Contact: Ian Howell, (01962) 847540; email: [email protected]

1 Summary

1.1 Under the Local Government Pension Scheme's regulations, an actuarial valuation of the Fund must be completed every three years. The Fund's actuary Hewitt Bacon & Woodrow are nearing completion of their work on the latest valuation as at 31 March 2007.

1.2 Very early indications of the outcome were reported to the Panel in May 2007 and to the Fund's employers at the Annual General Meeting on 17 September 2007. This suggested that the employer's contribution rate would have to increase from 17.6% of pay in 2007/08 to around 20.1% by 2010/11. The County Treasurer commented at the AGM that he hoped that the final results would be lower than 20.1%.

1.3 This report sets out Hewitt's provisional results for the 2007 valuation. They indicate that the employer's contribution rate can be constrained to 19.1% of pay in 2010/11. Final confirmation of the rates should be available towards the end of November 2007 and will then be notified to the Fund's employers.

2 Recommendation

That the report be noted.

3 Purpose of the actuarial valuation

3.1 The main purpose of the valuation is to determine the rate at which employers contribute to the Fund for the following three years, 2008/09 to 2010/11. It also establishes whether the Fund is in deficit or surplus.

4 Provisional results

4.1 The County Treasurer recently met Tim Lunn from Hewitt to discuss the preliminary results from the valuation at 31 March 2007 and to confirm the key assumptions. Hewitt need to undertake further work following that meeting and so the results outlined in this report may be subject to amendment.

What has happened since the 2004 valuation?

4.2 The following key issues and events since the 2004 valuation provide the context for the outcome of the 2007 valuation:

· the removal of the 85 year rule and the changes to the transitional protection for those affected (the 85 year rule allows contributors to retire at age of 60 onwards if their age and LGPS service total at least 85 years)

· the introduction from April 2006 of an option on retirement for contributors to exchange pension for an additional lump sum (known as commutation)

· the Government's announcement of its decision on the benefit structure and other terms of the `new look' Scheme to be introduced from 1 April 2008

· better investment returns over the years since 31 March 2004 than had been assumed in the 2004 valuation

· a trend upwards in inflation expectations, as measured by the current difference between the yields on index linked gilts and fixed interest gilts, adding 0.3% to the proposed inflation assumption (from 2.9% to 3.2%)

· actual pension increases slightly higher than assumed in the 2004 valuation

· actual pay awards in line with the assumptions in the 2004 valuation

· continued improvements in longevity

· fewer ill health retirements than expected, but more withdrawals from service.

Provisional proposals for employers' contribution rate

4.3 The following employers' contribution rates reflect the issues outlined above. They are still provisional and may change. The rates apply to scheduled bodies only, with the rates for admitted bodies still to be calculated by Hewitt. The increase to 19.1% in 2010/11 will be stepped over the three years.

Why has the employers' contribution rate increased?

4.4 Subject to the further work currently being undertaken by Hewitt, the provisional employers' contribution rate for 2010/11 can be compared with the rate for 2007/08 from the 2004 valuation as follows.

Past service deficit - improved funding level

4.5 The net effect of changes since the last valuation has led to an improvement in the funding level from 69% at 31 March 2004 to 77% at 31 March 2007. This is the ratio between the Fund's assets and the value of its liabilities for past service. As the gap between assets and liabilities (the past service deficit) has reduced, the cost of funding the deficit from the employers' contribution rate will reduce by 1.3% of pay between 2007/08 and 2010/11, as shown in Table 1 above. The main driver of this improvement has been the Fund's higher investment returns over the last three years since the 2004 valuation.

Recovery period for the funding deficit

4.6 It was assumed in the 2004 valuation that the deficit between assets and liabilities would be recovered over 25 years for scheduled bodies (mainly the local authorities and former local authority-run colleges). A recovery period of 40 years was used for most of the other `admitted' bodies. It is proposed that these 25 and 40 year assumptions are unchanged in the 2007 valuation.

Future service

4.7 Although the changes to the 85 year rule and the introduction of the `new look' scheme have added to the future service cost of the Scheme, they are largely offset by the projected savings from contributors deciding on retirement to commute part of their pensions into lump sums and the higher average employees' contributions payable under the `new look' scheme. However, the higher assumption about future inflation, 3.2% instead of 2.9%, has increased the cost of future service. This is based on the actual evidence of inflation expectations from the difference between the yields on index linked and fixed interest gilts at 31 March 2007. The net effect is a 1.7% increase in the cost of future service, as a percentage of pay (as shown in Table 1 above).

Short-term investment return

4.8 The 2004 valuation included an assumption that investment returns during the three years 2005/06, 2006/07 and 2007/08 would be higher than would be achieved in the long term. It was assumed that the return would be 3.0% per annum above gilts for the Fund's assets invested in equities and property, and 0.5% per annum above gilts for the Fund's other assets. This short-term investment return assumption was considered reasonable and prudent at the time, as markets had only just begun to recover following the collapse of the dot-com boom. It had the effect of reducing the employers' contribution rates set by the 2004 valuation by 2.4% of pay. The assumption has proven to be correct, with equity markets rising steadily in recent years. Indeed, returns have been higher than allowed for by the short term investment return assumption in the 2004 valuation.

4.9 Market conditions now in 2007 are different, after nearly four years of rising markets. A similar assumption for the 2007 valuation about higher short term investment returns at that level would be more difficult to justify. However, the Fund has yet to see the full benefit of the new investment strategy implemented on 1 January 2007. By moving to a specialist management approach dividing the portfolio between high performance and low risk mandates, the Panel has sought to raise future returns within an unchanged risk envelope. This provides a rationale for the inclusion of a short-term investment return assumption in the 2007 valuation, although at a lower level than in 2004 which will have the effect of increasing the employers' contribution rate. Hewitt are currently working on the exact details of the additional returns to be assumed.

4.10 The very preliminary figure of 20.1% in 2010/11 for the employers' contribution rate reported to the Panel in May 2007 and at the AGM in September 2007 did not include any short-term investment return assumption in the 2007 valuation. The proposed inclusion now of a short-term investment return assumption is the main reason why the proposed rate for 2010/11 has been reduced from the preliminary figure of 20.1% reported in May 2007 to the current provisional estimate of 19.1%.

Effect of tiered employees' contribution rates

4.11 With the introduction of the `new look' Scheme from 1 April 2008, the employers' contribution rates will be expressed as a percentage of payroll, as shown in this report, instead of the previous practice of quoting them as a percentage of the employees' contribution rate. (For example, the 2007/08 rate of 17.6% of payroll is 295% of the current average employees' contribution rate of just under 6%). This form of presentation of the employers' rate is necessary because of the introduction of tiered employees' contribution rates in the `new look' Scheme.

4.12 Under the `new look' Scheme, employees will contribute between 5.5% and 7.5% of their pay, depending on the level of their pensionable pay. From April 2008, scheduled employers will contribute 19.1% of the employees' pay in 2010/11 (if that rate is confirmed), irrespective of the level of employees' pay. In other words, employers' contribution rates will not be tiered in the same way as the employees' contribution rates. Employers will contribute the same percentage, provisionally 19.1% in 2010/11, of the pay of their chief officers and of their administrative assistants.

5 Further work

5.1 Hewitt are continuing to work on the figures and so it has not been possible to include the full details of the results in this report. An update of the assumptions underpinning the 2007 valuation will be circulated to the Panel once Hewitt have finalised the calculations, using the format of the letter on the 2004 valuation sent to the Panel following the last meeting in May 2007.

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.

TITLE FILE

None

i:\ . . . . \ian\docs\penpanel 161107 actl valn.doc 08 November 2007