Dyfed 97% funded but private schemes lag behind

The Dyfed scheme, run by Carmarthenshire County Council, has seen its funding level rise to 97 per cent as at March 2016, from 89 per cent three years earlier.

The fund is considering adding infrastructure to its portfolio for diversification benefits, and to achieve a level of uniformity across the Welsh funds.

That picture is replicated across the Local Government Pension Scheme universe, which has an average standard funding ratio of 95 per cent, according to figures released by the LGPS advisory board in September last year.

You could end up merging half a dozen funds and have them all looking like they’re funded to the same level, and in reality they’re not

David Davison, Spence & Partners

It stands in stark contrast to the funding levels of corporate defined benefit schemes, which struggle with lower discount rates.

However, there are significant variations in the funding levels and valuation methodologies of local authority schemes.

The anonymised breakdown from the advisory board gives the best as 123 per cent funded, with the worst languishing at just 66 per cent.

Long-term investors

That improvement was partly driven by an investment strategy that outstripped the 2013 return assumptions by £103m.

Commenting on the scheme’s 69 per cent equity allocation with just a handful of managers, Carmarthenshire County Council treasury and pension investments manager Anthony Parnell said: “Simplicity is the key. Traditional and not over-complicating things, that’s our view on strategies really for the LGPS.”

For Henry Tapper, business development director at First Actuarial, this growth-orientated strategy is something that is desirable for the entire DB sector, albeit constrained by the “corporate agenda” of winding up schemes as soon as possible.

“The big difference is that these [LGPS funds] are schemes that don’t consider they’re going to close, and because of that they feel they can take a long-term view on investments,” he said, adding that the strength of local authority covenants is also key to their strategies being viable.

Local authorities in the UK cannot easily become insolvent, as they could recoup the funding needed for a large deficit increase from council taxpayers. As such, they can take greater investment risk and use higher discount rates, typically between 5.2 and 5.8 per cent.

You can be too generous

For David Davison, head of consultancy Spence & Partners’ public sector, charities and not-for-profit practice, the huge difference in covenant strength between councils and corporate sponsors makes an equity-heavy strategy unrealistic for private sector schemes.

However, he added that the generous discount rate can cloud the picture of affordability and lead to issues for other participating employers in LGPS schemes.

“They don’t have... anywhere near the same covenant as the councils,” he said.

The generous discount rate means contributions required from these employers are not as high as they would have to be in the private sector.

However, if the employer has to leave the scheme, said Davison, it would have to pay a cessation charge derived from the cost of funding the liabilities using gilts.

“The gap between the ongoing cost and the cessation cost is effectively widening,” he said

Moreover, Davison said the difference in discount rate between funds and between the four main actuarial firms in the sector could lead to difficulties, in the event that schemes decide to further their pooling programme by merging.

“You could end up merging half a dozen funds and [have] them all looking like they’re funded to the same level, and in reality they’re not,” he said.

To consolidate or not to consolidate?

Whether or not public or private schemes should pursue that level of consolidation at all is a subject of intense debate.

The LGPS pooling, under which Dyfed will join seven other Welsh funds to form £13bn in total assets, is expected to deliver significant cost savings, albeit over a relatively long period.

The Pensions and Lifetime Savings Association has suggested that to solve the problem of private sector DB affordability, schemes should be merged into superfunds, with benefits actuarially equivalised and assets invested collectively.

But for many in the pensions industry this solution would be unworkable, in part because the PLSA’s proposal removes the sponsor, but also because of more fundamental barriers.

“It will be very difficult given that we don’t have an infrastructure or a culture of [consolidation] as they do for example in Holland,” said Neil McPherson, managing director of Capital Cranfield Trustees.

Pooling governance functions, he said, could achieve many of the benefits at a much lower cost.