Monitoring the cost of the LGPS

The Government Actuary’s Department (GAD) have now released the results of their 2020 valuation of the LGPS in England and Wales. Distinct from the triennial funding valuations with which most of us are more familiar, GAD’s valuation is carried out every four years and covers the entire Scheme.

The primary purpose is to monitor changes in the cost of providing LGPS benefits and to provide assurance that these costs remain sustainable. If their valuation suggests that costs have risen or fallen significantly, then changes must be made to the Scheme to bring those costs back under control. 

Before we look at the main findings, it might be helpful to understand more about the origins of this process and its objectives. Please feel free to explore the interactive timeline below if you would like a recap.

Lessons learned

It is an understatement to say that that the 2016 cost cap process was not exactly a smooth experience and brought about some unintended consequences, so it is perhaps unsurprising that the Government felt some changes might be needed in terms of how it would operate going forward.

Following a consultation, they announced technical changes to the operation of the Cost Control Mechanism for the 2020 valuations onwards. This reflected concerns that, after the initial 2016 breach, the mechanism was too volatile. The changes now make it less likely for a breach to occur, by excluding costs related to the legacy final salary schemes and by widening the acceptable range of costs. In addition, an “economic check” has been introduced which separately considers the impact of changes in the long-term economic outlook prior to considering any changes to the Scheme. 

Likewise, the SAB has introduced some analogous changes to its own process to ensure greater integration with the Treasury mechanism.

Results of the 2020 cost cap valuations

The SAB’s 2020 valuation has identified only a small deviation from the target cost of the Scheme, amounting to an increase of 1% of payroll. Being within an acceptable range, the SAB opted to not recommend any changes to the Scheme.

Under a spruced-up methodology, the Treasury mechanism is now rather convoluted and operates in two stages. 

First, there is the “core cost”. This, being the main objective of the mechanism, assesses only changes in “member costs” and therefore excludes the costs of changes in long-term economic assumptions (which are instead met by employers through changes to contribution rates). The results of changes in the core cost are illustrated in the chart below. Note that, to avoid a breach, the total change must remain inside a 3% corridor, which is shaded in blue.

As can be seen, by far the biggest contributor is the change in mortality assumptions. Even prior to Covid, there has been a trend of declining longevity improvements in the general population which has been reflected in lower life expectancies being assumed in this valuation. Further cost savings arise due to changes to “other demographic assumptions”, such as how much pension members are assumed to exchange for cash.

The chart shows that there has been a slight breach of the cost floor, which previously would have been enough to trigger improvements to scheme benefits. Under the new approach however, and this is where the second stage of the process comes in, there is an “economic check”. The idea is that if the wider economic outlook has shifted, as this may have an impact on the financial health of the local authorities who ultimately underwrite the Scheme, then it would not always be appropriate to make changes to scheme benefits.

Once the impact of the economic outlook is considered, the picture could not be more different:

Far from a breach of the cost floor, the economic check results in costs exceeding the cost ceiling. This is not unexpected given that the indicator of the economic outlook used in the calculation is the same as the discount rate used to set contributions in the unfunded schemes. This rate is referred to as the Superannuation Contributions Adjusted for Past Experience rate, or “SCAPE” rate for short, and has reduced enormously since the previous valuations, thereby causing spiralling contributions in those schemes. 

The logic of the Treasury’s economic check therefore becomes much clearer when we consider the unfunded schemes – if contributions are going up by so much then some might say it makes little sense to suggest that costs are going down and that the taxpayer is better off.

Raising the offside flag

A key feature of the economic check is that it may offset a breach but it cannot itself cause or contribute to one. In other words, it can act only to invalidate a breach. Perhaps think of it as a football referee raising the offside flag after a striker hits the back of the net. In this case, the fall in core costs suggests an initial change to the scoreline however, as the impact of the economic check completely wipes out the reduction in core costs, the flag is raised and the “goal” is disallowed.

The upshot therefore is that the 2020 Cost Control Mechanism will not result in changes to scheme benefits and so, barring any further legal developments, it is a case of “as you were”. It’s worth remembering too that, unlike in the unfunded schemes, these results will have no bearing on the contributions that must be paid into the LGPS, which of course will be reviewed as part of the next triennial funding valuations.

In the meantime, please do get in touch with your usual Barnett Waddingham contact if you have any queries on the above.