Contact: David Wilson, ext 7407

1 Introduction

1.1 At its last meeting on 29 November 2002, the Panel considered a report reviewing the Fund's actuarial position in the light of the continuing poor performance of equity markets.

1.2 The Panel noted that the Fund's past service deficit was continuing to rise, but agreed to take no action to address the issue until the results of the next triennial valuation as at March 2004. This was based on the managers' view that yields on bonds relative to dividend yields on equities were at a historic low, and that a correction in markets was likely, although the timing was uncertain. The funding level would improve once such a correction had taken place.

1.3 Since then the Fund's deficit has been the subject of press comment and speculation. This report:

· Reminds the Panel of the results of the last full actuarial valuation in March 2001.

· Updates the Panel on the current funding position and Hewitt Bacon & Woodrow's latest projection of the position as at March 2004.

1 The last actuarial valuation as at 31 March 2001

1.1 The last actuarial valuation revealed that the Fund's assets at that date represented 88% of its liabilities, and that its past service deficit was £271m.

1.2 The actuarial value of the Fund's assets was £2,001m. This was based on the Fund's actual market value at 31 March 2001 of £1,935m plus a `smoothing adjustment' of £66m. The actuary used smoothing to allow for the possibility that markets may have underperformed in the period leading up to the valuation. This meant placing a value on the Fund's assets using valuations over the preceding three years.

1.3 The actuarial value of the Fund's liabilities was £2,272m. Hewitt Bacon & Woodrow estimated future accrued liabilities to current contributors, pensioners and deferred pensioners based on data supplied by the County Treasurer and demographic factors, in particular life expectancies. Those estimates were then discounted back to values as at 31 March 2001 using discount rates based on market yields on fixed-interest stocks and index-linked Government stocks on that date.

1.4 The deficit of £271m was £109m higher than that revealed by the previous valuation in 1998. There were then two main reasons for the declining position:

· Returns had not matched those assumed at the 1998 valuation.

· Pensioners were living longer.

1.5 To tackle the deficit, the actuary advised that a past service adjustment to employers' contributions was necessary at a level of 40% of employees' contributions for scheduled bodies. This sought to amortise the past service deficit over 40 years.

1.6 The cost of future service had also risen, mainly because of the lower investment return assumption used to discount the Fund's future, as opposed to accrued, liabilities. Hewitt Bacon & Woodrow set the future service rate at 185% of employees' contributions for all employers, compared with 170% following the 1998 exercise.

1.7 This gave a total employers' rate of 225% (40% plus 185%).

1.8 To minimise disruption to the County Council's budget, and the budgets of other scheduled bodies in the Fund, the increase in the employers' rate was introduced in three steps, as shown in the table below.

2 The current funding position and projection for March 2004

2.1 The actuary recently provided an update on the Fund's solvency level at 31 March 2003 and an updated projection of the position at 31 March 2004 assuming current market conditions persist. The following table summarises the position. Funding levels are shown on a smoothed basis.

2.2 The Panel should bear in mind that this table assumes that the Fund retains its 40-year amortisation period for eliminating the past service deficit. Hewitt Bacon & Woodrow have indicated that, if the position does not improve by March 2004, they will review both the viability of this and their smoothing methodology. Such a review could mean that the Fund could see employers' contribution rates higher than 300% from April 2005 if market conditions do not improve from what may prove to be the low point of the bear market.

3 Sensitivity analysis

3.1 Hewitt Bacon & Woodrow carried out a sensitivity analysis to show the effect of different FTSE-100 index levels on the unsmoothed funding level. The graph below shows the results. One axis shows varying levels of the index and the other the other main variable affecting funding levels, the yield on index-linked gilts, which is used to discount the Fund's liabilities.

3.2 The cross on the diagram shows where the Fund is now, with an unsmoothed funding level of 65%. The diagram shows, for example, that if the FTSE index (currently 4,003) rose further to 4,500, the unsmoothed funding level would rise to around 70%. If it rose to 5,000, the unsmoothed funding level would rise to around 75%. However, if the real discount rate, based on the gross redemption yield on index-linked gilts, rose by 0.5% on top of that, the funding level would be in excess of 80%.

4 Action

4.1 The Panel decided at the last meeting not to take any action to increase the employers' rate for 2003/04 beyond the phased increase to 215% previously agreed. The employers' rate will increase to the full rate certified by the actuary under the 31 March 2001 valuation, 225%, in 2004/05 in line with the phased introduction previously agreed by the Panel. There would be no basis from that valuation for any increase in 2004/05. It will be necessary to wait for the results of the 31 March 2004 valuation before setting new employers' rates for 2005/06. In other words, there is no scope for further action until then.

Recommendation

1 That the Panel note this report.

Section 100 D - Local Government Act 1972 - background papers

The following documents disclose facts or matters on which this report, or an important part of it, is based and has been relied upon to a material extent in the preparation of this report.

NB the list excludes:

1. Published works.

2. Documents which disclose exempt or confidential information as defined in the Act.

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