Prudence will be one of the “key” principles for the upcoming UK’s Government Actuary’s Department (GAD) Section 13 Review of the Public Services Pensions Act 2013, with defined benefit (DB) pension fund surplus extraction being a crucial focus.
Speaking at the Pensions and Lifetime Savings Association’s (PLSA) local authority conference on Tuesday, Garth Foster, actuary at GAD, said that as part of the Section 13 Review, the department will be looking at pension funds that release surplus “most quickly” and the funds that release it “least quickly”.
Section 13 requires GAD to report on the actuarial valuation of Local Government Pension Schemes (LGPS) and assess whether the funds are compliant, consistent, solvent, and cost-efficient.
Foster told conference delegates: “We are also going to look at a scheme as an aggregate and give a narrative of the overall position in surpluses, and how we see that might develop.”
He said that for GAD, it will be “key” to understand the decisions that were made along the way and the rationale for those decisions.
“We encourage funds to consider ways that they can make this information as available as possible for us and other third parties, so that it can be subject to scrutiny and ensure that we’re bolstering the credibility of schemes and their evaluations as much as possible.”
According to Foster, the key principles for GAD will be stability and prudence and how those interplay with surpluses.
He said that while everyone recognises the importance of stability, the question is: “How prudent should you be? And what does stability mean in the particular context of your own client?”
He continued: “A key driver of how we think this will play out in 2025 valuations is the Gilt yields. Over the period between the 2022 and 2025 valuations, we have seen a real change – the world has changed over that period. That change is the risk-free rate of return that will be a consideration when schemes and actuaries are looking at setting the assumptions about future investment returns for valuations.”
Foster said there are “lots of different ways” pension funds can do that, and it will be “really important” to see how stability improvements apply through that principle.
But Foster added that it is also important to recognise that a “funding level is just a funding level”.
He said: “It is only meaningful to the extent that you understand how much stability and how much prudence is actually baked into that.
“So I encourage you all when you are looking at your valuations to get under the bonnet and understand how those two factors are playing out.”
Foster also encouraged the audience to consider going beyond funding levels and to look at cost efficiency and how contribution rates impact employers.
“This might be deciding over what length of period you should spread your surplus and how long or short that should be. It might also be a stability mechanism that you might want to use, and to that extent, you might want to limit the change in contribution rates from one year to the next and whether that should be an X percent limit or a Y percent limit,” he explained.
“You might also think about surplus buffers and the extent to which they limit the amount of surplus available to reduce contribution rates, and how you decide at what level the buffer should be,” he added.
Foster acknowledged that these are not “easy decisions” to be made, but said: “We think it’s really important to open yourself up to scrutiny and allow challenge to ensure all stakeholders’ views are taken into account.”
He added that it is important to remember that prudence can play out in various elements of valuations, it can be part of the funding level, but also part of the above mechanism.
“It’s important to remember that you need to aggregate all of this to ensure the level of prudence that you’re choosing is appropriate once you consider it as a totality.”
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