Local Government Pension Scheme (LGPS) funding levels have improved due to rising asset prices, but inflation continues to pose a challenge for scheme liabilities, according to the LGPS Board’s 2022 valuation.
The Valuation Report summarised the data collected from 85 out of the 87 LGPS funds and revealed that funding levels have risen to 107%, from 98% in 2019. As a result, schemes have eradicated their deficits and are now sitting on a healthy combined surplus of more than £22bn.
These improvements were driven by the rise in bond yields, which led to a more favourable discount rate for LGPS schemes who are using gilt yields to determine their funding status.
Unexpectedly strong equity market performance may have also bolstered assets, with more than half of all LGPS assets being invested in stocks. But the LGPS board also warned that investment returns across the LGPS “will have been lower than that assumed at the 2022 valuation which will lead to a worsening in the funding position”.
Drop in contribution rates
The LGPS report is published to guide employer contribution rates for each LGPS fund for the period from 1 April 2023 to 31 March 2026.
Amid overall positive data for 2022, contribution rates have decreased from 22.9% of payroll in 2019 to 21.2% of payroll in 2022.
“Across the analysed funds, there is significant variation in this change in average total contribution rate, ranging from a drop in total equivalent contributions of 27.1% of payroll, to an increase of 7.9% of payroll,” the LGPS board said.
“The average change was a decrease of 1.5% of payroll, generally reflecting the reduction in secondary rates, due to strong asset performance helping to reduce deficits, balancing out the increase in primary contributions.
“However, contributions are paid on an individual employer level rather than a whole fund level, and we expect even more variation at the individual employer level.”
‘Significant market turbulence’ impact
However, the Scheme Advisory Board’s report highlighted that since the valuation date, there has been some “significant market turbulence” including material increases in short-term inflation, which have resulted in a 10.1% pension increase being awarded in April 2023.
The report stated that on the liability side, the movement will depend on the impact that changes in market conditions will have had on each fund’s local funding basis. “Generally, high short-term inflation will lead to an increase in the value placed on the liabilities, although it may have been built into the valuation of the liabilities to some extent,” the report noted.
In addition, since the valuation date, there have been significant increases in gilt yields. “Therefore, there may be a further impact on funds using a discount rate, which is set in relation to the inflation assumption and/or gilt yields,” the report added.
The report said that on the asset side, it is expected that investment returns across the LGPS will have been lower than assumed at the 2022 valuation, which will lead to a worsening in the funding position for the period to the next valuation.
This also comes as the government has confirmed that it will continue with its proposed approach to the McCloud remedy for civil service pension schemes, following a recent industry consultation. The McCloud remedy is a legal measure to remove the age discrimination that has occurred in the LGPS.
The report revealed that the potential impact of the government’s proposals was estimated to cost £1.6bn across the 85 funds that were analysed.
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