LPFA confronts employer risk through covenant monitoring

Assessing employer risk will keep actuaries busy ahead of next year’s triennial valuation of the Local Government Pension Scheme, a key benchmark for the scheme’s future and a hot topic at the Local Government Pensions Investment Forum, held in London last week.

We’ve used the Pensions Regulator’s guidance in terms of affordability of contributions and applied that in the public sector

Tony Williams, LPFA

Tony Williams, head of employer services at the LPFA, said adopting aspects of the Pensions Regulator's affordability criteria used for defined benefit schemes and monitoring the risk posed by more than 600 participating employers had improved its oversight of key funding risks. 

Williams urged attendant scheme delegates to implement a similar risk-management strategy among employer members.

“It's perfectly possible for every fund to look at this issue more closely,” he said.

“[It] enables funds to have a far greater understanding of the financial strengths of employers and the keys risks facing funds.”

Assessing employer risk

At the 2013 triennial valuation, the LPFA adopted a differential discount rate for each employer in the fund relative to the risk they posed to scheme funding.

Through that process the fund has agreed £310m of security measures with 25 participating employers through 'first-charge-on-assets' arrangements, cash injections, parent company guarantees and assurances from government departments.

Since then, the LPFA has continued to engage with individual employers. Williams said that at March 31 2015, the fund had obtained £54m worth of security from government departments, who he said saw value in using spare cash to provide extra security to the fund. 

Additional measures, such as secured income streams and in some cases escrow accounts, could reduce uncertainties in the event of insolvency and mitigate the impact of contribution rate increases for employers, he said.  

“We’ve used the Pensions Regulator’s guidance in terms of affordability of contributions and applied that in the public sector.

“The cost of monitoring employer risk and updating legal documents is low, relative to the cost to the scheme of an insolvency event… If you wait too long you are past the point of no return.”

Avoiding nasty surprises

Barry McKay, partner at consultancy Hymans Robertson, said monitoring employer risk on an ongoing basis would help individual funds and the LGPS avoid any “nasty surprises”.

“This is something a lot of funds will be doing prior to the 2016 valuation,” he said.

Matthew Harrison, managing director at covenant specialist Lincoln Pensions, said it was encouraging to see the LGPS moving towards more regular monitoring of participating employers.

“This will allow decisions made with respect to the scheme to be based on a better understanding of the capacity of the employers to support their obligations,” he said.

However, Harrison added: "As sector-wide schemes in the public sector have found, real thought needs to be given to the level of financial analysis and inquiry that can practically underpin monitoring of the employer covenant, where the employer base is so wide, and many of the entities concerned are small.”