The £250 billion Local Government Pension Scheme for council workers needs to make 4.5% a year from its investments to fix its deficit, according to the latest calculations from the investment consultancy, Hymans Robertson. That is down from 5% a year calculated in 2013.
The figures, disclosed in a report Hymans has prepared for council funds’ December meetings, shine a light on the results of the schemes’ 2016 deficit valuations.
The full figures aren’t yet complete, but according to Barry McKay, head of actuarial consultancy for public sector schemes at Hymans, it is likely that the overall deficit fell by about 5% to 6% on average between 2013 and 2016.
The UK’s Local Government Pension Scheme – actually a set of 101 sub-funds run by major local councils across the country – has improved its solvency thanks to increased payments into the funds from councils, staff layoffs in the public sector, and better-than-expected investment returns over the past three years, according to McKay.
The shift could be seen as good news for fund managers, who may be set less challenging investment targets by council pension funds. On the other hand, the funds may shift money to low-cost index-tracking investments, or bonds, if the need for market-beating returns is reduced.
It is also likely the schemes have lowered their expected returns in the past three years, McKay said. The expected return – what schemes think their investments will make in future – is a factor in the required return – what they need to make – but deficit payments and staff layoffs will have had more of an effect, McKay explained.
McKay said that Hymans has been advising its local government pension clients to lower their expected returns from about 4.7% a year to around 4.1%.
Public sector pension funds are often criticised for over-optimistic return expectations. If they bake higher return expectations into their calculations, this can lower their deficits, as it implies they need less money today to pay pensions in the years ahead.
The biggest US state pension fund, the California Public Employees Retirement System, caused a stir just before Christmas by dropping its return target from 7.5% a year to 7%. This could increase its deficit.
The required return, by contrast, is a number that flows automatically from the expected return, together with assumptions on life expectancy, future payments into the fund and staffing levels. For the UK’s LGPS, any decrease to the expected return – which would increase deficits – looks to have been offset by deficit-reducing changes in the other factors.
Hymans found a range of required return figures across the 89 council funds in England and Wales from as low as 3% a year to as high as 6%. But only one fund among the 89 saw its required rate increase from 2013 to 2016; all the others saw a reduction. The Hymans report did not cover the 12 funds in Scotland and Northern Ireland.
The Hymans report said “funding levels are generally up” and “LGPS funds are holding more assets per pound of pension to be paid”.
The reduced return requirement is good news for council workers owed pensions by the scheme, as it is well below what City economists are forecasting for markets in the long-term. In November, JP Morgan Asset Management reduced its 15-year market returns assumption from 6.25% a year to 5.5% – the biggest drop since 2009.