1. UK Actuarial Advisory Firm of the Year SLCC Larger Councils Conference graeme.muir@bwllp.co.uk

2. Agenda What is an actuary? Why do we need one? Role of actuary in the LGPS How do we do valuations? Managing deficits Current Issues Questions 2

3. What is an Actuary? Crystal ball gazer? 3

4. What is an Actuary? Thinking mans bookmaker? 4

5. What is an Actuary? Mathematical wizard? 5

6. What is an Actuary? Accountant with a personality? 6

7. What is an Actuary? Assessors/quantifiers of long term financial risks and uncertainties We “value” future uncertain cashflows Life Insurance Investment Pension Funds General Insurance Healthcare Capital Projects 7

8. UK Actuarial Advisory Firm of the Year Why do we need an actuary ?

9. Costing the pension promise Employer makes benefit promise when employment commences Cost of benefit promise not known in advanceNeed to assess the cost of the promise madeTwo stage process Estimate the future pension liabilities Place a value of them More than one valuation possible! 9

10. UK Actuarial Advisory Firm of the Year How do we do valuations?

11. Purpose of valuations Many questions! Approach depends on question being asked How much do employers need to pay in future to have enough assets to pay benefits? Ongoing triennial funding valuation Help accountants compare If we were a plc how much would we need to borrow to finance liabilities? Annual accounting valuations (IAS19/FRS17) 11 Accounting deficit usually bigger than funding deficit

12. Triennial Funding Valuation to certify levels of employer contributions to secure the solvency of the Fund Set out in LGPS Regulations As determined by administering authority With some actuarial help! Also have to look at Funding Strategy Statement Function of Funding Model / investment strategy Spreading and stepping Actuary to “have regard to desirability of maintaining as stable a contribution rate as possible” Statutory/non statutory bodies Open or closed admission agreements Different approaches possible for different employer types 12

13. Annual Accounting Valuations Essentially the same FRS17 or IAS19 Help accountants compare Key objective is consistency of measurement Discount rate? Some hard coding of assumptions Lots of volatility Some counter intuitive results sometimes Inconsistent asset and liability valuations 13

14. How do we do it? Step 1 Projection of all possible benefit payments for each member 14

15. How do we do it? Step 1 Projection of all possible benefit payments for each member Step 2 Attach probabilities to each possible payment to get “expected” payments 15

16. How do we do it? Step 1 Projection of all possible benefit payments for each member Step 2 Attach probabilities to each possible payment to get “expected” payments Step 3 Discount “expected” payments to obtain “value” 16

17. How do we do it? Look at accrued benefits and future benefits separatelyPast Service Compare assets with value of accrued benefits Future Service Determine contribution required to meet value of annual accrual of benefits Calculations completed at Whole fund level At individual employer level as well 17

18. Individual Employer Rates and Pooling All employers initially treated separately As if each had their own Fund But contribution stability less easy the smaller the employer So pool assets and liabilities of similar employers Essentially certify the average contribution rate Price is some cross subsidy of cost Hybrid pooling Separate ongoing rate but pool accrued assets and liabilities – same funding level Can “load” contributions for bad behaviour in the pool! 18

19. UK Actuarial Advisory Firm of the Year Assumptions to generate the cashflows

20. Assumptions Price Inflation (RPI) Usually difference between fixed interest and index linked gilts CPI adjustment required Salary Increases Usually 1-2% pa more than price inflation Short term adjustment? Long term adjustment? Discount rates Depends on purpose and objectives of valuation Statistical assumptions Investigate past experience Use national data Adjust for actual experience 20

21. Discount Rates Choice of discount rate depends on the question being asked Funding valuation What contributions are required to build up a fund of assets to meet pension liabilities for a given investment strategy? Accounting valuation How much would a corporate body need to borrow to finance their pension liabilities? Cessation valuation How much cash would we need to buy gilts to fund liabilities? 21

22. Discount Rates Assets at book value Discount rate = income yield on book cost First half of 20 th century – book value approach Long term assumptions Assets at discounted income value Second half of 20 th century – discounted income approach Focus on stability of valuation But not “marked to market” Both approaches essentially long term More for accounting reasons But has also influenced approach to funding Move to market related approach in last 10 - 15 years 22

23. Discount Rates Accounting valuation Corporate bond yields / cost of borrowing Minimum risk cessation Gilt yields Ongoing funding valuation Expected future investment returns from actual investment strategy Gilts and bonds – easy…. Redemption yields Equities – less easy…. Fixed risk premium over gilts (Gilt + model) Economic model (Economic model) Property/alternatives – keep it simple Somewhere between equities and gilts 23

24. Discount Rates / Equity Returns Gilt Plus models“Risk based” approach based on alleged tPR approach Doesn’t apply to LGPS! Value liabilities on minimum risk gilts basis Increase risk factor via fixed risk premium Discount rate then gilts plus something Based on asset strategy and employer covenant Seems quite sensible and nice and simple But liability values then behave like gilts Potential for lots of volatility Equities and gilts not well correlated especially in short term Problems with quantitative easing BoE making pensions “more expensive” Government taking an interest 24

25. Discount Rates / Equity Returns Our economic model Been using and developing for over 15 years Specifically designed for LGPS Assumes equity returns function of Dividend income plus Economic/dividend growth Returns then risk adjusted If more than 75% in equities Minimum and maximum real discount rates as well Valuation results assessed over 6 month period spanning valuation date Essentially some smoothing Helps meet stability objective More complex model But more robust and stable valuation results 25

26. Change in Employer Contribution 26

27. Conclusions Different valuation methods Different valuation results No “correct” answer No “real” funding level Question being asked Purpose of valuation Funding objectives Method adopted will depend on 27

28. Managing Your Deficit Essentially money owed to the Fund – a debt Pension deficits Buffer for adverse experience Reduce interest cost Reduce recovery period if affordable Interest cost more than initial deficit contributions If period more than c 20 years If assumptions borne out in practice More now means less later 28

29. 20 Year Recovery Period Total Deficit Contributions - £183m

30. 30 Year Recovery Period Total Deficit Contributions - £249m

31. Current Issues An okay last 3 years Overall employer contributions not changing much (cash terms) ? Some outliers though 2013 Valuations Robin Hood scheme More benefits for some but wait longer Short term - similar cost to old scheme Longer term – should prove less expensive 2014 Career Average Scheme Ministerial belief that bigger is better However many Funds already pretty big Potential dis-economies of scale if too big? Watch this space! Scheme Restructuring 31

32. 32 Any questions?