UK - The government is proposing two alternative approaches for local government pension schemes (LGPS) to meet solvency requirements from the 2010 valuation instead of relying on a 100% funding target, an informal consultation from the department for communities and local government (CLG) has revealed.

The consultation document - issued ahead of a broader debate on LGPS reforms later in the year - outlines initial suggestions for a "feasible and balanced response to the current stock market impacts on LGPS pension fund liabilities likely to be identified in the forthcoming 2010 valuation exercise".

At the last triennial valuation in 2007, the LGPS for England and Wales had total assets of £132bn (€153.5bn), but liabilities of £159bn, resulting in a shortfall of £27bn and a scheme-wide funding level of 83%.

But the CLG warned many stakeholders believed unless some adjustments are made to stabilise the treatment of scheme liabilities at the 2010 valuation, to mitigate any short term impacts of the economic recession, "the effect on members, employers and taxpayers could be disproportionately significant in terms of increased costs".

Contribution rates to the scheme are currently set by actuaries for each triennial period, to ensure the fund will be able to meet its pension promises through the achievement of a 100% funding level. However, the CLG claimed stakeholders had suggested the 100% target can be "artificial and impose significant short-term cost pressures on employers" particularly in a period of economic downturn and falling investment returns.

The government agreed that measuring the scheme against an actuarially defined notional 100% funding target "automatically creates the concept of a deficit event" whenever funding falls below this level, so its proposals aim to better reflect the "actual local funding dynamics of the scheme".

It argued scheme solvency relates to the capacity and status of employers to meet pension promises, so while this often translates to a 100% funding target, the CLG suggested "given the strong liquidity of the scheme, the constitutional permanence of local government and a strong employers' covenant, it is questionable whether fund authorities need to build up what, in effect, amounts to a financial reserve in the process of achieving that solvency level".

The government admitted a financial reserve and investment assets are needed for short-term liquidity requirements, but "setting employer contribution rates at a level to achieve long term funding targets can be considered to be a blunt instrument which imposes unrealistic and burdensome short/medium term costs on scheme employers, and potentially, council taxpayers". 

It suggested a "more flexible model might be appropriate" such as either:

Financing Plan - instead of a 100% funding recovery plan to make good past deficits, each authority would prepare and maintain a plan - as part of their funding strategy statement (FSS) - detailing how they will fund the scheme over the short, medium and long-term, and how it will manage the funding of long-term liabilities using a prudent approach and risk management analysis, or Local funding targets - essentially retaining the existing funding regime but allowing administering authorities to adopt a long-term funding target that could be less than 100% provided it could be sustained and justified by the pension fund in its FSS.

The consultation also suggested revisions to the employee contribution tariff, introduced in the new LGPS scheme on 1 April 2008, so that those earning over £75,000 will pay higher contributions and the lower contribution rate of 5.5% will be extended to people earning up to £15,000 instead of £12,000.  

Responding to the proposals John Wright, head of public sector consulting at Hymans Robertson, admitted the proposed Financing Plan and risk management analysis "represents sound governance", though he raised concerns about some of the other suggestions.

He said: "We think the proposals could result in funding plans that place too much emphasis on affordability without setting boundaries, and are over-reliant on a fund's current liquidity at the expense of long-term solvency.  We believe that 100% solvency should remain the long-term objective."

In particular, Hymans Robertson pointed out that the alternative approach of local funding targets has "already been tried before and failed", as schemes that took advantage of a previous relaxation of the solvency target to 75% "are still suffering the consequences".

Wright added: "There needs to be a transparent approach to funding which avoids sharp increases in contributions in unfavourable market conditions. But care will be needed to ensure these proposals don't result in long-term under-funding storing up problems for future generations."

The consultation will close to responses on 30 September 2009 and submissions should be sent to the CLG or emailed to Richard.mcdonagh@communities.gsi.gov.uk

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