Transparent Methodology Reveals Larger Than Reported Variations in LGPS Valuations.
In this report, CLERUS, in collaboration with Dr Iain Clacher from Leeds University Business School, sets out a methodology for comparing LPGS valuations on a council-by-council basis using public data and transparent calculations. The use of a standard portfolio-based approach allows stakeholders, including taxpayers, to identify schemes that are being transparent and prudent in their approach to valuation. It also enables the public to compare all schemes on a consistent basis, which has not been possible to date.
We believe that this approach is an improvement to existing proposals and could be implemented in time for the 2016 valuations.
- Overall LGPS deficit does not change materially if the long-run equity risk premium is set at 3% per annum across all 88 local authorities in England and Wales, however, if our analysis is representative across LGPS the funding levels of individual schemes could change significantly:
- -Worcestershire could see improved funding level of 15% (to 84%) / Deficit decrease of £450m
-Berkshire could see reduced funding level of 26% (to 49%) / Deficit increase of £1.1bn
- 1% change in performance assumptions equals a 9% or £35bn change in overall LGPS deficit
- Extension of recovery periods from 2010 to 2013 valuation generated a ‘paper gain’ of £9.2bn
With the 2016 valuation due at the end of March, setting out a transparent methodology allows all stakeholders to make a considered judgement about the assumptions used in past and future valuations and whether they are prudent. This is of particular importance as the forthcoming pooling of LGPS needs clear and comparable data to ensure that potential mergers are going to be effective and deliver value for the taxpayer.
Overall, we find that the aggregate deficit for LGPS does not change materially if the long-run equity risk premium is set at 3% across the board. However, if our analysis is representative for individual schemes, we find that the funding position of a number of authorities could change and in some cases significantly. This information is of particular importance if a local authority with a strong funding position is asked to merge, and therefore in effect subsidise another, where the deficit could be much higher than reported if realistic and consistent assumptions were used.
TABLE 1: Impact on overall funding levels from applying uniform return assumptions
The recommendation of this report are:
- LGPS valuations should be made comparable and shown for a range of similar performance assumptions so that stakeholders can assess the funding risk for different scenarios.
- A transparent portfolio-based valuation approach should be used where the discount rate is a function of the riskiness of the portfolio.
- Excess performance assumptions over and above standard long-run risk reward trade-offs should not be allowed as there is no free lunch in financial markets over long time horizons
- A government actuary should decide what performance assumption criteria should be used for all LGPS. We suggest that the values for excess expected return on equities over Gilts be based on 0%, 1%, 2% and 3%.
- The £ and % impact of recovery period extensions should be specified in the valuation report so that stakeholders can evaluate the extent to which each council has sought to improve the funding position from these kind of paper gains.
Dr Iain Clacher, Leeds University Business School said:
“There is a need for a consistent approach to valuation across LGPS to ensure that there can be a true assessment of value for money for the taxpayer. The present myriad of approaches makes it difficult for straight forward assessment and benchmarking to take place and this is not good for the effective management of public money.”
Henrik Pedersen, Managing Partner & Co-Founder of CLERUS said:
“The aim of this report is to illustrate how relatively straightforward and beneficial it is to set out a transparent methodology which allows all stakeholders to compare LGPS valuations on a consistent basis, which has not been possible to-date. We hope our recommendation will be included in the 2016 valuations.””
To preview the report “A Simple Way to Compare Pension Fund Deficits – Case study LGPS” click here
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CLERUS is an independent consultancy. As experienced investors we bring professional and value-added investment governance expertise directly to pension schemes and other asset owners. We add value to decision-makers because we are able to provide informed, independent and objective investment analysis. We help review and improve the performance of service providers who are not being independently or appropriately assessed. Increased transparency is created which helps identify the investment activities that provide value-for-money, and those that are detracting value. This reduces cost and improves investment outcomes.