This is an article that I wrote recently for
Professional Pensions magazine
"John Gray asks why agreement can’t be made on appropriate discount rates for the LGPS.
Currently I sit on three different open defined benefit pension
bodies in different employer and employee roles. While I think that all
my past and present scheme actuaries are personally wise and wonderful. I
just wish they could agree with each other a little more often.
For example, at the moment those of us who are involved in the Local
Government Pension Scheme (LGPS) in England and Wales are gearing up for
the triennial valuation of funds this April (April 2017 in Scotland).
Different actuarial companies hold different "house views" on discount rates. The question is why?
Net Discount
The LGPS is collectively one of the biggest funded pension schemes in
the world with some five million members and assets of around £192bn.
Bizarrely there are currently 101 different administrative authorities
who manage the scheme. It is a major investor in the UK and overseas.
Some 25% of active members do not work directly for local councils.
Income from its investments subsidises the cost of providing pensions by
some £3bn per year. While nearly all funds have historic deficits due
to past underfunding, future employer contributions are capped.
Putting aside for the moment the important arguments that the way we
calculate pension liabilities (and therefore deficits) is simply bonkers
in these days of negative inflation, QE and ridiculously low gilt
prices, we need our actuaries to make up their minds about what is the
correct Net Discount Rate (NDR) to apply to this national scheme.
The discount rate really matters. It decides future funding
requirements and – most important of all to financially hard pressed
councils and other LGPS employers - decides what their contributions
will need to be.
NDR is the projected growth of the fund above inflation. So if the
inflation is assumed to be 2% and growth is 5% the NDR would be 3%. The
sting in the tale is that the lower the NDR the more employers will
usually be expected to pay.
Range of discount rates
Quite rightly it is our
scheme actuaries who make the final decision what the NDR is after
consultation with the administrative authorities. However, currently
there are a range of net discount rates across the different funds in
the LGPS that go from under 2% to 3.5%. Different actuarial companies
hold different 'house views' on discount rates. The question is why.
I could just about understand different schemes having different
discount rates but for funds that offer the same scheme benefits with
the same extremely strong employer covenant this doesn't seem credible.
Two of the four actuarial firms that value the LGPS tend to have
lower NDR than the others. If they all used the same NDR as the
Government Actuaries Department, which is 3%, then it has been estimated
that the combined LGPS deficits would be cut by nearly a half, a
staggering £19bn. This suggests to me that since the NDR drives
contributions many employers are already paying far more than they need
to.
The NDR is not the only controversial assumption (otherwise known as
an educated guess) made by actuaries. There are different assumptions
made and argued over around future inflation, pay increases and life
expectancy. There is even a debate about whether or not life expectancy
is currently declining.
If liabilities and contributions to the LGPS are over stated by some
too prudent actuaries then this will lead to further politically
motivated attacks and scaremongering upon the LGPS. We cannot allow the
LGPS to be destroyed in the same way as happened to defined benefit
provision in the private sector.
John Gray is a pension board member at the London Borough of Tower Hamlets. (Personal capacity and hat tip to Glyn Jenkins from UNISON following his recent presentation to the London Pension Forum).
