New index reveals LGPS is fully funded on a ‘low-risk’ basis

• Isio’s inaugural LGPS (England and Wales) Low-Risk Funding Index reveals an aggregate funding position of 102%
• This marks a transformational funding swing of approximately £190 billion since 31 March 2022, following a significant rise in gilt yields
• However, substantial funding differences remain between the participating funds, with some still significantly underfunded
• The Index suggests that the majority of LGPS funds have scope to reduce employer contributions or shift to lower risk investment strategies
• Future developments of the Index will reveal funding levels for each individual LGPS fund and track the LGPS’s response to these new market conditions
• An equivalent Index is under development for the Scottish LGPS funds
  

11 September 2023: A new index from Isio benchmarks the aggregate funding position for the 87 funds that participate in the Local Government Pension Scheme (LGPS) in England and Wales, revealing that the LGPS is fully funded on a ‘low-risk’ basis.

Isio’s ‘LGPS Low-Risk Funding Index’ estimates the funding position for the LGPS using the pensions industry standard approach to low-risk funding for past service liabilities, namely using a discount rate based on government bond yields. The Index reveals, as at 31 July 2023, that overall the LGPS in England and Wales is 102% funded.

The funding level has improved dramatically since the most recent LGPS England and Wales triennial valuations were carried out as at 31 March 2022, when funding was estimated to be 67% on the same low risk basis (with a corresponding deficit of over £180 billion) and none of the 87 funds had a funding level of 100% or higher. The improved funding level is primarily due to the significant increase in UK government bond yields, which has resulted in the value of liabilities assessed with reference to bond yields falling dramatically.

Every LGPS fund’s funding level has increased by at least 30%* on a low-risk basis over the period 31 March 2022 to 31 July 2023, however there are still significant differences in funding position between funds. Currently, 46 funds are fully or over-funded and 41 are under-funded, while the funding level varies from 150% on the over-funded side to just 66% at the under-funded end of the spectrum.

Every LGPS fund has many employers, each with their own assets and liabilities. Individual employers have different funding levels depending on their participation history, so a fund that is 100% funded will have individual employers which are under- and over-funded on a low risk basis – 100% represents the average position. Employers who are over-funded are most likely to seek change as a result of these new market conditions.

Where there have been material improvements in funding levels for funds and their employers, Isio  suggests those funds:

1. Actively review investment strategies: Consider taking advantage of de-risking opportunities, but be mindful that these might differ based on whether funding levels are approaching or exceeding 100%.

2. Consider reducing employer contributions: Should these be reduced before the next actuarial valuation comes into effect on 1 April 2026 to avoid further overfunding?

3. Consider flexibilities for employers: Recognise the different needs of their fund’s employer base and enable participating employers to agree funding and investment arrangements that reduce contribution levels and/or reduce ongoing risk exposure.

Each month from September onwards, Isio will release its LGPS Low-Risk Funding Index based on market conditions at the end of the previous month, tracking levels and the impact of further changes in market conditions. Going forwards, the Index will be extended to reveal funding levels for each individual LGPS fund and monitor how funds are responding to current market conditions through their investment strategies and employer engagement.

Isio hopes to collaborate with funds to strengthen the Index’s database and access to recent changes and actions being taken.

*Apart from the Environment Agency (Closed) Pension Fund.

Steve Simkins, partner and public services leader at Isio, says: “Prevailing market conditions are a huge success story for the LGPS and present an immediate opportunity to enhance long-term sustainability for funds and their employers. LGPS funds are in a significantly better position to March last year and it is important that those close to or exceeding full funding consider what they do now to capitalise, both to lock in their position and to avoid overpaying contributions.

“While de-risking is almost always the right answer for fully funded trust-based schemes, it must be carefully considered by individual LGPS funds given their open status and long-term nature. However, de-risking does not need to be wholesale and it does not need to be permanent. Each Fund is made up of many participating employers, each with different funding positions and objectives, and so each Fund should actively engage with its employers on their own merits, enabling de-risking or reductions in future contribution rate levels where appropriate. There is a risk of inaction, if market conditions were to worsen again.”

“At the same time, with such a paradigm shift for the LGPS’s finances, we expect the Department for Levelling Up, Housing and Communities and the LGPS Scheme Advisory Board to urgently engage with these changes and consider whether an out of cycle actuarial valuation should be triggered to avoid further over-funding. This could have a significant and positive financial benefit for councils, many of whom are struggling to deliver core services. Excessive pension contributions constitute unnecessary spend and should be challenged.”