Michael Welford, consultant and actuary at Quantum Advisory, considers the next steps for the Local Government Pension Scheme, with the results of its triennial valuation due later this year.
The last valuation was carried out as at March 31 2019: 
*Based on an analysis of the funding reports for 86 of the 88 LGPS funds at that time.
**The Government Actuaries Department reviewed the 2019 LGPS valuations against a standard basis (established by the Scheme Advisory Board) and ranked the individual funds by their funding level on this basis.
What has happened since March 31 2019?
Liability movements
The value placed on a pension schemes’ liabilities is driven by the way that three key assumptions move over a period of time:
the discount rate
the rate of inflation (which is generally used to set future member benefit increases before and after retirement), and
mortality rates (ie, how long members will live for and hence how long their pension will be paid to them).
Since the 2019 LGPS valuation, 20-year gilt yields have risen from around 1.5 per cent a year to around 1.8 per cent
Many different approaches can be taken when setting a discount rate, but generally looking at the movement in fixed interest gilt yields over a period will give a good indication of how liabilities may have changed. Since the 2019 LGPS valuation, 20-year gilt yields have risen from around 1.5 per cent a year to around 1.8 per cent.
With the cost of living crisis filling headlines, short-term inflation rates are currently at levels not seen for many years. However, it is the long-term expectation of future inflation that is used to place a value on the LGPS pension liabilities.
Since the 2019 LGPS valuation, market implied rates of retail price index inflation have increased from around 3.5 per cent a year to more than 4 per cent.
Therefore, the net difference between the inflation and discount rate assumptions is likely to have increased by around 0.2 per cent a year, which could result in a circa 5 per cent increase in liabilities.
This rule of thumb is useful but cannot allow for things like a change of methodology by the fund actuaries at this valuation.
Another major factor in calculating liability values is the mortality assumption. There is currently a lot of uncertainty around future mortality improvements, with differing views on whether the long-term impact of the Covid-19 pandemic will be to increase or decrease future life expectancies.
We expect the funds’ actuaries will choose to make no allowance for the heavy mortality seen over recent years while they wait for credible evidence on the long-term effects of the virus.
Asset movements
Each fund will hold different assets and be implementing different investment strategies. However, the chart below shows the overall asset allocation across the whole LGPS at the 2019 valuation.
Performance of the major assets classes over the three years was as follows: 
Based on a typical LGPS fund investment strategy that is invested approximately 70 per cent in equities, 20 per cent in corporate bonds, and 10 per cent in gilts, we would expect a three-year return of around 23 per cent (or 7 per cent a year).
Clearly, the investment return is heavily dependent on the exact make-up of a fund’s investment strategy and, in particular, how its equity allocation is split between UK and global equity.
In 2019, the discount rate assumptions used across the funds varied from around 3.1 per cent to 5.3 per cent a year. Therefore, we would expect asset performance to have a positive impact on the 2022 results across the LGPS funds.
Overall impact on funding levels
In 2019, total future service contribution rates varied from 20 per cent to more than 35 per cent of pensionable pay.
The calculated cost of funding future service is not directly impacted by positive asset experience and, therefore, due mainly to the increase in expected net discount rates. We would expect to see an increase in required future service contributions as a result of the 2022 valuation.
Long-term strategy
Many employers will have a limited lifespan in the LGPS and, when an employer no longer has any contributing employees, it will trigger a cessation event and an exit debt will be calculated on a “least-risk” or “cessation” basis.
Due to the very cautious assumptions used for such a valuation, even employers with funding and accounting surpluses are likely to have significant deficits on a cessation basis — a deficit that is usually demanded by the fund as a lump sum payment soon after the last contributing member leaves the employer.
Historically, leaving an LGPS fund was an expensive and uncertain business. Bespoke agreements were sometimes available but were subject to negotiation with individual funds, which all tended to take a different approach.
In 2020, new legislation was introduced that standardised this process and required individual funds to set out a policy for exit terms in advance. Two structured options were introduced: 
Employers with guarantors may also be able to negotiate special exit terms with their administering authority, often paying less than the exit cost and sometimes making no further payments at all.
These options are helpful for employers because they present an avenue for them to manage their pension liabilities without the threat of an unaffordable exit debt suddenly becoming due.
Even if the likely increase in future contributions for the next three years is affordable for employers and exit from the LGPS is not on the immediate horizon, employers should still take steps now to review their LGPS strategy to make sure they avoid big problems further down the road, such as large unexpected exit debts.
Michael Welford is a consultant and actuary at Quantum Advisory
