Posts by David

David Davison

David Davison

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

A concerted campaign to provide charities who participate in the local government pension scheme with greater flexibility in managing their risks and associated costs at last seems to have finally resulted in a positive outcome.

The recent publication by the Ministry of Housing, Communities & Local Government of a “Review of employer contributions and flexibility on exit payments” at last seems to offer some hope for charities seemingly trapped in LGPS.

The problem has always been that when charities run out of contributing members or look to exit LGPS a cessation (exit) debt will be calculated. This is carried out on a ‘nil risk basis’ which means that the liabilities, and therefore any deficit, is much higher than on an ‘on-going’ or FRS102 accounting basis. Many third sector organisations therefore find themselves with the Hobson’s choice of continuing to build additional unaffordable liabilities or an unaffordable exit payment. A number of organisations have recently found themselves driven in to insolvency by the weight of their pension liabilities.

In order to help with this the Government is now planning to amend the LGPS Regulations in two key ways:-

  1. Greater flexibility on exit payments – this would allow exiting employers to enter into agreements with LGPS to fund any cessation debt due over a period of time. This would allow uncertain pension liabilities to be turned in to a stream of fixed payments to be set over an affordable agreed term.
  2. The introduction of a Deferred Debt option – this would allow schemes to defer any exit payment and to permit the employer to carry on in the scheme on an on-going basis. The employer would retain all the same obligations to the scheme with future payments uncertain. However, immediate costs are likely to be lower and therefore much more affordable, allowing employers to better manage the risk of future benefits building up. Valuations would be carried out regularly and contributions adjusted if necessary.

These changes will be hugely welcome for many charities.

Fortunately, a number of Funds had already seen the common sense in making pragmatic arrangements to deal with exits however, to date they have been in the minority with the vast majority choosing to await a formal change in Regulation, which hopefully now should not be far away.

It is proposed that the new Regulations will provide Funds with a lot of discretion over how they are operated based upon their local experience. To ensure consistency and transparency funds need to consult with their professional advisers and to publish their approach in their Funding Strategy Statement.   

Given the imminence of the changes, the level of control this is likely to provide Funds and the value in dealing with further accrual as quickly as possible I would like to think that they should be prepared to engage with charities to look at their future options straight away, especially given that any solution is likely to take a number of months to agree. Charities should therefore engage with their professional advisers and the Funds to consider what approach would best suit them.

Article first published in Charity Finance Group Finance Focus – September 2020.

David Davison

Until quite recently I was blissfully unaware that common sense was regional, at least where LGPS is concerned.

Through advising third sector bodies in LGPS across the UK I get the chance to see variations in practice, good and bad. It is quite startling how widespread these variations are given everyone is working from broadly the same set of regulations but, unfortunately in some key areas good practice is hard to find.

A good example is in the divergence of practice in relation to how funds manage exit debts. Firstly, at a regional level, Regulation is in place in Scotland which provides funds with the option to suspend a cessation debt, which is a freedom not currently in statute in England & Wales. As per my previous Bulletin it is, however being consulted upon, though very, very, very slowly.

Fortunately, a number of funds can see the common sense in making pragmatic arrangements to deal with exits, recognising that it cannot be in anyone’s interests for admitted bodies to be accruing liabilities which ultimately they will be unable to afford. This is not only bad for scheme funding but I would also question if funds are properly discharging their responsibilities in relation to other employers, by exposing them to this level of unwarranted risk.

Some funds are issuing options papers which outline all of the options including a ‘suspension’ along with supporting details, which allows employers to make an informed choice. This seems like a sensible approach for all concerned.

Whilst ceasing further accrual can be seen by the admitted bodies as a desirable outcome in responsibly managing risk, something equally well recognised across all other DB provision in the UK, unfortunately this simple truth does not seem quite as obvious to some funds. They instead are taking a King Canute approach and just trying to avoid the rising tides around them and expressing the view that they couldn’t possibly do anything pragmatic without the specific Regulation being in place to allow them to act in a sensible way. They are much happier to see employers continue to build liabilities beyond their means, as recognised by the employers, rather than take steps to deal with the issue.

What I find interesting is how quickly action was taken to address a flaw in regulation around the treatment of surpluses, as this had a negative impact on funds’ finances, but we seem to be in an interminable loop of consultation on exits without any sign of implementation.

We’ve already witnessed numerous insolvencies directly as a result of LGPS pension participation (and indeed in other schemes such as Plumbing Pensions with similar legislation), and against a background of Covid-19 the outlook doesn’t get any more promising.

To those enlightened souls out there taking a pragmatic approach to this issue, I salute you. To everyone else including MHCLG, please get your finger out!

David Davison

Finally at the end of February 2020 the results were published on the consultation on LGPS Reform for England & Wales, which ended 31 July 2019, and it’s a bit of a mixed bag.

Valuation Cycle

It is proposed to move the local fund valuation cycle from 3 years to 4 years to link with the Government scheme valuation. With this change it is proposed to provide funds with the power to undertake interim valuation and a widening of the power to amend employers’ contribution rates. What unfortunately has not been proposed is a strengthening of the communication requirements on Funds to ensure that admitted bodies are aware of their funding position more regularly over this lengthened period.

Dealing with ‘Tier 3’ employers

In terms of seeking to help funds provide additional options for employers looking to exit the response states “Current regulations require that when the last active member of an employer leaves the scheme, the employer must pay a lump sum exit payment calculated on a full buy-out basis.” This is fundamentally incorrect and is a misunderstanding also commonly held by LGPS Funds. Regulation 64 specifies that Funds must obtain “an actuarial valuation at the exit date”. It neither specifies that this must be done on a buy-out basis, or even that when carried out that it has to be enforced. It is the Funds, and their actuarial advisers, who chose to enforce this exit on a buy-out type basis but it is not actually stipulated.

The response makes the proposal “to introduce ‘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.” Whilst at a high level the proposal is welcome it is deficient in a number of key areas:-

  • As part of our response to the consultation we highlighted specific experience of the introduction of similar provisions in Scottish LGPS in 2018. The revised Regulations were effectively ignored by Funds and has resulted in SPPA having to issue further consultation to see how the changes could be better implemented. The proposals made effectively replicate the Scottish wording without making any attempt to look to learn from their adverse experience.
  • Helpfully the response does recognise that “some smaller and less financially robust employers are finding the current exit payment in LGPS onerous” and that “rather than protecting the interests of members, it may mean employers continue to accrue liabilities that they cannot afford.” It can also mean they are “driven out of business.” This is certainly becoming a much more common occurrence and is likely to continue apace over months and years as admission bodies closed to new entrants gradually reach a point where they have no active members.

However, worryingly, the response then does not specifically deal with this referring to employers with a “sufficiently strong covenant”. How would this be defined? What would happen for those employers who do not meet this classification? The response wholly ignores that employers with a weak covenant only option is to continue to accrue further liabilities without a solution which is neither in their interests, the Fund as a whole and other employers in the Fund.

There continues to be no recognition of the risk of future accrual and the strain that puts on Funds and other employers and that there needs to be compromise for weaker covenants to reach an amicable solution.

  • There is a proposal that consideration is given to whether a maximum funding time limit of perhaps 3 years is considered. This is frankly ridiculous as the vast majority would struggle to pay cessation debts over even a 10 year term and much longer repayment terms need to be considered. For example, in Scotland, Strathclyde Pension Fund and Lothian Pension Fund are considering terms of up to 20 years. I would be interested to know what specific research has been carried out to consider if 3 years is affordable? None I suspect.
  • There is little recognition that S75 deferred status being used (or more rather not being used) in private sector multi-employer schemes is very different to what is likely to be needed on LGPS schemes as the background is completely different. The overall covenant for LGPS schemes is much stronger as more employers have public sector backing and the distribution of liabilities much more widely distributed with small charities representing a tiny fraction of overall liabilities and therefore small changes in deficit amounts making a negligible impact on the overall Fund value at risk. Most importantly also it is much less likely that LGPS will ever close to future accrual so being able to fund over a long period of time is much more palatable.
  • The issue of legacy liabilities which has seen admission bodies assume material amounts of historic benefits for ex public sector staff has been completely ignored.
  • The seemingly endless round of consultation on ‘Tier 3’ employers looks to continue as the SAB have commissioned AON to look at funding, legal and administrative issues. Surely after all this time there can’t be key individuals within Funds who don’t understand the issues and options. But no, lets rehash them all again with a view to the SAB making some recommendations to the Secretary of State later in the year.  A bit more fiddling while Rome burns!

Thankfully there are signs that some Funds are adopting a more pro-active approach even ahead of Regulatory change recognising that they need to do so in order to better deal with the issues. Unfortunately not all are quite so enlightened, choosing to wait for ‘chapter & verse’ when the consultation already confirms that the Ministry is not intending “to legislate for every aspect” but to provide a more flexible framework lead by Funds.

I can only hope we’re finally nearing the end of the ‘consultation’ and will soon move into something that looks more like implementation as demand is already high and only likely to increase.

David Davison

With most charities in LGPS having to disclose their pension funding position in their accounts at 31 March 2020, the recent turmoil in the markets is likely to be causing concern, particularly for those with limited balance sheet surplus. 

The FTSE 100 has fallen by over 30% since March 2019. While this does not directly reflect the impact on individual funds it is a good proxy for the change in growth assets over the year.

A ‘flight to safety’ will have increased the value of government bonds.  However, a widening of credit spreads will have reduced the value of corporate bonds. 

Overall, depending on the investment strategy employed by the fund, asset values may be down with Funds with very little hedging likely to see a significant fall in asset values.

The deficit recorded in your accounts also depends on the value placed on your liabilities, and at the moment there is some good news on that front.  Widening credit spreads have increased corporate bond yields and they are now higher than they were in March 2019.  Inflation has also fallen.  Both of these factors will reduce the value places on liabilities.

At time of writing therefore charities may see an improvement in their position in comparison to last year.  The position is highly volatile however and Is changing significantly every day.

If you are concerned about the figure likely to be placed on your balance sheet there are steps you can take to help manage this.

What is not universally known is that it is the Directors /Charity Trustees who have responsibility for setting the FRS disclosure assumptions and not the Fund actuary.  You can therefore chose to use a different set of assumptions if those are more suitable for you and bearing in mind that one set of global assumptions issued by the Fund actuary can’t be specific to each employer, this is probably something worth considering, especially if your balance sheet position is important.

You may well be surprised by just how much of a difference small changes in the assumptions can make to your liabilities and therefore your deficit and balance sheet position.

I would therefore encourage employers already disclosing an LGPS pension liability to consider the assumptions used and whether or not they are appropriate.

The table below shows the potential impact of varying the assumptions used to calculate the FRS 102 liability.  Please note this will vary for each scheme and the figures below are provided as an example only (based on a scheme with a duration of approximately 20 years).

Change in assumption Change in liability
+0.1% p.a. discount rate -2%
-0.1% p.a. inflation -2%
-0.5% p.a. salary increases -1%


Indicative results showing the impact on deficit and balance sheet position based on the above changes to the assumptions are shown below.

‘Standard’ assumptions £000 Organisation specific assumptions £000
Assets 2,000 2,000
Liabilities 3,000 2,850
Deficit 1,000 850


So, for this illustrative example, a change of around 5% in the liabilities as in this case could reduce the deficit by around 18% and improve the balance sheet position by £150,000.

Therefore, you can see that for organisations participating in LGPS, it is well worth considering the use of bespoke assumptions, particularly if you are looking to manage your balance sheet. If you would like an indication of how changes could have impacted your 2019 disclosures, please let me know and we would be happy to provide these.

If you are looking to incorporate non standard assumptions, you need to consider this now as Funds usually require some advance notice that a different process will be used. We provide this service for many of our clients so don’t hesitate to contact us if you need more information.

David Davison

In mid 2018 the LGPS (Scotland) Regulations were amended (as outlined in Bulletin 21 – Hope Springs Eternal to introduce the concept of a suspension of the cessation debt when an employer exits a Fund. This brought a welcome and much needed option to assist admission bodies, many of whom are charities, in better managing their LGPS liabilities.

Unfortunately to date Funds have chosen not to utilise this additional flexibility through the adoption of alternative solutions in some cases but primarily by choosing to just ignore the change and carry on as previously.

In January SPPA issued a consultation to identify who had used the new provisions and how often, and to consider what changes might be needed to Regulation to have Funds more frequently utilise them. It also asked for suggestions about what other measures could be considered to add additional flexibility to the exit process.

Here is a link to our submission which looks to make some practical proposals how a more consistent, equitable and flexible approach could be adopted. We would hope to engage further with SPPA and the Funds to provide any additional support necessary to reach mutually beneficial solutions.

David Davison

Employers in England, Wales and Northern Ireland LGPS will be bracing themselves for the results of the March 2019 actuarial valuations which should be landing in the inbox shortly (Scottish employers have another year to wait). So, what are they likely to see?

Asset returns have been positive over the period which will have a positive impact on the funding level, all other things being equal. Inflation is also broadly unchanged over the period. There was some optimism around mortality rates although an announcement of a fall in deaths in 2019 has potentially put something of a damper on that.

However, that’s likely to be all the good news. Gilt yields have continued to fall from just below 2.3% in 2016 to around 1.6% in 2019 placing a higher value on liabilities. Gilt yields have continued to fall subsequently with yields down around the 1.0% level now.

The big issues likely to make an impact are likely to be legislative ones. These valuations will see the incorporation of additional liabilities related to GMP equalisation. In July we also witnessed the Government being defeated in the McCloud case with speculation this could cost Funds billions of pounds. The case found that the Government had forced younger members of the Judges and Firefighters schemes to join less valuable schemes while older colleagues were protected by transitional arrangements providing them with valuable additional benefits. The Government was not granted leave to appeal so steps will now have to be taken to rectify the problem. The LGPS has similar transitional protections.

These issues will likely increase liabilities and therefore funding costs.

The uncertainty created is also likely to hit exiting employers and will result in uncertainty around the impact for employers providing out-sourced services who may be left ‘holding the baby’.

Many schemes had been going through a cost cap review which suggested they may have to increase the level of benefits being provided (as there was a cost surplus), however these deliberations were deferred awaiting the impact of these changes.

Employers may have to brace themselves for further cost increases with no real viable route to escape. Hopefully the LGPS England & Wales Consultation will look at offering some additional flexibilities and a more equitable exit basis. Fingers crossed.

David Davison

In my last Bulletin I provided some detail on why the current exit basis used by LGPS funds is based upon excessive prudence and is totally inequitable to exiting charities costing them £100’s of millions in excess exit payments, swelling Fund assets and reducing Council costs.

The approach is unfortunately also counter-productive as it locks charities in schemes by presenting them with unaffordable exit payments thereby increasing risk for other participants in the Scheme. Funds focus on the risk of default and don’t really assess the material risk of future accrual, particularly for organisations with a weak covenant. It could be argued that the greater risk lies with an employer continuing to accrue further liabilities, which they may be unable to afford, which places other employers at risk.

The cessation lottery

Below is a table showing gilt yields and inflation over the last 12 years.

It can be seen from this that yields were broadly above 4% until around 2011 when we began to witness a steady decline to current levels where they are at or below 2%. There has been some volatility in the inflation position though not to the same extent as with gilt yields. Lower gilt yields will be resulting in very materially higher cessation debts being required from exiting employers which often makes them unaffordable.

Cessation debts could have been 2 to 3 times the size depending upon when the cessation debt was calculated. As an example we recently witnessed a debt move by around 50% over a matter of months and because of where the assets were held the employer had no control over the figure during the period when they were awaiting cessation numbers from the Fund Actuary.

Taking cessation payments based on gilt yields may make some theoretical sense where liabilities in Funds are being secured by the purchase of broadly matching gilts. However, very few Funds do this and we would question if that is sensible and a good use of public monies given the longer term view that Funds can adopt, the relatively small proportion of overall liabilities these Funds are likely to represent as well as the potential returns which could be foregone. This would be particularly the case where small exiting employers had very young staff where a 100% gilts-based investment would be wholly inappropriate.

The vast majority of Funds take these cessation payments and continue to fully invest them in their standard growth portfolio meaning the Fund continues to take the investment risk, and indeed return, as demonstrated in my previous article.

Alternative solutions

A number of alternatives exist which could provide for a fairer distribution of risk on exit.

The PWC Report referred to in my previous article suggested the use of Liability Driven Investments which could increase the ‘secure’ discount rate which could be used, thereby reducing exit payments and making exit more affordable.

The cessation basis could also reflect the likely duration of the liabilities with a moving discount rate applied depending upon the likely term the assets will be held. This basis could also be adjusted depending upon the level of any security which could be provided.

We would urge the Ministry of Housing, Communities and Local Government and LGPS to consider these alternative solutions to look to achieve a more equitable distribution of risk and reward.

David Davison

I have long been of the view that the current basis of assessing payments for charities when they exit an LGPS is excessive and doesn’t provide a fair balance between the schemes and the charities. Indeed I’m not the only one to hold this view.

In 2015 the Scheme Advisory Board in England & Wales commissioned research from PWC on this specific issue which commented:-

“We recommend that Funds should not be permitted to use very onerous assumptions for exit bases. One way to achieve this would be to require that the discount rate applied should not be stronger than CPI plus 1.0% or plus 1.5%. This would be the maximum strength exit basis. The range suggested is consistent with cautious investment policies but not zero risk investment policies.”

Needless to say this view represented ‘an inconvenient truth’ for LGPS Funds so the recommendation was just completely ignored. Its likely that this approach may have needlessly cost the UK’s charity sector many £100’s of millions. So just how much have Funds, and indeed their sponsoring local authorities, benefitted from these payments?

If we use a simple example comparing returns and gilt yields to highlight the issue (i.e. at this stage we are assuming all other factors remain constant). We have cessation assets and liabilities of £1m at outset with estimated on-going liabilities of £670,000 based on a 67% cessation funding rate. Table 1 shows the potential return based upon a gilts-based discount rate of 1.7% and returns of 0.5%, 1.0% and 2.0% above gilt yield (the latter reflecting broadly the on-going funding assumption).

The table shows that a matching gilts-based liability would have increased to £1.4m after 20 years and £1.66m after 30 years. Over 20 years the equivalent asset value covering this at 0.5%, 1.0% and 2.0% above gilts would be £1.55m, £1.70m and £2.07m respectively. So effectively the Fund (i.e. other active employers – primarily the Council) would have benefitted from the cessation payment by anywhere between £150,000 (11%) to £670,000 (48%) over this period based on these assumptions.

The equivalent ‘on-going’ liability reflecting a 2% return above gilts would have been around £670,000 so the exiting employer would have been paying a cessation ‘premium’ of £330,000. Allowing for a discount rate of 1.0% and 0.5% above gilts this cessation payment would reduce by £180,000 and £90,000 respectively while still providing a reasonable security margin for the Fund.

However, the position is in reality much worse than the example as the actual returns achieved by the Funds over the last decade or so have been hugely in excess of those assumed. If we consider an employer exiting in 2008 using the actual average return disclosed in the LGPS SAB Annual Reports across all Funds (net of charges) and the actual prevailing gilt yields the picture is alarming.

Based upon the £1m starting point the actual return from April 2007 to March 2018 was 87.7% (average 7.97% p.a.) and the gilts return over the same period was 35.75% (average 3.25% p.a.). This means that the actual gilt value of the £1m liability would now be around £1.42m however the actual value of the assets would be nearly £2.3m. So the Fund will have made nearly £900,000 excess return over gilts on the £1m of assets over only 11 years and around £1.3m in total. Even with no cessation payment the assumed on-going asset value (£670,000) would by 2018 be in excess of £1.5m and therefore over the gilts-based value and well in excess of a likely ‘on-going’ value which would be around £1.2m.

Funds are therefore collecting huge and, in our view, unreasonable payments on exit well in excess of the amount of money actually needed to provide the benefits. We do not question the need for some form of prudence margin to be applicable for exiting employers but Funds are demonstrating excessive prudence and refusing to consider change because they have the power not to do so. It is not unreasonable to assume that Funds could easily have taken £100’s of millions in cessation debts from the charitable sector over the last decade or so and benefitted by additional multiples of that figure. Is it reasonable for public bodies to effectively ask our charitable organisations to cross subsidise their costs to that extent?

We are firmly of the view that the existing approach is flawed and in need of revision and we made some proposals how this could be addressed in our submission to the Consultation on LGPS in England & Wales though would be less than confident that the turkeys will vote for Christmas!

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.

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