This is the Funding Strategy Statement (FSS) of the Leicestershire County Council Pension Fund (“the Fund”), which is administered by Leicestershire County Council (“the Administering Authority”).  

It has been prepared by the Administering Authority in collaboration with the Fund’s actuary, Hymans Robertson, and after consultation with the Fund’s employers and investment adviser and is effective from 31 March 2005.

1.1  Regulatory Framework

Members’ accrued benefits are guaranteed by statute.   Members’ contributions are fixed in the Regulations at a level which covers only part of the cost of accruing benefits.  Employers pay the balance of the cost of delivering the benefits to members.  The FSS focuses on the pace at which these liabilities are funded and, insofar as is practical, the measures to ensure that employers pay for their own liabilities.

The FSS forms part of a framework which includes:

This is the framework within which the Fund’s actuary carries out triennial valuations to set employers’ contributions, provides recommendations to the Administering Authority when other funding decisions are required, such as when employers join or leave the Fund.  The FSS applies to all employers participating in the Fund.

1.2  Reviews of FSS

The FSS is reviewed in detail at least every three years ahead of triennial valuations being carried out, with the next full review due to be completed by 31 March 2008.  More frequently, Annex A is updated to reflect any changes to employers.  

The FSS is a summary of the Fund’s approach to funding liabilities.  It is not an exhaustive statement of policy on all issues.  If you have any queries please contact Colin Pratt in the first instance at cpratt@leics.gov.uk or on 0116 3057656.  

2.1  Purpose of FSS

These objectives are desirable individually, but may be mutually conflicting.

This statement sets out how the Administering Authority has balanced the conflicting aims of affordability of contributions, transparency of processes, stability of employers’ contributions, and prudence in the funding basis.

2.2  Purpose of the Fund

The Fund is a vehicle by which scheme benefits are delivered.  The Fund:

One of the objectives of a funded scheme is to reduce the variability of pension costs over time for employers compared with an unfunded (pay-as-you-go) alternative.

The roles and responsibilities of the key parties involved in the management of the pension scheme are summarised in Annex B.

2.3  Aims of the Funding Policy

The objectives of the Fund’s funding policy include the following, although the list is not exhaustive:

3.1  Derivation of Employer Contributions

Employer contributions are normally made up of two elements:

The Fund’s actuary is required by the regulations to report the Common Contribution Rate, for all employers collectively at each triennial valuation.  It combines items (a) and (b) and is expressed as a percentage of pay.   For the purpose of calculating the Common Contribution Rate, the surplus or deficit under (b) is currently spread over a period of 20 years.

The Fund’s actuary is also required to adjust the Common Contribution Rate for circumstances which are deemed “peculiar” to an individual employer.  It is the adjusted contribution rate which employers are actually required to pay.  The sorts of peculiar factors which are considered are discussed in Section 3.5.

In effect, the Common Contribution Rate is a notional quantity.  Separate future service rates are calculated for each employer together with individual past service adjustments according to employer-specific spreading and phasing periods.

For some employers it may be agreed to pool contributions, see Section 3.7.6.

Annex A contains a breakdown of each employer’s contributions following the 2004 valuation for the financial years 2005/06, 2006/07 and 2007/08. For a number of employers the increases required as a result of the 2004 valuation were very large and a four year phasing period was agreed. Where relevant the 2008/09 agreed rate has been included, although in reality this rate will be superseded by a new rate derived from the 2007 valuation. It includes a reconciliation of each employer’s rate with the Common Contribution Rate.    It also identifies which employers’ contributions have been pooled with others.

Any costs of non ill-health early retirements must be paid as lump sum payments at the time of the employer’s decision in addition to the contributions described above (or over a maximum of five equal annual instalments).

Employers’ contributions are expressed as minima, with employers able to pay regular contributions at a higher rate.    Employers should discuss with the Administering Authority before making one-off capital payments.

3.2   Solvency and Target Funding Levels

The Fund’s actuary is required to report on the “solvency” of the whole fund at least every three years.

‘Solvency” for ongoing employers is defined to be the ratio of the market value of assets to the value placed on accrued benefits on the Fund actuary’s ongoing funding basis.   This quantity is known as a funding level.

The ongoing funding basis is that used for each triennial valuation and the Fund actuary agrees the financial and demographic assumptions to be used for each such valuation with the administering authority.

The fund operates the same target funding level for all ongoing employers of 100% of its accrued liabilities valued on the ongoing basis.   Please refer to paragraph 3.8 for the treatment of departing employers.

3.3  Ongoing Funding Basis

The demographic assumptions are intended to be best estimates of future experience in the Fund.  They vary by type of member reflecting the different profile of employers.

The key financial assumption is the anticipated return on the Fund’s investments.  The investment return assumption makes allowance for anticipated returns from equities in excess of bonds.  There is, however, no guarantee that equities will out-perform bonds.  The risk is greater when measured over short periods such as the three years between formal actuarial valuations, when the actual returns and assumed returns can deviate sharply.

It is therefore normally appropriate to restrict the degree of change to employers’ contributions at triennial valuation dates.

Given the very long-term nature of the liabilities, a long term view of prospective returns from equities is taken.  For the 2004 valuation, it is assumed that the Fund’s equity investments will deliver an average additional return of 2% a year in excess of the return available from investing in index-linked government bonds at the time of the valuation.

The same financial assumptions are adopted for all employers.   

3.4  Future Service Contribution Rates

The future service element of the employer contribution rate is calculated on the ongoing valuation basis, with the aim of ensuring that there are sufficient assets built up to meet future benefit payments in respect of future service.  The approach used to calculate each employer’s future service contribution rate depends on whether or not new entrants are being admitted.  Employers should note that it is only Admission Bodies that may have the power not to admit automatically all eligible new staff to the Fund, depending on the terms of their Admission Agreements and employment contracts.

3.4.1  Employers that admit new entrants

The employer’s future service rate will be based upon the cost (in excess of members’ contributions) of the benefits which employee members earn from their service each year.  Technically these rates will be derived using the Projected Unit Method of valuation with a one year control period.

If future experience is in line with assumptions, and the employer’s membership profile remains stable, this rate should be broadly stable over time.  If the membership of employees matures (e.g. because of lower recruitment) the rate would rise.

3.4.2  Employers that do not admit new entrants

Two Admission Bodies have closed the scheme to new entrants.  This is expected to lead to the average age of employee members increasing over time and hence, all other things being equal, the future service rate is expected to increase as the membership ages.

To give more long term stability to such employers’ contributions, the Attained Age funding method is adopted.   This will limit the degree of future contribution rises by paying higher rates at the outset.

Both funding methods are described in the Actuary’s report on the valuation.

Both future service rates will include expenses of administration to the extent that they are borne by the Fund and include an allowance for benefits payable on death in service and ill health retirement.  

3.5  Adjustments for Individual Employers   

Adjustments to individual employer contribution rates are applied both through the calculation of employer-specific future service contribution rates and the calculation of the employer’s asset share.

The combined effect of these adjustments for individual employers applied by the Fund actuary relate to:

over the period between each triennial valuation.]

Actual investment returns achieved on the Fund between each valuation are applied proportionately across all employers.  Transfers of liabilities between employers within the Fund occur automatically within this process, with a sum broadly equivalent to the reserve required on the ongoing basis being exchanged between the two employers.   

The Fund actuary does not allow for certain relatively minor events occurring in the period since the last formal valuation  including, but not limited to:

These effects are swept up within a miscellaneous item in the analysis of surplus, which is split between employers in proportion to their liabilities.

3.6  Asset Share Calculations for Individual Employers

The Administering Authority does not account for each employer’s assets separately.  The Fund’s actuary is required to apportion the assets of the whole fund between the employers at each triennial valuation using the income and expenditure figures provided for certain cash flows for each employer.   This process adjusts for transfers of liabilities between employers participating in the Fund, but does make a number of simplifying assumptions.   The split is calculated using an actuarial technique known as “analysis of surplus”. The methodology adopted means that there will inevitably be some difference between the asset shares calculated for individual employers and those that would have resulted had they participated in their own ring-fenced section of the Fund. The asset apportionment is capable of verification but not to audit standard.

The Administering Authority recognises the limitations in the process, but having regard to the extra administration cost of building in new protections, it considers that the Fund actuary’s approach addresses the risks of employer cross-subsidisation to an acceptable degree. It is believed that the techniques used do not bring any risk of material error in the calculation of the assets apportioned to each employing body.

The Administering Authority is currently considering the introduction of new processes that will allow all of the Fund’s cash flows to be analysed on an employer-by-employer basis. If it is deemed that the increased accuracy of such processes will outweigh the significant additional administrative burden and extra cost, processes may be introduced from some future date.   

3.7  Stability of Employer Contributions

3.7.1  Deficit Recovery Periods

The Administering Authority instructs the actuary to adopt specific deficit recovery periods for all employers when calculating their contributions.

The Administering Authority has increased the target for the recovery of any deficit over a period not exceeding 20 years.  However, these are subject to the maximum lengths set out in the table below.

This maximum period is used in calculating each employer’s minimum contributions.  Employers may opt to pay higher regular contributions than these minimum rates.

The deficit recovery period starts at the commencement of the revised contribution rate (1 April 2005 for 2004 valuation).  The Administering Authority would normally expect the same period to be used at successive triennial valuations, but would reserve the right to propose alternative spreading periods, for example to improve the stability of contributions.  

3.7.2  Surplus Spreading Periods

Any employers deemed to be in surplus may be permitted to reduce their contributions below the cost of accruing benefits, by spreading the surplus element over the maximum periods shown above for deficits in calculating their minimum contributions.

However, to help meet the stability requirement, employers may prefer not to take such reductions.   

3.7.3  Phasing in of Contribution Rises

Contractors and employers who have closed the scheme to new members will not generally be eligible for phasing in of contribution rises, unless the Administering Authority has taken the view that the long term financial risks are negligible. Other employers may opt to phase in contribution rises over a maximum of four years, but only if the contribution rises are particularly significant. Less significant rises will be subject to a maximum phasing in period of 3 years.  

3.7.4  Phasing in of Contribution Reductions

At the 2004 valuation there were no employers that were subject to a contribution reduction.

3.7.5  The Effect of Opting for Longer Spreading or Phasing-In  

Employers which are permitted and elect to use a longer deficit spreading period or to phase-in contribution changes will be assumed to incur a greater loss of investment returns on the deficit by opting to defer repayment.  Thus, deferring paying contributions will lead to higher contributions in the long-term.   

3.7.6  Pooled Contributions

3.7.6.1  Smaller Employers

The Administering Authority allows Parish and Town Councils to pool their contributions as a way of sharing experience and smoothing out the effects of costly but relatively rare events such as ill-health retirements or deaths in service.

The actuary does, however, maintain separate asset and liability calculations for all Parish and Town Councils and it will be possible to remove this pooling at future valuations. There is no intention of removing this pooling arrangement unless individual Parish or Town Councils begin to display significantly different funding positions and the cash sums involved become overly large. Even in these circumstances, it would be intended to maintain the pool for all Parish and Town Councils that continue to exhibit similar funding positions.  There were no other pooled contribution arrangements in place at the 2004 actuarial valuation.

3.8  Admission Bodies ceasing

Admission Agreements for contractors are assumed to expire at the end of the contract.

Admission Agreements for other employers are generally assumed to be open-ended and to continue until the last pensioner dies.  Contributions, expressed as capital payments, can continue to be levied after all the employees have retired.   These Admission Agreements can however be terminated at any point.

If an Admission Body’s admission agreement is terminated, the Administering Authority instructs the Fund actuary to carry out a special valuation to determine whether there is any deficit.

The assumptions adopted to value the departing employer’s liabilities for this valuation will depend upon the circumstances.   For example:

a)  For external contractors, the assumptions would be those used for an ongoing valuation to be consistent with those used to calculate the initial transfer of assets to accompany the active member liabilities transferred

b)  For other Admission Bodies that elect to voluntarily terminate their participation, the Administering Authority must look to protect the interests of other ongoing employers and will require the actuary to adopt valuation assumptions which, to the extent reasonably practicable, protect the other employers from the likelihood of any material loss emerging in future.    This could give rise to significant payments being required.

c)  For Admission Bodies with guarantors, it is possible that any deficit could be transferred to the guarantor in which case it may be possible to simply transfer the former Admission Bodies members and assets to the guarantor, without needing to crystallise any deficit.

Under (a) and (b), any shortfall would be levied on the departing Admission Body as a capital payment.

3.9  Early Retirement Costs

3.9.1  Non Ill Health retirements

The actuary’s funding basis makes no allowance for premature retirement except on grounds of ill-health.   Employers are required to pay additional contributions wherever an employee retires before attaining the age at which the valuation assumes that benefits are payable.     The current costs of these are provided to the Administering Authority by Hymans Robertson, and updated when necessary.

It is assumed that members’ benefits on age retirement are payable from the earliest age that the employee could retire without incurring a reduction to their benefit and without requiring their employer’s consent to retire.

The additional costs of premature retirement are calculated by reference to these ages.

3.9.2  Ill health monitoring

The Fund monitors each employer’s, or pool of employers, ill health experience on an ongoing basis.  If the cumulative number of ill health retirements in any financial year exceeds the allowance at the previous valuation, the employer may be charged additional contributions on the same basis as apply for non ill-health cases.

Whilst this may seem rather unfair – ill-health retirements are, effectively, unavoidable – it should be noted that the allowance made for ill-health retirements in the 2004 actuarial valuation was much lower than in previous valuations. Whilst this reduction is justified on the basis of the Fund’s recent experience, it does increase the risk of an unexpectedly large number of ill-health retirements putting extra pressure on the funding positions for all employers.

Funding and investment strategy are inextricably linked.  Investment strategy is set by Leicestershire County Council’s Pension Fund Management Board, after taking investment advice.

The Board includes members representing the County Council, Leicester City Council, the District Councils and the two Universities, as well as five non-voting staff representatives. The structure of the Board ensures that, in as practical a way as possible, the strategy set is agreed by most major stakeholders.

4.1  Investment Strategy

The investment strategy currently being pursued is described in the Fund’s Statement of Investment Principles.

The investment strategy is set for the long-term, but is reviewed from time to time, normally at least every three years, to ensure that it remains appropriate to the Fund’s liability profile.  The Administering Authority has adopted a benchmark, which sets the proportion of assets to be invested in key asset classes such as equities, bonds and property.    As at 31 March 2004, the proportion held in equities and property was 80% of the total Fund assets.

The investment strategy of lowest risk – but not necessarily the most cost-effective in the long-term – would be 100% investment in index-linked government bonds.

The Fund’s benchmark includes a significant holding in equities in the pursuit of long-term higher returns than from index-linked bonds. The Administering Authority’s strategy effectively recognises the relatively immature liabilities of the Fund and the secure nature of most employers’ covenants.

The same investment strategy is currently followed for all employers.  The number of employers whose liability profile may make a different investment strategy relevant is too small to make the operation of  different investment strategies for different employers practical or cost effective.

4.2  Consistency with Funding Basis

The Fund’s investment adviser’s current best estimate of the long-term return from equities is around 3% a year in excess of the return available from investing in index-linked government bonds.

The funding policy anticipates returns of 2% a year, that is 1% a year less than the best estimate return.

The anticipated future returns from equities used to place a value on employers’ liabilities only relate to the part of the Fund’s assets invested in equities (or equity type investments), currently 70% of all the Fund’s assets.

Non equity assets invested in bonds and cash are assumed to deliver long-term returns of 0.25%pa more than the prevailing redemption yield on Government bonds, and this reflects the fact that a substantial part of the Fund’s bond holdings are issued by companies and have a higher on-going yield and return expectation. Property holdings are assumed to deliver long-term returns of 1% more than the prevailing redemption yield on Government bonds.

In this way, the employer contributions anticipate returns from Fund assets which in the Fund actuary’s opinion there is a better than 50:50 chance of delivering over the long-term (measured over periods in excess of 20 years).

However, in the short term – such as the three yearly assessments at formal valuations – there is the scope for considerable volatility and there is a material chance that in the short-term and even medium term, asset returns will fall short of this target. There is, however, also a material chance that investment returns will be above the target. The stability measures described in Section 5 will damp down, but not remove, the effect on employers’ contributions.

The Fund does not hold a contingency reserve to protect it against the volatility of equity investments.  

4.3  Balance between risk and reward

Prior to implementing its current investment strategy, the Administering Authority  considered the balance between risk and reward by considering the level of investment in potentially higher yielding, but more volatile, asset classes like equities.  This process was informed by the use of Asset-Liability techniques to model the range of potential future solvency levels and contribution rates.

In the light of the 2004 valuation results which showed the sensitivity of individual employers’ contributions to changes in investment returns, the Administering Authority is reviewing whether its investment strategy should be refined.

4.4  Intervaluation Monitoring of Funding Position

It is intended that the Administering Authority will commence a system whereby the performance of the Fund’s assets are considered relative to the value of the liabilities during the 2005/06 financial year. This will be done by means of quarterly inter-valuation monitoring reports which will assist the Pension Fund Management Board is assessing whether minor changes the Fund’s strategic benchmark may be appropriate – for example to protect an improved funding position from the risk of a downturn in the equity market.

Employers will be informed of the estimated funding position – which will only be calculated at a Total Fund level – as part of the Pension Fund Management Board’s Annual Report.

5.1  Types of Risk

The Administering Authority’s has an active risk management programme in place. The measures that the Administering Authority has in place to control key risks are summarised below under the following headings:

5.2  Financial Risks

5.3  Demographic Risks

5.4  Regulatory

5.5  Governance

Annex A – Employers’ Contributions, Spreading and Phasing Periods

Following the 2004 valuation, the minimum employer contributions shown in the Rates and Adjustment certificate attached to the 2004 valuation report are based on the deficit recovery periods and phasing periods shown in the table below.  The table also shows the individual adjustments under Regulation 77(6) to each employer’s contributions from the ‘Common Contribution Rate’.     

Annex B – Responsibilities of Key Parties

The Administering Authority should:-

The Individual Employer should:-

The Fund actuary should:-