The Local Government Pension Scheme Advisory Board has warned funds in the LGPS to think carefully and seek input before agreeing to lower employer contributions in light of current pension surpluses, citing a need for stability in contribution levels to avoid sharp increases in future.  

The average funding level of LGPS pension funds reached 107% in 2022, leading some employers in the scheme to ask if they need to continue contributing at the same level. Some advisers have also previously raised the question of whether local authorities should keep building buffers for their staff pension funds while many councils are in a precarious financial state.  

The National Audit Office found in 2018 that there was a 49.1% real-terms reduction in government funding for local authorities and a 28.6% real-terms reduction in local authorities’ spending power between 2010-11 and 2017-18. More recently, several councils have come under such financial strain they were ordered to stop making spending commitments – by being handed section 114 notices under the Local Government Finance Act 1988 – and have to make cuts to public services. 
   

   

Despite these pressures, the LGPS Advisory Board has now issued a statement about pension surplus and employer contributions, stressing that local authorities have a statutory obligation to pay employer contributions to the fund in which they participate.  

The board warned that “changes in funding values due to market movements are not of themselves sufficient to trigger a review and are best managed through the triennial valuation process”.  

LGPS regulations permit administering authorities to review an employer’s contribution rate where there has been a significant change to the liabilities or covenant of that employer. The Advisory Board agrees this can be the case where there are changes such as, for example, a bulk transfer in or out. 

However, it sees the covenant strength of local authorities as an immutable quantity – despite their reduced spending power and the fact some have credit ratings – saying: “Local authorities and other tax-backed employers are not subject to change in covenant.”  

The board also warned that where administering authorities want to review their own employer contribution, they “will need to consider very carefully how they manage the conflict of interest between their role as an employer in the scheme and as an administering authority”.  

Employers in the LGPS can, however, make negative ‘secondary’ contributions in case of pension fund surplus. The Advisory Board told funds they need to “have a clear rationale and be able to explain their approach to setting secondary contributions and how employers’ covenant positions have been recognised”. 

Where employer contributions would fall below employee contribution levels as a result of negative secondary contributions, pension funds should seek input before agreeing to this: “In the rare cases where it is proposed to set a negative secondary contribution at a level that puts the overall employer contribution in line with, or below, average employee contributions (generally around 6.5%), funds should consider how best to present this and may wish to seek views from employee representative members on their Local Pension Board, before moving to do so.” 

LGPSAB also told funds to educate employers about surplus, saying that because of “differing levels of expertise and resources amongst the 18,000+ LGPS employers”, they might want to have “specific communications to explain to employers particularly why their accounting surplus looks different from their funding surplus, and why neither are necessarily ‘realisable’”, even if employer exit is permitted.  

Some employers have, according to the Advisory Board, proposed ‘partial termination’, where an employer exits the fund for deferred and pensioner members but remains a participating employer for active members. This locks in current liability values for the deferred and pensioner members. However, the board highlights that if those estimates prove too low in future, “the extra costs become the responsibility of all employers in the fund”. It therefore told funds that they “should satisfy themselves that such an approach is consistent with the regulations” and the interests of other employers in the scheme. 

There is evidently a strong view among SAB members that there is a need for contribution stability which does not easily allow for lowering contributions in light of surpluses.   

“If current market and demographic trends continue, we could see a long-term downward [movement] in employer contributions, but it isn’t in anybody’s interests to make large reductions in contributions now only to have to reverse them sharply if market conditions change,” said LGPSAB deputy secretary Jeremy Hughes. 

“What we have advised is that funds should consider the need for stability in determining their general approach and to set this out for employers clearly in their funding strategy statement. That includes sharing their rationale for dealing with different employer circumstances,” he added.   

Regarding covenant, Hughes said in the board’s view, tax-raising bodies like local councils are “generally” not likely to see much change in covenant.  

He added: “The board recognises that councils are under ever-increasing financial strain. But there have been no cases where councils have been unable to pay their LGPS contributions, which is a statutory duty, even when a s114 notice has had to be issued. In such circumstances, though, it is right that LGPS funds keep under review the financial strength of their major employers and discuss with them sensitively any changes in position.”  

Given the level of surpluses, now is the right time to consider surplus management, said Alistair Russell-Smith, head of the charity and not-for-profit practice at consultancy Spence & Partners.  

However, this could be difficult for some employers without more support from the LGPS pension funds they are paying into, he suggested: “It’s a missed opportunity that a structured set of proposals that funds could use for helping employers best manage their LGPS cost and risk has not been developed.”   

Many so-called admitted bodies have a closed group of staff in the LGPS, he noted, and are on an “inevitable” journey to their eventual exit.   

“It would be hugely positive for these organisations, many of which are often cash-poor charities, if they could be given more support on implementing these exits in a risk-controlled way,” he said.  

“One glaring risk is the inability, in many cases, to derisk the investment strategy for individual employers so that they can better lock in favourable funding positions ahead of any exit and reduce the risk of cessation debts re-emerging. I’d therefore be supportive of SAB encouraging more funds to develop investment strategy choices for employers,” he added, arguing that this could be done cost effectively. 

Russell-Smith is also in favour of partial cessations, of which SAB appears to be sceptical. They would be a “straightforward” way for many charities to derisk their LGPS exposure without having to disturb pension benefits for remaining active members, he argued.  

Partial cessation also “does not have to be problematic for funds”, he believes, pointing again to the possibility of offering investment strategy choices, which would allow pension funds to match the deferred and pensioner liabilities with gilts or buy-ins, “thereby removing cross-subsidy risk for other employers”.   

He said clearer guidance in England and Wales on exit credits – where there is a pension surplus in relation to an employer leaving the LGPS – would also be “useful”, pointing to regulations for Scottish funds.    

“This needs to change to help employers plan their exits with confidence,” Russell-Smith said.   

Should LGPS pension funds be concerned if employers propose to reduce contributions?