Setting employer contribution rates

This page explains how employer contribution rates are calculated and the role of actuarial valuations.

It provides information about: 

• Local Government Pension Scheme (LGPS) funding approach.
• Purpose of the actuarial valuation for new employers. 
• Importance of the triennial valuation.
• Employer covenant assessments and relevant considerations.
• Role of the Funding Strategy Statement.
• Significance of accurate and reliable data.
• Notification of any significant events.
• Difference between the actuarial valuation and year-end accounting requirements.

Funding approach to LGPS pensions

The LGPS is funded through three key methods:

1. Employer Contributions: Employers contribute a percentage of their employees’ salaries (often referred to as the future service rate) which are “primary contributions”, plus additional contributions (referred to as the secondary rate) if there are benefits accrued to date that are not fully funded (deficits).  These rates are calculated by the Actuary via an actuarial valuation.
2. Employee Contributions: Employees also contribute a portion of their salaries. The bandings and rates payable are set out in the LGPS Regulations. Find out about Employee Contributions.
3. Investment Income: Funds are invested in various assets, such as equities, bonds and property, to generate returns over time. Further details on the APF investments can be found in the Investment Strategy Statement on the APF Member website.

The goal is to ensure that there are enough assets (cash and investments) to cover the cost of the liabilities (future pension benefits) through a combination of the above funding sources. If the value of the pension scheme assets is not sufficient to meet the pension promises made to scheme members, as calculated by the Actuary, then the scheme is in deficit. Alternatively, if the value of the pension scheme assets exceeds the pension promises made to scheme members, then the scheme will be in surplus. 

The APF and the Brunel Pension Partnership are jointly responsible for investing and managing LGPS assets after taking professional advice. The Actuary is responsible for setting employer contribution rates. 

Initial employer contribution rates are calculated when new employers join the APF. The Actuary provides these by way of an Admission Summary Paper.  Thereafter, the contribution rates are recalculated at least every 3 years as part of the Triennial Valuation.

Purpose of an Admission Summary Paper

When a new employer joins the APF the Actuary will prepare an Admission Summary Paper, setting out:

• Key details of the admission.
• Pension liabilities relating to the new employer.
• Assets attributable to the new employer (normally equal to liabilities).
• Statistics of the membership.
• Future Service Rate.
• Risk assessment/sensitivity analysis (if applicable). 

Assumptions used in the calculations will be consistent with the last triennial valuation but will vary depending on employer type and specifics of the admission, i.e. whether the employer is closed to new members and the choice of investment strategy. Multi-academy trusts may have one employer contribution rate payable across the Trust, although deficit or surplus contributions will still be calculated separately.

Employer contribution rates vary depending on the type of employer and the characteristics of the membership. As a general guide, scheme employers typically contribute around three-quarters of the total cost of pensions, with employees covering the remaining quarter.

If there is a new employer joining the APF, the actuarial valuation should be requested before admission so there is no delay in obtaining and paying the correct contribution rate. Find out about the process of joining the Fund.

Updating funding positions at the Triennial Valuation

When preparing the Admission Summary Paper, the Actuary will make a number of assumptions to estimate the potential movement in assets and liabilities. The key assumptions are:

• Expected Investment Returns – the basis of the discount rate.
• Inflation – based on CPI (soon to be CPIH).
• Salary increases.
• Membership movements.
• Demographic assumptions (mortality and longevity).

Each of these variables are unpredictable, and over time changes in these assumptions can have a substantial impact on a scheme employer’s funding position and contribution rate. As a result, by law, the Fund is required to commission an actuarial valuation every three years to assess how these factors have affected employer positions – this is called the “Triennial Valuation”. The actuary will revisit the assumptions made three years ago and may decide that, in the light of changed economic and demographic conditions, the assumptions need to change. The actuary will then revisit each employer’s valuation in detail, also taking membership changes into account, and discover that in terms of contributions either too much or too little has been collected based on the revised assumptions. If the actuary determines that too little has been collected, employer contributions in future may include a deficit contribution (secondary rate) in addition to the future service rate. This is necessary to ensure that, where benefits have not been covered by contributions to-date, they are fully funded going forwards. The period over which deficits will need to be paid is known as the “deficit recovery period”. The average deficit recovery period for Fund employers is around 12 years.

Just as important as the calculation of liabilities is the performance of the Fund’s investments over the three years since the last valuation. This can be critical factor so far as the funding level is concerned. Underperformance can result in funding deficits while performance in excess of expectations can result in funding surpluses.

In summary, during the triennial valuation the actuary will recalculate:

• The future service contribution rate (Primary rate)– the current estimated cost of providing new benefits to members.
• The past service contributions (Secondary rate) – this materialises when the scheme employers’ assets do not match their liabilities. This can either lead to deficit payments or refunds of surplus (where contributions to date have exceeded requirements based on the new assumptions).

Any resulting change in employer contributions will be effective from the 1st April in the year following the date of the Triennial Valuation and will set the contributions payable for the following three years. When an initial version of the Triennial Valuation is available, the APF will contact each employer individually to identify any additional factors which need to be taken into account. The APF’s assessment of the employer’s covenant (please see section below) may also have a bearing on the valuation result.

There are circumstances where a scheme employer’s contributions can be assessed outside of the three-year cycle; this normally occurs when there is material change in circumstances, for example, where there have been large scale redundancies – please see section “Notifiable events”.

Considerations around employer covenant

Your contribution rates may be affected by the APF’s view of your ‘covenant’. This is your financial ability to support your obligations to the scheme now and in the future. These reviews are carried out both to address potential solvency issues in a timely manner and to minimise their impact on other scheme employers so far as possible.

You may be asked for information about your financial position to inform this process - it is a legal requirement that you respond to any such requests.  Information provided will be treated in the strictest confidence.

The APF may also ask to meet with you as part of this covenant review process – this is generally to get a better understanding of the scheme employer’s circumstances and is not in itself indicative that there are concerns. The Fund will meet with a wide array of employers to get a better understanding of the general landscape.

The result of the covenant assessments is confidential and may inform contribution rates, deficit recovery period, any refund of surplus and other risk mitigation options. 

The Funding Strategy Statement

In the context of the LGPS, “Funding” is making advance provision to meet the cost of pension and other benefit promises.  Decisions taken on the approach to the issue of Funding will determine the pace at which the provision is made. Although the LGPS Regulations specify the fundamental principles on which contributions should be calculated, implementation of the Funding Strategy is the responsibility of the Administering Authority (Bath & North East Somerset Council), acting on the professional advice provided by the Actuary. The objectives of the Funding Strategy Statement (FSS) are:

• Transparency: To establish a clear and transparent fund-specific strategy which will identify how scheme employers’ pension liabilities are best met going forward by taking a prudent long-term view of liabilities.
• Solvency: To establish contributions at a level to secure the solvency of the pension fund and the long-term cost efficiency.
• Consistency: To have regard to the desirability of maintaining as nearly constant a primary rate of contribution as possible.

The intention is for this strategy to be both cohesive and comprehensive for the Fund as a whole, recognising that there will be conflicting objectives which need to be balanced and reconciled. It is also important that the Investment Strategy Statement is considered when formulating the FSS as it is a key contributor in achieving the objectives set out.

The APF will consult employers ahead of the Triennial Valuation exercise seeking feedback on the changes to the FSS, as this document sets out the core assumptions to be used in the valuation. It is important that you understand the information set out in the FSS and provide any feedback as this may affect the outcome of the Triennial Valuation results. Once consultation on the FSS has concluded, and amendments are made where appropriate, it will be taken to Pensions Committee for final approval, allowing the Actuary to then finalise the Triennial Valuation results.

The most recent Funding Strategy Statement and Investment Strategy Statement can be found in the Investments section of the APF Member website.

Accurate and timely data for the valuation

Each employer is responsible for providing the APF with information around membership and ensuring that the records are up to date. 

The information provided by Scheme Employers as part of normal monthly submissions, as well as any ad-hoc exercises, feeds directly into the Triennial Valuation results. As such, it is especially important to ensure that the information held by the APF in the lead up to the Triennial Valuation is correct and that changes in membership are recorded in a timely fashion. If a service is outsourced to a third party, responsibility for accurate data still lies with the outsourcing Scheme Employer so they should ensure that appropriate due diligence and monitoring is in place to ensure that the responsibility which has effectively been delegated to the third party is being met.

Where incorrect information has been provided, the Actuary will make prudent assumptions to ensure that any potential liability that might arise because of that missing/incorrect data is covered.

If there is expected to be any material changes in membership, whether that is redundancy, ill-health retirements, or business changes, please contact the APF’s Employer Valuation’s team (apf_employervaluations@bathnes.gov.uk) so that we can determine if any further action is needed in regards to the valuation.

Notifiable events

It is in the best interests of the Scheme Employer to inform the APF of any notifiable events that occur. This will enable the Fund to work with you to find an effective solution, particularly in times of change or financial distress and keep the interests of the Scheme Employer, the Fund, the members and the guarantor (if one exists) in mind. Early engagement is always more effective and efficient for all parties than retrospective action.

In the case of guaranteed employers (outsourcings) the Notifiable Events policy applies to both the Scheme Employer and the guarantor.

A notifiable event is any event or circumstance that, in the judgement of the APF, could materially affect one or more of the following:

• The employer’s basis for continued participation in the Fund.
• The employer’s ability to pay its ongoing contributions to the Fund.
• The employer’s ability to pay its termination debt to the Fund in the event of ceasing to participate in the Fund.

The full policy on notifiable events, including a comprehensive list of events where the APF must be notified, can be found in the Funding Strategy Statement located in the Investments section of the APF Member website.

Difference between the Actuarial/Triennial Valuation and year-end accounting

As noted in this guide, an Actuarial Valuation is produced when: 

• A new employer joins the APF (Admission Summary Paper). 
• There has been a material change in position to warrant an updated valuation. 
• Results are updated as part of the as part of the Triennial Valuation every three years.

The purpose of these valuations is to assess each Scheme Employer’s funding position and set their contribution requirements for the following years.

Accounting pension disclosures, whether FRS101/102 or IAS19, are produced solely to meet accounting requirements. They are performed annually and disclosed in employer year-end financial statements and rely on a different set of assumptions to the actuarial valuation. You should not expect the results to be comparable as, most significantly, the discount rate (investment returns) is based on corporate bonds whereas most employers’ normal funding positions rely on a higher risk/return strategy backed by equities, bonds, infrastructure etc.

While the pension figures provided for year-end accounting may indicate a trend in increasing or reducing deficit based on changes in expected corporate bond returns, this is not directly correlated to the Scheme Employer’s funding position within the Avon Pension Fund and should not be treated as a proxy for that. In short, the accounting figures are provided for disclosure purposes only and have no bearing on the Scheme Employer’s ongoing funding position.