferability between roles.

There is some guidance on the order of payments in Section 6 of the draft Restriction of Public Sector Exit Payments Regulations 2019. The legislation also proposes some flexibility in the implementation of the cap. Where there is flexibility—such as the priority between cash payments and pension strain costs—these will have to be clearly communicated to the employee to allow the required decisions to be taken. It’s likely that engagement will be required at a much earlier stage in the process to facilitate this.

One major concern with the proposals is that they would create a two-tier system in the public sector between employees who are in funded pension schemes and those who are in unfunded schemes. In funded schemes the ‘strain cost’ for early retirement would be deducted from the capped figure or benefits reduced. For those in unfunded schemes no equivalent mechanism exists to recoup redundancy/early retirement costs even though the same equivalent cost would be experienced by the Exchequer. This could mean that employees (and in some cases employers) in unfunded schemes benefit from a much better deal than their counterparts in funded schemes.

Employers will also have to be very careful in the implementation period not to take decisions which could result in costs materially higher than the level of the cap when it is imposed.

What is the timetable for implementation of the changes? What are HM Treasury’s next steps?

The consultation will last for 12 weeks to 3 July 2019. Responses to the consultation may be published. Post this, the draft Regulations may be implemented as proposed or revised.

Interviewed by Varsha Patel.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

Link to original article –
https://www.lexisnexis.com/uk/lexispsl/localgovernment/document/412012/8V8N-WKK2-8T41-D1GT-00000-00/Capping-exit-payments-in-the-public-sector%E2%80%94a-review-of-the-draft-regulations-for-consultation/31544

David Davison

We have analysed the 2017 Fund actuarial valuations and carried out some analysis of the employer membership in Scottish LGPS to see how this is distributed. From this we can identify what issues Funds and employers might face.

There are 11 Scottish Funds with the share of overall employers shown below.

The numbers are dominated by Strathclyde Pension Fund, Lothian Pension Fund and North East Pension Fund who account for two thirds of the employers with the other eight Funds making up only one third. Borders, Dumfries & Galloway and Shetland all account for only around 2% each.

We identified a total of 544 employers and have classified them in to the six broad Groups as shown below.

Public bodies, such as Councils, Police and Fire Service, account for around 11% of the total number of employers though these bodies will account for the vast majority of the Funds liabilities.

Leisure organisations will tend to have been formed from outsourced agreements from local authorities and will be run as autonomous organisations.  Often this switch however has left these organisations without any protection should they wish to revise their membership of the schemes and has left them saddled them with huge inherited legacy liabilities from the Councils which they do not have the underlying asset base to support. These organisations therefore are effectively trapped in schemes and leaving them without the level of autonomy they believed they had.

Similarly schools and colleges will have evolved out of public entities or be private schools with public sector links. Participation in LGPS tends to be for non teaching staff. Again these organisations will have little if any financial protection and will find any changes to their LGPS membership complex and expensive to achieve. These organisations are also likely to be facing additional financial pressures from rising costs in the teachers pension scheme as well as some having to deal with membership of the University Superannuation Scheme (‘USS’) all putting a strain on already hard pressed budgets.

Private companies will tend to participate as a result of providing out-sourced public sector services and the requirement to maintain equivalent benefits for contracted staff under Fair Deal. Some of these organisations will be protected by Council guarantees or ‘pass through’ arrangements but many will not, often leaving their shareholders oblivious to the underlying risks they are running.

That leaves the vast majority of employers (around 360) as either charities, who account for nearly 60% of the employer membership, or social housing organisations who account for about 7%, so nearly two thirds in total. In liability terms they will probably account for considerably less than 10% of overall fund liabilities. Some of these bodies may have exited the Fund since the 2017 valuation was carried out.

Some of these charities may also be undertaking public sector contracts and therefore have some form of guarantee or transferee admission body status but the vast majority will not.

The key SPPA findings were that:-

  • There were 530 employers with at least one active member. Of these 422 were admission bodies (covering both transferee and community admission bodies) of which 223 had no guarantor and so were at some point likely to be liable for a cessation payment. Of these 102 had 5 or fewer members where a cessation payment could be deemed to be payable in the short term.
  • Worryingly of the 102, 60 remain open to new members and are therefore building further liabilities which suggests either a lack of understanding of their position or a position forced upon them as a result of the Scottish LGPS Regulations.
  • Of the 121 with no guarantor and more than 5 members 94 remained open to new members.
  • There are 41 employers at greatest risk as they have fewer than 5 members and are closed to new members which mean that a cessation is imminent.
  • The cessation deficit associated with the ‘at risk’ group of 41 was estimated to be in the region of £12m-£15m (i.e. and average of around £300,000 per body). Two LGPS Funds looked at the financial position in their schemes which showed that for organisations with 5 or less members the funding position moved from around £1.93m in surplus on an on-going basis to around £9.4m deficit on a cessation basis. This very much resonates with my experience.
  • The total liabilities for the 223 admitted bodies with no guarantor were in excess of £350m and the cessation deficit could be in excess of £150m.
  • The cessation position could be materially worse now given falls in gilts yields since 2014 which highlights the issue with the cessation basis being adopted.

Based on these numbers I would expect that the position in England and Wales would be 8-10 times greater, so these issues could affect in the region of 2000 other charities and account for deficits approaching £80-£100m. A material proportion of this will relate to liabilities transitioned surreptitiously from local authority to unsuspecting charities.

Changes to Scottish LGPS Regulations in 2018 looked to provide additional flexibility to look to manage these issues however they haven’t been widely adopted by the Funds.

More research needs to be carried out to understand the pension position fully in relation to the covenant position of the organisations concerned and to look to develop solutions, and potentially further update Regulation, to allow this issue to be effectively managed.

David Davison

On the 8th May the Ministry of Housing, Communities & Local Government issued a policy consultation entitled “Local Government Pension Scheme: Changes to the Local Valuation Cycle and the Management of Employer Risk.” This comes following the publication in September of the “Tier 3 employers in the LGPS” research findings. The consultation closes on the 31 July 2019.

The first proposal is to change the actuarial valuation cycle in LGPS, from every 3 years to every 4 years, to coincide with the 4 yearly valuations of LGPS as a whole. I do have some concerns that for admitted bodies in the Schemes this will mean that they receive less information and ultimately the information provided will have to have a much longer shelf life. I suspect this is driven more by the inefficiencies in administration and a drive for cost savings than it is for any drive for valuation consistency.

I think to make this change work Schemes should be supplying annual updates on the funding and cessation position (perhaps linked to the provision of FRS102 information) which would allow organisations to be better informed about their position and options.

Of greater importance to charity participants are a series of proposals primarily aimed at looking to help employers better manage exits from the Schemes.

The document recognises that “for some employers a significant issue is the cost of exiting the scheme which can be prohibitive.” The consultation seeks views on two alternative approaches:-

  • To introduce a ‘deferred employer’ status that would allow funds to defer the triggering of an exit payment for certain employers who have a sufficiently strong covenant. Whilst this arrangement remains in place, deferred employers would continue to pay contributions to the fund on an on-going basis. This is looking to broadly replicate the ‘deferred debt arrangements’ (‘DDA’) brought in by DWP to deal with Section 75 debts in multi-employer schemes and the suspension arrangements implemented in Scottish LGPS in 2018;
  • To allow an exit payment calculated on a full buyout basis to be recovered flexibly – i.e. over a period of time providing this is deemed to be in the interests of the Fund and other employers. This is designed to put in to regulation a framework to provide flexibilities on a more formal and consistent basis to those being utilised ‘informally’ by some funds via alternative arrangements.

Whilst I welcome the sentiment and the objective to formalise any additional flexibilities offered the consultation proposals stop well short of fully recognising the issues and finding a full range of workable solutions to deal with them.

  • The DDA legislation and the changes to the cessation position in LGPS in Scotland brought in in 2018 have both been damp squibs with schemes choosing to ignore the changes and to continue to plough their own furrow. The fundamental issue seems to be that schemes are using any request to use the new regulations as an opportunity to re-negotiate security arrangements with the participant. This is hugely short-sighted as it ignores the lack of security on the benefits already built up and that it cannot be in the interests of the organisation, or indeed the other organisations participating, to build further liabilities. This stance in most cases therefore forces organisations to stay in the Scheme which is exactly the result the changes were looking to avoid! The proposals in this Consultation just seem re-inforce this issue referring to employers who are “sufficiently strong” being the only ones who avail of the proposed funding flexibilities – exactly the employers who can probably afford to exit or even potentially continue in the Scheme;
  • The proposals need to consider what options are available for less “sufficiently strong” employers. It cannot be sensible to force employers in to insolvency as a result of their pension liabilities but instead find a better way to manage these. In the interests of the impacted employer and others in the Scheme it would seem more productive to identify methods where the fund can obtain the maximum possible amount, even if this amount is less than the full cessation position. Some LGPS have already pioneered work in this area and the proposed changes are well behind the curve in terms of effective solutions;
  • The gilts based cessation methodology is flawed. Over the past 10 years gilt yields have fallen from over 5% to well below 2% which means that exiting employers are subjected to something of a lottery in exit terms. Currently high cessation values based on low gilt yields make exits less affordable keeping employers tied to the scheme – again counter-productive. Funds feel their hands are tied in investment terms forcing them to either invest very long term liabilities in poorly performing gilt assets or some funds remaining invested in the same way effectively just taking the cross subsidy benefit from their charity participant to help fund public sector liabilities. A more equitable system could be to look at the rolling average gilt value over a period or based upon the expected local authority borrowing costs;
  • There continues to be no recognition of the issue of legacy liabilities within LGPS. It is wholly inequitable for public sector bodies to expect admitted bodies in their Funds, often charities, to cross subsidise the public entity for benefits built up by staff while working for them. These liabilities should continue to be held by the public body in the same way as they were pre a transfer and new employers should be fully protected from these. Benefits reverting back to a prior employer for service linked to that employer just means that they continue to be dealt with on an on-going’ valuation basis (as they were initially) and not converted to a cessation basis. This is a solution which is also likely to make exits more affordable.
  • The suggestion that the steps proposed are linked to protecting the remaining employers in the Funds and this is repeated here. This whole issue of residual risk has been over-egged. The risk is already there and rising – what is needed is an affordable way to minimise the associated risk with the accrued liability and limit any future accrual. How can it be sensible to have 2 employers where one has one active member and one has no active members and yet they are both treated in vastly different ways.

The proposals in this consultation paper are a hugely disappointing response to the issues and in my view provide a wholly inadequate range of options to address the major issues faced. You’d have thought having sat on its hands over this issue for such a long time that the response would have been more comprehensive and considered.

I will be preparing a more detailed response to the consultation which I will share in a future Bulletin. I would also suggest that if you are a charity affected by these issues that you also respond to the Consultation.

David Davison

This is a challenging time for LGPS. Funding pressures, consolidation, Tier 3 issues and investment pooling are all high on the agenda. When it comes to taking effective decisions and shaping the future direction of LGPS there needs to be confidence that these issues are being addressed independently and without conflicts of interest. However is this really the case?

LGPS are run as parts of a local authority and the key staff are Council employees. Usually the individual ultimately responsible for the delivery of scheme services is a senior executive or finance officer in the Council. Can these individuals discharge their duties to the scheme independently of their responsibilities to the Council and can Pension Managers do likewise when their ultimate line manager holds this position? How independent can these key people ultimately be when they are beholding to councillors in the local authority for agreeing budgeting and staffing levels? Would decisions in any way be swayed by these day to day concerns rather than the complete impartiality required on any decision they are taking?

Conflicts of interest are obvious so the key question must therefore be how well are they managed? The 7 principles in public life (‘the Nolan Principles’) require selflessness, integrity, objectivity, accountability, openness, honesty and leadership.

The Pension Regulator’s guidance on conflicts of interest in public service schemes (such as LGPS) focuses on potential conflicts of interest as a member of the pension board. Any such member must not have “a financial or other interest which is likely to prejudice a person’s exercise of functions.” It goes on to confirm that “actual conflicts cannot be managed, only potential conflicts.” Wider examples are given where senior staff may be conflicted.

The test is that the scheme manager must be satisfied. 

Conflicts must be managed in 3 stages, namely identifying, monitoring and managing.

In practice however does this really fully address governance concerns. How seriously are Executives taking these conflicts, fully meeting the relevant Nolan principles and codes of conduct?

How might this impact on non Council participants in the Fund?

Information cannot be available to a Pension Fund Head as part of a negotiation and not to a Council FD if both are the same person! How can a Council FD claim to be detached from the policy in a Fund’s Funding Strategy Statement when they are the individual who has signed and issued it!  How can a Fund be expected to robustly pursue a Council guarantee for an employer when it is the Council FD who is required to agree it and provide sign off? And yet from the schemes perspective it should be doing so to protect other employers.

This does not create an environment for challenge, growth and change but one which favours the status quo. There is little or no motivation to change historic practices and to innovate and this reflects the ponderous pace of change in schemes and their inability to reflect their employer and employee needs. This is also reflected in the myriad of local practices which have evolved in schemes over many years which do not bear close scrutiny. Schemes a short geographical distance apart can adopt wildly differing approaches to managing exactly the same issue.

I am not for a moment suggesting that decisions are deliberately being subject to bias but the potential is there for implicit bias, which is exactly what good governance and the necessary checks and balances are there to resolve.

The model operated by Local Pension Partnership covering a number of regions also provides offers some room for optimism as it has implemented the required additional independent governance tier and their approach has resulted in welcome levels of innovation and flexibility.

One of the options considered as part of the review of local government pension schemes in Scotland could provide a blueprint for change. The formation of a single Scottish LGPS operated independently from local authorities, which could be self-financing and run autonomously by a wholly independent board would provide complete independence and additional comfort that the required governance structure is in place and operating efficiently.

But how close are we to getting something like this more consistently? A long way off I suspect. There aren’t really similar discussions to those in Scotland on-going in England, Wales and Northern Ireland, and those in Scotland are some way from implementation. Why would Funds themselves be the turkeys voting for Christmas and push this change agenda earlier? Any impetus really needs to come from central government and have a reasonable timescale imposed if it is not to be subject to local / regional self-interest. Central government need to grasp the nettle here if financial savings are to be made and a more independent and consistent form of governance is to be achieved.

David Davison

I have highlighted the issue of legacy debt in LGPS in numerous previous bulletins, in numerous publications and at events. The whole issue is often met with some degree of disbelief. Rightly organisations question why should they be made responsible for pension liabilities which belong to someone else and why are public bodies taking the opportunity to avoid costs which are rightfully theirs.

Pension Funds and Councils are just choosing to avoid the issue and Government are just choosing to put it in the too difficult pile and ignore.

At the start of the year I issued an open letter to the Work & Pensions Committee to see if they would be prepared to raise the problem as the number of organisations I’m witnessing who are experiencing difficulties as a result of this issue has increased very significantly over the past number of months, I suspect as membership numbers in LGPS within charities continue to fall having closed schemes to new entrants.

I strongly believe that there is a potential tidal wave facing the charitable sector linked to this issue and the wider cessation debt regulation. Statistics compiled by Scottish Government back in 2014 for their schemes identified that of 422 admission bodies 223 had no guarantor. Of these 102 had fewer than 5 members and so were close to the point where they would have to manage a cessation.

Two LGPS Funds looked at the financial position in their schemes which showed that for organisations with 5 or less members the funding position moved from around £1.93m in surplus on an on-going basis to around £9.4m deficit on a cessation basis. This very much resonates with my experience and I suspect the gap has widened since 2014.

Based on these numbers I would expect that the position in England and Wales would be 8-10 times greater, so these issues could affect in the region of 2000 other charities and account for deficits approaching £80-£100m a material proportion of which relates to liabilities transitioned surreptitiously from local authority to unsuspecting charities.

A small number of LGPS have recognised the issue and made changes to deal with it but they are very much in the minority as the majority continue to stubbornly cling to the inequitable status quo.

Recent changes to the Scottish LGPS Regulations wholly ignored the issue and it was also studiously ignored by the Tier 3 review in England & Wales carried out towards the end of 2018.

The response from the Work & Pensions Committee has been positive and they have referred the matter to the Pensions Minister. I thank them for that. I will publish the letter and any response when it is received.

In the interim I would ask LGPS Funds to review this issue and to decide to ‘do the right thing’.

David Davison

What pointers does the SHPS Valuation provide for employers in SHAPS

In early October the results of the Social Housing Pension Scheme (‘SHPS’) actuarial valuation at 30 September 2017 were published and are available here. I’ve provided a full commentary on the impact and options for employers in the scheme here.

Given that the SHPS results are 12 months ahead of those in the Scottish Housing Associations Pension Scheme (‘SHAPS’) which are due at 30 September 2018 I wanted to consider if the results would provide a good barometer for what Scottish RSL’s might expect when they get their results next year.

The SHAPS scheme is much smaller than SHPS with a smaller number of employers but the two schemes do share many similarities in terms of employer covenant, trusteeship and investment methodology so the results should certainly identify trends.

If we start with the actuarial valuation assumptions for SHPS and SHAPS these are shown in the table below.

Assumption SHPS Valuation

30 September 2014

SHAPS Valuation

30 September 2015

SHPS Valuation

30 September 2017

(Equivalent basis)

Price Inflation RPI – 3.1%

CPI – 2.2%

RPI – 3.1%

CPI – 2.2%

RPI Curve (3.4%)

RPI Curve less 0.9% (2.5%)

Discount rate

Pre-retirement

– Post-retirement

 

5.9%

3.3%

 

5.7%

3.1%

 

Gilt Curve plus 2.4% (4.2%)

Gilt Curve plus 0.45% (2.25%)

Pensionable earnings growth (annual) 4.2% 3.7% CPI+1% (3.5%)

You can immediately see that the SHAPS assumptions at 30 September 2015 are very similar to those adopted by SHPS in 2014 with only a slight reduction in the discount rate pre and post retirement from 5.9% and 3.3% to 5.7% and 3.1% respectively and a salary increase assumption of 3.7% versus 4.2% to reflect different market conditions. The inflation assumptions were identical.

The changes to the SHPS valuation assumptions reflects changes in market conditions and a strengthening of the assumptions being used and these changes accounted for almost all of the identified deficit.

In a commentary I wrote on the 2015 SHAPS Valuation results I expressed some surprise/shock at the funding assumptions used. At a time when all the market indices were indicating a reduction in gilt yields the trustees decided to increase the discount rate used pre retirement from 5.3% p.a. in 2012 to 5.7% p.a. in 2015. This was apparently to reflect a strengthening in employer covenant. This decision had the effect of reducing the scheme liabilities and therefore the on-going deficit by around £100m. This would have been positive news for the employers but was this improvement real or some funding smoke and mirrors. Comparing the on-going deficit in 2012 of £304m to a cessation deficit of £732m compared to an on-going deficit of £198m in 2015 and a cessation deficit of £937m highlighted the change in funding prudence. My expressed concern was that this approach may result in additional future prudence and therefore increased future deficit contributions being required.

Given the similarities in the covenant strength and investment / funding approach across both schemes it does not seem unreasonable to assume that a similar methodology will be applied to the SHAPS valuation, though this would be something of a backtrack from the 2015 position.

If the trustees are adopting the same commitment “to both security and affordability” how can they not apply a consistent basis which would result in a materially higher deficit amount? If they do employers may reasonably question the approach taken in 2015.

We do not have the exact details of the SHPS change but from the information provided it looks like the discount rate has been reduced by 0.6% p.a. which alone could increase liabilities by around 5%. There may also be a further increase in liabilities to move the SHAPS assumptions in line with SHPS which could further increase the scheme deficit. Given that, as an example, the pre-retirement discount rate assumption in the SHPS valuation reduced from 5.9% to 4.2% this could be very material.

Like SHPS, SHAPS has deficit contributions based on proportion of salary and proportion of liabilities and a move to simplify contributions similar to SHPS could be attractive to the scheme. Whilst in my view the setting of contributions based purely on share of liabilities is a fairer distribution of cost it will mean that that there are some winners and losers in terms of contributions with potentially small numbers of employers seeing very material increases as a result of any change.

What would also be concerning for employers would be how the conversion from the existing funding basis with contributions reducing over the next few years to a level basis costed as a share of liabilities, similar to SHPS, would result in very material increases in future contributions and a linked increase in FRS102 accounting deficits just at the point where the scheme is promoting a move to a full FRS102 disclosure basis.

In terms of future service contributions the position may be less dramatic in SHAPS than in SHPS. Contributions increased materially at the 2015 SHAPS valuation to 27.1% p.a. for Final Salary 60th benefits and 25.8% p.a. for CARE 60th benefits. Both these figures include 0.7% p.a. death-in-service costs and reduced by 2% where employers offer DB to new entrants. These contributions are in my view more reflective of the costs of buying benefits and compare reasonably with the new SHPS rates. I would however still expect some increase to future service rates in SHAPS to reflect current market conditions, maturing scheme membership and costs being shared over a smaller membership population.

Given the more the material re-distribution of members in SHAPS away from DB I suspect we could also see an increase in on-going scheme expenses similar to that in SHPS.

Based on the above therefore I think it’s wholly reasonable to assume that SHAPS employers can expect similar bad news when they receive their results in 2019 as SHPS employers are currently dealing with. There could be something of a ‘triple whammy’ with negative movements in market conditions, a strengthening of valuation assumptions and increases in operational costs.

With DB membership numbers continuing to fall (now only around 1,000 compared to the 3,500 participating in 2012), only around 1/3rd of employers open to new DB members and huge increases in DC membership the scheme shape is changing. Any further increases in SHAPS contributions is likely to further hasten exits from DB and there must come a point where there will need to be a serious discussion about the future of the DB section of the scheme. Employers may also be once again questioning the approach adopted in 2015.

David Davison

The results of the Social Housing Pension Scheme (‘SHPS’) actuarial valuation at 30 September 2017 have been published and are available here. With new contributions due to be implemented from April 2019 RSL’s will need to consider their options and take any required decisions in the very short term.

The headlines from the SHPS Valuation are:-

  • The funding level has improved to 75% (from 70% as at 30 September 2014) but the monetary deficit has increased from £1.323Bn to £1.522Bn. While assets increased from £3.123Bn to £4.553Bn over the period (i.e. 46%) liabilities increased from £4.446Bn to £6.075Bn (i.e. 37%). A huge driver in the increase in liabilities, and therefore monetary deficit, was some material changes in the key valuation assumptions as shown in the table below:-
Assumption 30 September 2014
Valuation
% p.a.
30 September 2017
Valuation
% p.a.
Price Inflation RPI – 3.1%

CPI – 2.2%

RPI Curve – equivalent to 3.4%

RPI Curve less 0.9% – equivalent to 2.5%

Discount rate

– Pre-retirement

– Post-retirement

 

5.9%

3.3%

 

Gilt Curve plus 2.4% – equivalent to 4.2%

Gilt Curve plus 0.45% – equivalent to 2.25%

Pensionable earnings growth (annual) 4.2% CPI+1% – equivalent to 3.5%

 

  • The changes have been as a result of two main factors:
    • Changes in market conditions over the period (a reduction in gilt yields and an increase in the markets expectation of inflation);
    • A change in the assumptions used to value the liabilities (less allowance is being made for expected returns in the pre-retirement discount rate and inflation looks to have also increase by more than pure market movements, the assumptions have also been updated for recent improvements in mortality)
  • The effect of these changes has been to increased the liabilities by £1.395Bn. So effectively the vast majority of the scheme deficit is accounted for by these two factors.
  • As a result of the increased monetary deficit, increased deficit contributions will be required from 1 April 2019. Total contributions will increase by £14m from £147m to £161m in April 2019 with contributions then rising by 2% per annum to 30 September 2026. This means that by April 2026 contributions will be around £180m per annum. What may have been missed by many however is that the existing contributions were to begin to reduce from next year tailing off to 2025 however this will not now happen so contributions in the last year could be as much as £100m more than under the previous funding plan. The option was there to look to extend the funding plan to retain existing contributions or smooth increases but this hasn’t been pursued.
  • Historic deficit contributions had been set based on a combination of pensionable salaries and share of scheme liabilities however all future deficit contributions from April 2019 will be paid based on share of liabilities. Whilst undoubtedly fairer, particularly where there is a mix of open and closed scheme accrual, as in this scheme, but the change could result in very large fluctuations in contributions for a number of employers.
  • Clearly the new higher contributions will have a negative impact on the FRS102 accounting disclosures, which are likely to be changing from 2019 from a net present value calculation to a full disclosure, so there could be a material balance sheet implications for scheme employers.
  • Future service contributions (i.e. the cost to buy more benefits) have increased by around 32% across the Board. Final salary 60th contribution s are up from 20.6% p.a. to 27.2% p.a. and CARE 60th contributions are up from 16.7% p.a. to 22.1% p.a. These are really material increases and it wouldn’t be unreasonable to wonder if historic contributions had been under-estimated, particularly when you see the cost of similar accrual in other Final Salary / CARE schemes.
  • Scheme expenses have increased from £1,800 per employer plus £70 per member pa to £1,900 per employer and £75 per member so a 5.6% and 7.1% increase respectively. I suspect this is not only inflationary but also a reflection of falling membership in the DB section and the need for TPT to recoup costs over a smaller membership base.

The direction of travel is seeing more and more RSL’s move to DC provision and away from DB and it’s easy to imagine that these changes will further encourage that move. It will be interesting to see the full valuation report when available to see how the membership profile has changed over the 3 year period.

So what can employers do?

  • In terms of deficit contributions not a great deal!! There is an appeals process where if contributions are deemed unaffordable this can be raised with the Scheme Trustees. However time to pursue this is short as appeals need to be in by 30 November 2018. If not pursued, or unsuccessful, then employers just have to find the money for the deficit contributions.
  • For future service contributions employers have a few more options:-They can just accept the increases as proposed
    • They can pass all or a proportion of the increases on to members. With member contributions in the final salary 60th option already at 10.3% then potentially increasing this to something up to either 13.6% or 16.9% must be unwelcome and really raises the question if this remains a viable option. In addition to the above if the membership is closed to new entrants an additional 1.1% of salary applies.
    • Employers could move to a lower DB accrual basis. The total cost of the final salary 80th option is now 20.5% in comparison to the 20.6% which previously applied to the final salary 60th option. A move to CARE 80th would have total contributions of 16.7% with the reduction potentially available to help fund the increased deficit contributions. Clearly remaining in the DB option, even at a lower accrual rate, does continue to build DB liabilities, though at a slower rate.
    • Employers could move to the DC Option within the scheme. Employer and employee contributions could be set at a fixed monetary amount at, above or below the level currently being paid. DB accrual would cease for these staff thereby limiting liabilities. This move could be for new staff only or for all staff.
    • Historically it has almost entirely been the case that new DC contributions would be arranged via the SHPS scheme primarily to avoid a cessation debt trigger on the DB liabilities. The relevant Section 75 legislation was amended in April 2018 which would allow DB accrual to be ceased without an automatic S75 debt trigger however at this stage it is unclear how TPT might provide access to this option and so this would have to be explored in more detail.
    • Employers could also consider setting up their own scheme or if they have a scheme already in place look at moving their assets and liabilities to that. Such an option is likely to be complex and potentially costly though, particularly for larger SHPS participants, is well worth considering as it does potentially increase the options available.
  • Clearly it’s likely any of the above changes would require communication with staff as a minimum and potentially consultation.
  • Employers need to be aware and manage any revised balance sheet impact.

Revised deficit contributions are applicable from April 2019 and future service contributions from July so employers will need to understand how the changes specifically impact on them and then consider what strategy they want to employ. Once a strategy is set they’ll need to consult with staff if there are any changes to contributions and/or benefits. This process will all have to be addressed in a relatively short period so engagement with the scheme and advisers in the short term will be necessary.

David Davison

In June 2018 the Scottish Local Government Pension Scheme Advisory Board launched a consultation on the future structure of the Scottish LGPS. The Board’s consultation sets out four options for the future structure of pension funds in Scotland. The review provides excellent background for all LGPS in the UK as the range of scheme sizes provides a microcosm in which to review the options presented more widely.

There are 11 Scottish Funds with total assets of around £42Bn and liabilities of about £55Bn. Scheme sizes range from the largest, Strathclyde Pension Fund, with around £20Bn of assets and 210,000 members to the smallest, Orkney Islands, with only £335m of assets and just over 3,600 members. The four options being explored along with the key considerations are shown below.

  1. Retain the existing structure

Retaining the status quo is likely to mean that inefficiencies will remain as most funds will not achieve the benefits of scale such as improved bargaining power, access to greater resources and reduced duplication of efforts in administration, governance, spending on advisers and fund management. Larger funds are also likely to be able to better access infrastructure investments. Maintain the existing approach is therefore likely to mean that costs per member are likely to be higher than necessary.

A potential negative would be the loss of local input and oversight and the regional diversification of resource such as staff as it may be difficult to access specialist staff in a single location. However the existing structure does potentially also create a key person risk as there is less available resource to cover key roles as well as budgetary and staff risk due to other competing local priorities..

Clearly any savings made or improvements achieved would need to outweigh any initial transition costs but all research to date would tend to support a move away from the status quo.

  1. Promote co-operation in investing and administration

There have already been some examples of collaboration particularly in the investment area and around procurement. This approach would allow the current governance structure to continue, allowing for continued local oversight, although requiring some sharing of control. There would also have to be some adaptation of governance.

Approaches to date seem to have been relatively informal which results in a degree of uncertainty over their future persistence so a more formal structure may be of value to assist with planning as well as the distribution of costs and returns. To date this sort of co-operation has been pretty limited despite its obvious benefits which would suggest that without strong vision and direction it will remain  something of an outlier. I can’t help feeling that greater structure and compulsion is needed to really drive change.

  1. Pool investments

This option would see all assets pooled in one or more asset pools managed centrally on behalf of a number of Funds. Schemes would retain their governance, administration and back office functions and continue to appoint and manage their advisers. This is very similar to the approach currently being adopted in England and Wales.

A single pool would double the asset size to about £42Bn over the largest Fund which has assets of just under £20Bn. At this size it would be of a similar size to 3 of the English pools and larger than the 3 others.

Fund assets and liabilities would still be allocated in the same way to ensure specific employer responsibility for liabilities.

A move of this type would be likely to result in lower cost investing though subject to some initial cost increases to manage a transition. It would also be likely to mean that the asset pool was of a significant enough size that more of the investment and administrative tasks could be undertaken in house.

From a governance perspective each Pension Committee would retain responsibility for asset allocation and managing the legislative structure however day to day investment management would be delegated to the pool. Each Fund would also maintain its Pension Board.

As has been shown in England and Wales this approach is very achievable and its hard to deny the value so would seem to be a minimum required step.

  1. Merge funds in to one or more funds

This option would see the creation of a Scottish ‘superfund’ which would manage all LGPS benefits in Scotland. Such a move would benefit from the asset pooling advantage s in 3 above but also allow for merging of the administrative and governance functions.

Such a move, whilst ultimately desirable from a cost and consistency perspective is not without its challenges. Each of the Schemes is funded at a different level and there would have to be a recognition of this and a mechanism to resolve it to ensure there was not a cross subsidy between different regions and even potentially employers. There would also have to be clarity in terms of governance, priorities and costs. There are also political drivers as well as a need to ensure that the right level of resource is available to the new consolidated scheme.

None of these challenges however are insurmountable and really just need commitment to achieve the objective and a clear plan to do so over a reasonable timescale.

The Funds all provide consistent benefits based upon a single regulatory framework. Consolidation would remove regional variations and inconsistency. Legacy arrangements would have to be clearly documented and honoured but future practice could be implemented on a wholly fair and consistent basis. Undoubtedly given the size distribution of schemes in Scotland a number of them would be likely to benefit from cost savings and improved governance very quickly. Market buying power in terms of services would be improved and greater investment possible in staff, technology and scheme communications.

Conclusion

Research carried out by Deloitte in 2011 suggested that costs per member in Scotland compared favourably with funds in England and Wales and that a single operating model and common administration system may have a greater benefit than formal administration mergers though research by APG concluded that administration costs decline with larger funds and certainly this seems to be the model being employed across UK defined contribution businesses.

It also needs to be considered that the number of employers participating in LGPS in Scotland is falling so less resources are needed and greater consistency of practice can be achieved. In addition with greater employer consolidation there will undoubtedly be increased demand for larger employers to have all benefits consolidated in a single fund rather than across multiple schemes.

In addition the benefits of having a single scheme which is not accountable to a local authority and can operate in an autonomous way based on its agreed priorities should provide greater flexibility in staff terms and conditions and therefore provide the opportunity to attract a much higher calibre of staff.

There are clear benefits which can be achieved through investment pooling and even further benefits through a consolidated single scheme for Scotland – it just needs vision and commitment to achieve them.

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