Hewitt Bacon & Woodrow Limited
Funding Strategy Statement
City of Westminster Pension Fund
8 February 2005
CONTENTS
Section This document provides information on the:
1. Overview
2. Purpose of the Funding Strategy Statement in Policy Terms
3. Aims and Purpose of the Pension Fund
4. Responsibilities of the key parties
5. Solvency Issues and Target Funding Levels
6. Identification of Risks and Counter-measures
7. Links to Investment Policy set out in the Statement of Investment Principles
8. Consultation
9. Further Information
CITY OF WESTMINSTER PENSION FUND
FUNDING STRATEGY STATEMENT
1 INTRODUCTION
1.1 The City of Westminster is the Administering Authority for the City of Westminster Pension Fund, a Local Government Pension Scheme (“the scheme”) established in accordance with statute to provide death and retirement benefits for all eligible employees of the City Council and the admitted bodies.
1.2 Regulation 76A of The Local Government Pension Scheme Regulations 1997 requires administering authorities to prepare (and bring into effect) a Funding Strategy Statement (FSS) no later than 31 March 2005. This document describes Westminster City Council’s strategy, in its capacity as Administering Authority (Westminster), for the funding of the City of Westminster Pension Fund (the Fund).
The Statement has been prepared in accordance with Regulation 76A of the LGPS 1997 Regulations, and as required by Regulation 76A(2), with regard to guidance published by CIPFA in March 2004.
1.3 This document was approved by the Superannuation Investments Committee on
7 February 2005.
2 PURPOSE OF THE FUNDING STRATEGY STATEMENT IN POLICY TERMS
2.1 The purpose of this Funding Strategy Statement (FSS) is:
v to establish a clear and transparent fund-specific strategy which will identify how employers’ pension liabilities are best met going forward;
v to support the regulatory requirement to maintain as nearly constant employer contribution rates as possible; and
v to take a prudent longer-term view of funding those liabilities.
3 AIMS AND PURPOSE OF THE PENSION FUND
3.1 The aim of the fund is to:
v to maintain a fund with sufficient resources to provide Member benefits, in accordance with statute and regulation as and when they fall due.
3.2 The purpose of the fund is to:
v receive monies in respect of contributions, transfer values and investment income, and
v pay out monies in respect of scheme benefits, transfer values, costs, charges and expenses,
as defined in the various Local Government Pension Scheme Regulations (as amended).
3.3 The corporate objectives for the fund are:
v To ensure that sufficient resources are available to meet all liabilities as they fall due
v To enable employer contribution rates to be kept as nearly constant as possible and at reasonable cost to the taxpayers, scheduled bodies and admitted bodies
3.4 The strategy for the fund is to:
v maximise the returns from investments within reasonable risk parameters.
v manage employers’ liabilities effectively
4 RESPONSIBILITIES OF THE KEY PARTIES
The sound management of the pension fund can only be achieved if all interested parties exercise their statutory duties and responsibilities conscientiously and diligently.
The three parties whose responsibilities to the Fund are of particular relevance are the Administering Authority, the Individual Employers and the Scheme Actuary.
Their key responsibilities are as follows:
4.1 Westminster, as the administering authority will :
v collect employer and employee contributions, and as far as Westminster is able to, ensure these contributions are paid by the due date
v invest surplus monies in accordance with the Regulation 9 of the Investment Regulations
v ensure that cash is available to meet liabilities as and when they fall due
v manage the valuation process in consultation with the fund’s actuary
v prepare and maintain a Funding Strategy Statement (FSS) and a Statement of Investment Principles (SIP), both after proper consultation with interested parties, and
v monitor all aspects of the fund’s performance on a quarterly basis, and the funding position on an annual basis, and review the Funding Strategy Statement and Statement of Investment Principles at least every three years.
4.2 The individual employers will:
v deduct contributions from employees’ pay correctly
v pay all contributions, including their own as determined by the actuary, promptly by the due date
v exercise discretions within the regulatory framework
v make additional contributions in accordance with agreed arrangements in respect of, for example, augmentation of scheme benefits and early retirement strain, and
v notify the administering authorities promptly of all changes to membership, or as may be proposed, which affect future funding.
4.3 The fund actuary will:
v prepare valuations including the setting of employers’ contribution rates after agreeing assumptions with Westminster and having regard to the FSS
v prepare advice and calculations in connections with bulk transfers and individual benefit-related matters.
5 SOLVENCY ISSUES AND TARGET FUNDING LEVELS
5.1 Solvency
Westminster will prudentially seek to secure the solvency of the Fund.
For this purpose Westminster defines solvency as being achieved when the value of the Fund’s assets is greater than or equal to the value of the Fund’s liabilities when measured using ‘ongoing’ actuarial methods and assumptions.
(‘Ongoing’ actuarial methods and assumptions are taken to be measurement by use of the projected unit method of valuation, using assumptions generally recognised as suitable for an open, ongoing UK pension fund with a sponsoring employer of sound covenant.)
5.2 Funding Levels
The financial assumptions used to assess the funding level will have regard to the yields available on long term fixed interest and index linked gilt edged investments, but Westminster has also agreed with the Fund Actuary that the assumptions will make partial allowance for the higher long term returns that are expected on the assets actually held by the Fund, and understands the risks of such an approach if those additional returns fail to materialise. Westminster has also agreed with the Fund Actuary the use of explicit smoothing adjustments in making the solvency measurement.
6 FUNDING STRATEGY
6.1 Where a valuation reveals that the Fund is in surplus or deficit against this solvency measure, employer contribution rates will be adjusted to restore the solvent position over a period of years (the recovery period). The recovery period applicable for each participating employer is set by Westminster in consultation with the Fund Actuary and the employer, with a view to balancing the various funding requirements against the risks involved due to such issues as the financial strength of the employer and the nature of its participation in the Fund.
6.2 Westminster recognises that a large proportion of the Fund’s liabilities are expected to arise as benefit payments over long periods of time. For employers of sound covenant, Westminster is prepared to agree to recovery periods which are longer than the average future working lifetime of the membership of that employer. Westminster recognises that such an approach is consistent with the aim of keeping employer contribution rates as nearly constant as possible. However, Westminster also recognises the risk in relying on long recovery periods and has agreed with the Fund Actuary a limit of 30 years. Westminster’s policy is to agree recovery periods with each employer which are as short as possible within this framework.
6.3 Again, consistent with the requirement to keep employer contribution rates as nearly constant as possible, Westminster will consider, at each valuation, whether new contribution rates should be payable immediately, or should be reached by a series of steps over future years. Westminster will discuss with the Fund Actuary the risks inherent in such an approach, and will examine the financial impact and risks associated with each employer. Westminster’s policy is that in the normal course of events no more than three equal annual steps will be permitted. (In extreme cases, and with the agreement of the actuary, further steps may be permitted).
7 THE INDENTIFICATION OF RISKS AND COUNTER-MEASURES
Westminster’s overall policy on risk is to identify all material risks to the Fund and to consider the position both in aggregate and at an individual risk level. Westminster will monitor the risks to the Fund, and will take appropriate action to limit the impact of these both before, and after, they emerge wherever possible
The main risks to the Fund are:
7.1 Financial Risks
v investment markets fail to perform in line with expectations
v market yields move at variance with assumptions
v investment fund managers fail to achieve performance targets over the longer term
v asset reallocations in volatile markets may lock in past losses
v pay and price inflation significantly more or less than anticipated
v the effect of a possible increase in employer’s contribution rate on service delivery and admitted/scheduled bodies.
Westminster will endeavour to reduce these financial risks by monitoring investment performance quarterly and annually, and taking remedial action if this is considered to be appropriate.
Many statistical or financial risks can be assessed by the use of sensitivity analysis, e.g. investment returns + or –1% per annum different from assumptions made by the fund actuary over, say, three-yearly periods.
7.2 Demographic
v the longevity horizon continues to expand
v deteriorating pattern of early retirements.
v changes in the anticipated scheme membership levels and profile
If significant demographic changes become apparent between valuations, Westminster will notify all participating employers of the anticipated impact on costs that will emerge at the next valuation.
7.3 Regulatory
v changes to regulations, e.g. more favourable benefits package, potential new entrants to scheme, e.g. part-time employees
v changes to national pension requirements and/or Inland Revenue rules
The impact of proposed changes to regulations should be considered carefully and views expressed during consultation periods as to how these might influence the determination of a suitable funding strategy. (The Government is planning major changes to the Local Government Pension Scheme from 2008. The plans are contained in a consultation paper published on 4 October 2004, and the effect of these potential changes on the future liabilities and solvency of the Fund and will be assessed, and reflected in future revisions to the FSS and SIP).
Where those assumptions relate to future changes in the regulations or their impact on funding levels, the changes should be clearly stated and evaluated. For example, these might include policies on funding early retirements, budgets for ill health retirements, assumptions on achieving higher average retirement ages, improved benefits and offsetting higher employee contribution rates.
7.4 Other Actuarial Assumptions
v Solvency measure
Westminster recognises that allowing for future investment returns in excess of those available on government bonds introduces an additional element of risk, in that those additional returns may not materialise. Westminster will reduce this risk by comparing the actual fund returns against the actuaries assumed returns as part of the annual solvency review process to ensure that the funding target remains realistic relative to the low risk position.
v Smoothing
Westminster will review the impact of this adjustment at each triennial and interim valuation to ensure that it remains within acceptable limits.
v Recovery period
Westminster will discuss the risks inherent in each situation with the Fund Actuary and limit the permitted length of recovery period to no longer than 30 years.
v Stepping
Westminster recognises that permitting contribution rate changes to be introduced by annual steps rather than immediately introduces a risk that action to restore solvency is insufficient in the early years of the process. Westminster will discuss the risks inherent in each situation with the Fund Actuary and limit the number of permitted steps to three annual steps.
7.5 Governance
v the administering authority unaware of structural changes in an employer’s membership (e.g. large fall in employee members, large number of retirements)
v the administering authority not advised of an employer closing to new entrants
v an employer ceasing to exist with insufficient funding or adequacy of a bond.
Risks of insufficient or untimely information should be countered by a rigorous approach to inter-valuation monitoring and communication with employers. This should include regular reviews of funding levels and bond arrangements, and also the financial standing of employers that are not tax-raising bodies.
8 LINKS TO INVESTMENT POLICY SET OUT IN THE STATEMENT OF INVESTMENT PRINCIPLES
Westminster, as the Administering Authority, has produced this Funding Strategy Statement, having taken an overall view of the level of risk inherent in the investment policy set out in the current Statement of Investment Principles approved by the Superannuation Investments Committee on 14 September 2004, and the funding policy set out in this Statement.
The assets that most closely match the liabilities of the Fund are fixed interest and index-linked gilts of appropriate term relative to the liabilities. The Fund’s asset allocation, as set out in the Statement of Investment Principles, entails investment of a significant proportion of the Fund in assets such as equities which are expected, but not guaranteed, to produce higher returns than gilts. The Administering Authority has agreed with the Fund Actuary that the funding target on the ongoing basis will be set after making some allowance for this higher expected return. However Westminster recognises that outperformance is not guaranteed and that, in the absence of any other effects, if the higher expected returns are not achieved the solvency position of the Fund will deteriorate.
The funding strategy recognises the investment targets and the inherent volatility arising from the investment strategy, by being based on financial assumptions which are consistent with the expected average return, and by including measures which can be used to smooth out the impact of such volatility.
Westminster will continue to review both documents at least triennially, to ensure that the overall risk profile remains appropriate for the long-term liabilities of the Fund, using
asset liability modelling or other analysis techniques" where appropriate.
9 CONSULTATION
In accordance with Regulation 76A(1), all employers participating within the City of Westminster Pension Fund have been consulted on the contents of this Statement and their views have been taken into account in formulating the Statement. However, the Statement describes a single strategy for the Fund as a whole.