24 | Professional Pensions | 6 March 2014 www.professionalpensions.com

Partner Insight

We have assisted other LGPS funds in monitoring covenant risk and continue to do so going forward. We have also devel-oped a partnership arrangement with Eversheds LLP to help ensure that admis-sion agreements and other legal documen-tation remains valid across funds.

Educating and engaging with employ-ers is vital and we are continually improv-ing their overall knowledge level. At this triennial valuation I have met with nearly 60 fund employers and we use a

collaborative approach in finalising valu-ation contribution rates.

Overall we have found that the benefits associated with covenant checks far out-weigh the costs, and we are likely to con-siderably improve our levels of security either through first charge arrangements, parent company guarantees or letters of assurance from government departments.

If you would like to find out more about how the LPFA is dealing with employer covenant, and would like to explore how our service could help your organisation, please visit our website at www.lpfa.org.uk/What-we-do/EMPLOYER-COVENANT-CHECKS.aspx or get in touch.

and if an employer is unable to meet the cost of at least future accrual we may now need to look to terminate admission agree-ments to prevent further liabilities accru-ing with the cessation deficit built into a legal payment plan. Often this approach is welcomed by employers who are strug-gling to meet their ongoing contributions.

One of the key objectives of public sec-tor pension schemes should be to pro-tect the taxpayer and we believe that our approach helps to achieve this. The Pension

Regulator is likely to look at overall fund governance across public sector pension funds including the LGPS and we believe that this approach helps achieve this goal.

At a recent CIPFA conference all LGPS actuaries highlighted that they are start-ing to look at the risks of fund employers either through basic covenant checks or discount rates used at whole fund level.

Our approach is different to this as we apply other categorisations and dis-count rates based on perceived risk and we believe this approach will be adopted further by other LGPS funds over the next three to six years.

Risks identified are passed to our board on a regular basis outlining the approach being adopted to mitigate risk. We also continue to engage with other funds such as USS and The Pensions Trust and vari-ous actuarial and legal advisers to contin-ually look to follow industry best practice.

• A 5.2% discount rate where there is no guarantees or security in place. We also use a 4.5% discount rate where additional risk has been identified to the fund.

This overall strategy helps ensure there is a reduced risk of liabilities being spread across all fund employers and that the strongest employers in the fund are not effectively subsidising weaker employers.

Prior to 2000 there was no requirement for an employer joining the LGPS to pro-vide a guarantor or bond to cover their

pension liabilities. This section of our fund is an area where we are looking to improve the overall security going forward in addi-tion to the improvements already made.

Where are we heading?The new approach protects the most secure funded employers and the affordability mechanism enables contribution rates to be adopted that allow businesses to grow while meeting their pension obligations.

We are also moving towards sector-wide covenant checks; examples of this are for housing associations and charities.

Certain organisations pension liabilities are effectively no longer safeguarded by Central Government guarantees and pub-lic sector spending cuts and grant reduc-tions are still impacting on organisations ability to repay deficit contributions. The likelihood of organisations being unable to meet pension liabilities remains high

Tony Williams of the LPFA explains how the LGPS provider maintains standards in employer covenant checks

Managing employer risk at the London Pensions Fund Authority

W e have been moni-toring employer cov-enant checks since 31 March 2010, so how will our fund con-

tinue to move forward in terms of moni-toring covenant risk?

Our board agreed to adopt a ‘risk-based’ approach to the 31 March triennial valu-ation process that applied different dis-count rates to employers based on their perceived risk to the fund.

This approach has been adopted so that employers who have weaker cove-nant strength are required to repay defi-cit contributions using a lower discount rate to help ensure they return to a fully funded position on an ongoing basis over a period of typically eight to 12 years.

Following the change in the Local Government Pension Scheme Regulations from 1 October 2012, which allow the tar-geting of a cessation valuation for closed employers prior to the last active mem-ber leaving the fund, we have been look-ing to avoid large deficits remaining that then need to be recovered by a legal pay-ment plan.

All contribution rates proposed under this strategy are based on affordability using the draft guidance proposals from The Pensions Regulator. Although the LGPS is not subject to scrutiny by the reg-ulator until 1 April 2015, we believe that following industry best practice helps ensure we continue to follow best scheme governance going forward.

Typically there are three main discount rates applied across the fund at the 31 March 2013 valuation:• A 5.9% discount rate which applies to employers who either have tax rais-ing powers, such as local authorities, have letters of assurance from Central Government or for an employer who has offered higher levels of security such as a ‘first charge’ arrangement’ against their overall cessation liability.• A 5.6% discount rate for employers who can either evidence secure income streams, have parent company guaran-tees, links to government departments or who have offered up lower levels of secu-rity to the fund.

Although the LGPS is not subject to scrutiny by the regulator until 1 April 2015, we believe following industry best practice helps ensure best scheme governance going forward

Tony WilliamsEmployer services team managerTel: 020 7369 6237tony.williams@lpfa.org.uk