ITEM PF14
PENSION FUND COMMITTEE – 26 NOVEMBER 2008
RECENT STOCK MARKET CHANGES: IMPACT ON THE PENSION FUND
Report by Assistant Chief Executive & Chief Finance Officer
Introduction
1. In light of all the recent high profile stories in respect of the state of the stock market, this report sets out how these events may be impacting on the Pension Fund, and more specifically on the employer contributions to the Fund. The report also looks at the potential options to mitigate any adverse implications.
Main Implications as at Today
2. Firstly the good news. The Pension Fund will only be affected marginally by the problems experienced by Icelandic Banks. The Fund does not currently own any shares in Icelandic Banks. However, a small proportion (c £0.5m) of Pension Fund cash has been invested in Landsbanki. This is part of the County Council’s £5m investment in Landsbanki which was made in early September and is due for repayment in late November/early December. These assets are currently frozen. All local authorities are working together through the Local Government Association to recover their assets.
3. Unfortunately, that is it for the good news. In respect of the significant fall in value on the various stock markets, and the growing inflationary pressures on pay levels, it is all bad news. The combination of these factors means that the liabilities are rising and the value of the assets is falling. How bad this news is for the Pension Fund, the contribution rates and therefore the budgets is dependent on a number of factors.
4. If firstly all these factors are ignored, the Valuation process can be rolled forward to establish what the results would be if the Valuation was undertaken under the current financial circumstances. The Fund Actuary has recently completed this exercise to establish the results as if the Valuation had been completed as at 30 September 2008. The results of this exercise would suggest that the average employer contribution to the Pension Fund would have to rise from 19.9% of pensionable pay to 27.4%. This average increase of 7.5% of pensionable pay, represents a 38% increase in the actual cash contribution.
Influencing Factors – Arguably outside our Control
5. The extent to which this result is likely to be mirrored in reality needs to be considered in the context of the following factors.
6. First and foremost, is the extent to which the current falls in market values are permanent, and how quickly any losses may be recovered. Whilst the picture is highly concerning today, the next Valuation of the Pension Fund is not due until March 2010, and it is the value of the Fund’s assets at that time which will determine changes to employer contribution rates. The 2007 Valuation assumed investment returns of around 6% per annum. This was an average return across the full range of the Pension Funds investments.
7. Looking at the value of the Pension Fund’s investment portfolio, during the period since the last valuation, i.e. 1 April 2007 to 30 September 2008, the total value fell by about 12.5%. October was particularly bad for financial markets and provisional returns for the end of October indicate that the reduction in the value of investments since 1 April 2007 stands at about 17%.
8. As a consequence of the drop in the value of the investment portfolio, the Pension Fund deficit jumped from 22% as at 31 March 2007 to 42% as at 30 September 2008. This increase in deficit contributes 5.5% of pensionable pay to the average increase in contribution rate. These figures would be worse if the Valuation exercise was undertaken on the day this report was written. However, to the extent that the markets recover by 30 March 2010, the deficit and hence our contribution rates, will decline.
9. Similarly, the views of future inflation have changed since March 2007, with the picture as at 30 September 2008 suggesting higher pay inflation than previously assumed, and therefore increasing the value of our liabilities which are all linked to final pay. The extent to which this view prevails when completing the 2010 Valuation will determine the level of required increase in the contribution rates. As noted above, the latest views of future general inflation would suggest there will be downward pressure on pay expectations.
Influencing Factors – Some Scope for Council Control
10. Investment returns and inflation will influence the result based on a roll forward of existing assumptions, and existing Regulations. However, if the results are as poor as the 30 September figures, then it is highly unlikely that the 2010 Valuation will be undertaken on the same basis as the 2007 Valuation.
11. Part of this will be Government influenced. The Government have included in the current Regulations, the requirement to introduce a cost sharing scheme, and have already undertaken an informal consultation exercise on how this would work. Whilst this consultation suggested that costs linked to past service deficits and movements in the financial markets would be met in full by employers, there was also a suggestion for a cap on the employers’ future service contribution. Depending on the final version of the cost sharing scheme therefore, it is possible that some of the potential increased costs to the Fund in 2010 will fall to employees.
12. The Government would also have to consider what further changes they would wish to make to the Scheme itself to maintain its sustainability if the financial position does not markedly improve by March 2010. This would need to include a review of the current benefit structure (including final salary against average salary, defined benefits against defined contributions etc), accrual rates, retirement ages etc.
13. Other aspects of the 2010 Valuation will be dependent on decisions by the Administering Authority, in consultation with all employers as appropriate. Key questions will be around the period set for the recovery of past service deficits, for which our Funding Strategy Statement currently sets a maximum of 25 years. This may well need to be extended to provide affordable increases in the employer contributions in respect of past service deficits. Other aspects that will need to be reviewed will include the re-instatement of the short term investment return, removed in 2007. This decision will need to be made in conjunction with assumptions about likely future investment returns. Whilst the assumptions can be set to reduce the potential liabilities, it is important that the overall package of assumptions remains realistic, to avoid building up greater problems going forward.
14. The above factors will all impact on the actual increase in the average contribution rate come the 2010 Valuation. The other key issue all employers need to consider is the extent to which they differ from the average employer in the Fund. The actual range of increases in employer contributions will be dependent on individual factors such as any variation in payroll over the period, the maturity of the employer (i.e. the ratio of active members to pensioners) etc.
15. A key factor to consider for individual employers is the basis of their membership to the Fund. The flexibility in terms of a number of the above factors will be greater for Scheduled Bodies, where there is an expectation that current membership levels will be maintained over the longer term. For Admitted Bodies, the situation could be very different. Where the admission agreement is closed to new members, or is linked to a fixed term contract, options to extend the recovery period are unlikely to be available. Unfortunately, in these cases, employers could face a significant cost in 2010 if today’s financial circumstances prevail until then. The Administering Authority, sponsoring employers and the employers themselves all need to consider the implications of this potential significant cost, review any indemnity bond arrangements currently in place, and consider the need for any contingency arrangements, including increasing the cover under indemnity bonds, and building reserves now.
16. Finally, it should be re-emphasised that the serious financial position that the Fund finds itself in today in itself has no direct bearing on the results of the 2010 Valuation. The 2010 results, effective from 1 April 2011, will be determined by the financial circumstances as at 31 March 2010, decisions made by the Government on cost sharing, and decisions made by the Administering Authority on funding strategy and other key assumptions. The purpose of this report is to alert the Committee to the potential severity of the position, and some of the issues you may want to keep an eye on over the next 18 months.
17. I have written to all Fund employers covering the issues contained in this report and this issue will be a key part of the Annual Pension Fund Forum on the morning of 5 December 2008. The Fund Actuary will be attending the Forum to provide an update, and to cover in more detail some of the issues individual employers should be monitoring.
RECOMMENDATION
18. At this stage, the Committee is RECOMMENDED to note the report, the seriousness of the potential implications, and the factors which will influence the outcome over the next 18 months.
SUE SCANE Assistant Chief Executive & Chief Finance Officer
Background papers:
Contact Officer: Sean Collins, Assistant Head of Shared Services (01865) 797190
November 2008
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