Norfolk Pension Fund Preparation for 2010 valuation Employer Forum, - - PowerPoint PPT Presentation

Hymans Robertson LLP and Hymans Robertson Financial Services LLP are authorised and regulated by the Financial Services Authority

Norfolk Pension Fund Preparation for 2010 valuation

Employer Forum, 2 March 2010

John Wright 2 March 2010

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Your presenter today

John Wright, Partner Head of Public Sector Consulting john.wright@hymans.co.uk 0141 566 7921

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What we will cover today

• 1. Introduction: some basics
• 2. Update to end January 2010
• 3. Why individual employer results are different
• 4. Setting contributions
• 5. Outlook for March 2010 FRS17
• 6. LGPS Topical Issues

Hymans Robertson LLP and Hymans Robertson Financial Services LLP are authorised and regulated by the Financial Services Authority

• 1. Introduction: some basics

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Features of the LGPS

Defined benefit (DB) scheme

Final salary (FS) Member contributions fixed Employer pays “balance of cost”

Funded scheme (not pay-as-you-go)

Assets built up from contributions, investment income, investment growth in order to meet future benefit payments

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Promise now, pay later

Lump Sum

Dependant’s Pension

Member’s Pension

40 65 85

Recruitment

Contributions

Expenditure Income Retirement Death

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Pension promises – a long term commitment

Future Benefit Payments (Past Service)

1 6 11 16 21 26 31 36 41 46 51 56 61 66 71 76 81 86 91 96

Benefit payments

Pensioners Deferreds Actives

Source: Hymans Robertson LLP , sample client

Years from Valuation Date

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Profile of emerging expenditure

Source: sample LGPS Fund; new entrants for 50 years

Funded schemes like LGPS have investment income too

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Funding valuations

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Keep her covered !

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Triennial valuation of Fund - purposes

Compliance with legislation Recommend contribution rates

Common rate Individual employer rate – “peculiar”

Assess reserves needed for accrued liabilities Assess solvency (“funding level”) Monitor experience vs. assumptions Actuary must have regard to Funding Strategy Statement (FSS)

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Summary of the valuation process

Data Assumptions Benefits Past service surplus or deficit? Value Assets & Value Liabilities Valuation Report FSS Administering Authority/ Employer Consultation Rates and Adjustments Certificate

Norfolk is test site for 2010 data

Q2/2010 Q3/Q4 2010 Q1 2011

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Valuing the liabilities of the Fund

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Value today of £100 in 10 years time

Future inflation In 10 years £100 grows to Assumed future investment return How much cash do I need today Zero £100 7% £48 3% £134 7% £65 3% £134 5% £80

Higher inflation => need more cash today Lower future investment return => need more cash today

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Discount rate: assumed future investment return

Gilt yield Outperformance

Discount rate = bond yield plus allowance for expected outperformance

Discount rate = 6.1%

4.5% 1.6%

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Value of Pension Fund Liabilities: How much money do I need today?

£1,000 p.a. 60 90

Capitalised cost ignoring interest = £30,000 Capitalised cost allowing for interest1 = £14,100 Capitalised cost allowing for interest and inflation2 = £20,100

30 years

1,2 Assume 6% investment return and 3% inflation

.. and allow for probability of survival

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Early retirement with unreduced pension is costly

Pension in Payment £10k pa for 12 years = £120k Current Age 55 Age at Retirement 65 Age at Death 77 £10k pa for 22 years = £220k Unreduced Pension in Payment Note: Illustration above ignores interest and inflation

This is what happens with redundancy/efficiency retirements Expected Actual

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Early retirement due to ill-health is also costly

Pension in Payment £10k pa for 12 years = £120k Current Age 55 Age at Retirement 65 Age at Death 77 £10k + say £5k pa for 22 years = £264k Unreduced Pension in Payment (£10k) Ill-heath Enhancement (say £5k) Note: Illustration above ignores interest and inflation

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Discount rate used depends on purpose

32.6m 38.5m

Liabilities March 09 FRS17 Liabilities March 09 Ongoing

Shortfall on “gilts” termination basis is higher 47.6m 4.2%

Liabilities March 09 Termination

6.7% 5.8%

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Living much longer

Life Expectancy at age 65: England and Wales

65 67 69 71 73 75 77 79 81 83 85 87 1838-54 1871-80 1881-90 1891-1900 1901-10 1910-12 1920-22 1930-32 1950-52 1960-62 1970-72 1980-82 1990-92 2000-02

Source: Government Actuary, English Life Table series of mortality tables

Average Expected Age at Death Men Women

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Two years of improvement per decade

Period expectations of life derived from calculated crude mortality rates. Source: Club VITA LLP, part of the Hymans Robertson group

79.4 79.7 79.8 80.0 80.4 80.4 80.5 80.8 81.0 81.1 81.4 81.7 81.9 82.3 82.7 +3.6

+3.5

+3.3 +3.5 +3.5 +3.2 +3.3 +3.4 +3.4 +3.2 +2.9 +3.0 +2.9 +2.9 +2.8

65 70 75 80 85 90

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Expected age at death of a 65 year old

Men

Extra Years for Women

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East meets west

High life expectancy Mid life expectancy Low life expectancy

Source: Club Vita research based on VitaBank as at 2 October 2008

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Effect of salary increases on liabilities

Example:

age 55 years £70k salary 10% pay rise accrued pension = £20,000

Cost of pay rise = £7k in first full year Additional pensions liabilities = £30k

Extra pension liabilities can cost more than extra pay

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Fund valuation - assumptions

Financial Assumptions Inflation Pay increases Pension increases Investment return Consider: Economic outlook Actual Scheme assets Historical pay growth Demographic Assumptions Life expectancy Retirement age and cause Withdrawals Marriage statistics Consider: Population trends Members’ social status Past Scheme experience Amounts paid and probability of payment

Hymans Robertson LLP and Hymans Robertson Financial Services LLP are authorised and regulated by the Financial Services Authority

• 2. Valuation update to

January 2010

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What has changed since 2007

Negatives

Investment experience since 2007 Government bond yields lower (inflation linked) Higher inflation expected over the long term Future improvements in life expectancy?

Positives

More realistic assumption for current life expectancy Pay increases may be lower than assumed? Cost sharing or “cap and share” (increases employee contribution rate or reduces benefits) but formula ignores effect of actual investment returns and market conditions

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LGPS assets and liabilities since last valuation

Source : Hymans Robertson, Median LGPS Fund March 07 to Nov 09

Assets underperformed, liability values increased

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Underperformance of investments damaging ...

Based on 20 year deficit spread period, experience from 31 January Median Fund Navigator report

... but increase in liabilities also significant

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Change in value placed on liabilities

31 March 2007 31 January 2010 Effect on Value

• f Liabilities

Discount rate 6.1% 6.0% Increase Salary increases 4.7% 5.3% Increase Inflation 3.2% 3.8% Increase Net discount rate* 2.8% 2.2% Increase

*Net discount rate is the discount rate less inflation

Net discount rate has reduced by around 0.6% pa This increases the value placed on liabilities (and the cost of benefits accruing) by around: 12-15% for active and deferred liabilities 7% for pensioner liabilities

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Funding level (solvency) has fallen

40% 50% 60% 70% 80% 90% 100% 31-Mar-07 1-May-07 1-Jun-07 1-Jul-07 1-Aug-07 1-Sep-07 1-Oct-07 1-Nov-07 1-Dec-07 1-Jan-08 1-Feb-08 1-Mar-08 1-Apr-08 1-May-08 1-Jun-08 1-Jul-08 1-Aug-08 1-Sep-08 1-Oct-08 1-Nov-08 1-Dec-08 1-Jan-09 1-Feb-09 1-Mar-09 1-Apr-09 1-May-09 1-Jun-09 1-Jul-09 1-Aug-09 1-Sep-09

Funding level Ongoing Funding Basis

Source: Hymans Robertson, Navigator, sample LGPS Fund

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Theoretical contributions higher

• 5%

0% 5% 10% 15% 20% 25% 30% 35% 40%

31-Mar-07 1-May-07 1-Jun-07 1-Jul-07 1-Aug-07 1-Sep-07 1-Oct-07 1-Nov-07 1-Dec-07 1-Jan-08 1-Feb-08 1-Mar-08 1-Apr-08 1-May-08 1-Jun-08 1-Jul-08 1-Aug-08 1-Sep-08 1-Oct-08 1-Nov-08 1-Dec-08 1-Jan-09 1-Feb-09 1-Mar-09 1-Apr-09 1-May-09 1-Jun-09 1-Jul-09 1-Aug-09 1-Sep-09

% of Pensionable Payroll

Results differ for individual employers

Total

Source: Hymans Robertson, Navigator, sample LGPS Fund

Future Service Rate Deficit payments

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How extreme are current conditions?

Funding levels within range modelled

Source: Hymans Robertson comPASS system

Median 1 in 20 chance 1 in 100 chance

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• 3. Individual Employers

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Why do contribution rates vary between employers?

Different membership profiles (average age, sex, etc) Different experience

Salaries Mortality Ill-health retirements Transfers in and out, e.g. TUPE transfer / outsources

Previous contributions paid to recover deficit Previous contributions paid to recover early retirement strains Security/guarantors Different deficit spread periods

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Effect of Deficit Repayment Period

5 10 15 20 25 10 years 15 years 20 years

Spread Period (years) Deficit repayments Future service rate

7.3% 14% 5.1% 14% 4% 14%

Employer rate (% pay)

Longer deficit spread period => lower contribution rate Must consider security of arrangements

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Each employer is different

Must consider: Individual funding levels Security of income stream (tax-raising)? Any guarantor in place? Closed to new entrants (shorter deficit recovery, monetary deficit payments) Close to ceasing participation in the Fund (e.g. contractors)

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• 4. Setting contributions

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What should we do?

• A. Rely on your investments?
• B. Hope cost sharing saves the day?
• C. Underpay and hope for the best?
• D. Stabilise contributions based on proper risk

assessment? Risk assessment increasingly important for governance reasons

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Dealing with cost pressure

Traditional approaches Alter the deficit repayment periods Phasing in increases/reductions Additional overlay in 2010 for long-term secure employers Explicit stabilisation rules – test the long term consequences (risk assessment)

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Contribution strategy for long term stability

Contributions % pay

2007 30

20 10

2010 2013 2016 2019

Theoretical contributions Actual contributions paid Note: Illustrative example only; future contribution rates uncertain

Underpay in bad times, overpay in better times

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What will future returns be?

‐25.0% ‐20.0% ‐15.0% ‐10.0% ‐5.0% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0%

Annual WM local authority return 1997 to 2008

Annual return

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Recognise that future is uncertain

0% 20% 40% 60% 80% 100% 120% 140% 160% 180% 200% 1 2 3 4 5 6 7 8 9 10 Funding level Years from now median Worst outcomes Best outcomes 1% 95% 84% 16% 5% 99%

Tail Value at Risk

Test different future outcomes for investment returns, interest rates and inflation

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5,000 scenarios gives a distribution of outcomes

Source: Hymans Robertson LLP, comPASS, sample fund

0% 25%

50% 75%

100% 125% 150% 175%

200%

3 6 9 12 15 18

Funding Level (%) Years from valuation date Median 1 in 6 chance 1 in 6 chance

More than 50% chance meet funding objective

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CLG financing plan for 2010 valuations

Achieve stability for tax-raising employers Test contribution strategy meets long-term funding objective Generate cashflows for future benefit expenditure Prudence and risk assessment

Norfolk Pension Fund will do all of this However, must understand risks and protect Fund

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Stabilisation is not for everyone

Applies only to tax-raising employers in the fund

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Other employers including contractors, CABS and other non-tax raising bodies

Consider deficit recovery periods (depends on security) Greater flexibility in deficit repayment is possible where there is a guarantor or additional security for the Fund Understand the risks

Administering authority must understand the risks and protect the Fund but recognises where possible the affordability challenges current conditions present for employers

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Conclusions and next steps

For tax-raising employers only… Can stabilise contributions without harming expected long term funding level Underpay in bad times, overpay in more favourable conditions Test contribution strategy: prudence, affordability, stabilisation, stewardship Consider options for non-tax raising employers

Hymans Robertson LLP and Hymans Robertson Financial Services LLP are authorised and regulated by the Financial Services Authority

• 5. Outlook for March 2010 FRS17

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Outlook for FRS17 at March 2010

31 March 2009 31 January 2010 Effect on FRS17 balance sheet Discount rate* 6.7% 5.5% Increases value of liabilities Inflation 3.1% 3.7% Increases value of liabilities Net of inflation discount rate 3.6% 1.7% Increases value of liabilities by 30-45% Investment return** N/A 24.1% Increase in asset value

But depends on market conditions at 31 March 2010

Notes: *Yield on AA corporate Bond; **Typical LGPS Fund from 31/3/09 to 31/01/10

Hymans Robertson LLP and Hymans Robertson Financial Services LLP are authorised and regulated by the Financial Services Authority

• 6. LGPS topical issues

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Topical issues

CLG consultation on 2010 valuation approach “Cap and share” (aka cost sharing) Guidance on Admitted Body Status Sustainability of scheme – future benefit reform Ill-health costs

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Ill-health retirement costs

Example Total contribution rate = 20% of pay Payroll = £1,000,000 Allowance for ill-health costs = 2% of pay = £20k Ill-health retirement 1 costs £15k (within budget) Ill-health retirement 2 costs £170k (exceed budget) Amount over budget = £185k less £20k = £165k

Regulations allow Administering Authority to charge employer for additional ill-health costs but would come through as upward pressure

• n employer’s contribution rates at next triennial valuation in any case

Hymans Robertson LLP and Hymans Robertson Financial Services LLP are authorised and regulated by the Financial Services Authority

Thank You

Any questions?

Hymans Robertson LLP and Hymans Robertson Financial Services LLP are authorised and regulated by the Financial Services Authority

Appendices

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Financial assumptions

March 07 March 09 December 09 Uses Gilts 4.5% 4.2% 4.4% Termination Index-linked 1.3% 1.03% 0.64% All Inflation 3.2% 3.1% 3.8% All Funding discount rate 6.1% 5.8% 6.0% Funding valuation AA corporate 6.7% 5.7% FRS17

Higher expected inflation + Lower future investment return = Higher value placed on liabilities

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Assess effect of contribution strategy

No material impact on funding levels Investment impact dominates

2007 2010 2013 2016 2019 2022 2025 Year 2007 2010 2013 2016 2019 2022 2025 Year

Stabilised Not stabilised

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Effect of different investment strategies

0% 20% 40% 60% 80% 100% 120% 140% 160% 180% 200% 3 6 9 12 15 18 Years from valuation date O n g o in g F u n d in g L e v e l ( % ) 0% 20% 40% 60% 80% 100% 120% 140% 160% 180% 200% 3 6 9 12 15 18 Years from valuation date O n g o in g F u n d in g L e v e l ( % )

74% equity 24% equity

Lower risk investment strategy, outcome more certain but contributions higher

Source: Hymans Robertson, Navigator, sample LGPS Fund

Funding level over 18 year period

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Risk assessment essential

0% 20% 40% 60% 80% 100% 120% 140% 160% 180% 200% 3 6 9 12 15 18 21 24 Ongoing Funding Level (%) Years from valuation date Probability that funding level is greater than 100% after 24 years = 61% Average of the worst 5% of

• utcomes

after 24 years = 45%