The next 12 months promise to be a very busy time for LGPS funds. Here, we share our outlook on the priorities that funds should be focusing on and planning for this year.

Actuarial

2022 looks set to be a pivotal year for funding strategies in the LGPS in England and Wales. Opportunities and challenges are generated in equal measure from strong asset returns, widening diversity of employers and evolving funding risks. Early engagement and planning will be critical to ensure we deliver a successful year that sets a strong future course for each fund.

Use of surplus options – for the first time in the working lives of many in the LGPS, it’s likely most funds will have a past-service funding surplus at the valuation. This presents a different kind of challenge for the LGPS to the one that it has faced over the last two decades. In the past, a large focus has (rightly) been on plugging deficits and reaching 100% funding. The challenge now is to consider the options available to maximise the impact of gains made in recent years.

Action: Decisions on how to use surplus will depend on each Fund’s views and priorities. The action is to create a clear future funding plan - developed through informed decision-making and strong analysis and modelling - to deliver the best outcomes for the lowest cost.

Recognising employer diversity – we might have thought the breadth of employer diversity had reached its limit in 2019, but the economic shock of the pandemic has widened this further. Even within the same sector, two different employers can have very different covenants, funding positions, risk appetites and preferences. The days of one-size-fits-all funding strategy at sector level are over. Adding employer cessation flexibility and exit credit regulations to this mix, and the range of options and factors which feed into creating an optimal employer funding plan has never been greater.

Action: It’s more important than ever to start employer funding and valuation engagement now to allow the time to consider the increasingly diverse employer population in each Fund. To succeed we must utilise all the tools available - robust planning, bringing forward discussions with employers, efficient covenant analysis and harnessing technology (like virtual meetings/forums and tuning employer valuation results in real-time).

Evolving funding risk – Investment, inflation and longevity are the long-term headline risks of an LGPS Fund. For various intertwined reasons (including the impact of the pandemic, climate change, RPI reform, etc), the challenge of understanding and managing risk requires more time for funds to consider, measure and mitigate. A key activity is to reach agreement on the level of prudence in the funding strategy to ensure the plans are robust in the face of each of these evolving risks.

Action: Use the valuations to better understand and integrate risk management into funding plans on both the asset and liability side. You guessed it: again, this means getting a head start on the analysis, scenario testing and modelling to extend the time available to fully consider and implement.

Investment

Climate change heats up - this topic received lots of attention during 2021 with many LGPS funds setting climate goals and policy. During 2022, we expect the focus to shift onto tangible actions in areas such as capital reallocation, engagement and reporting. We believe the LGPS pools can play a vital role in implementing funds’ responses to climate change and we expect this to become increasingly apparent during the year. We believe climate change represents a great opportunity for long-term investors as well as bringing huge risks; we hope the former receives as much attention as the latter over the year.

Action: Develop a high-level action plan for the next 3-5 years which is sufficient to deliver your medium-term climate objectives. Remain flexible as the policy, societal and technological responses to climate change will evolve, presenting new investment opportunities.

All eyes on inflation - inflation has risen further and faster than most market participants expected. Most, including Hymans Robertson, believe that higher inflation will prove to be transient, falling back sharply in the latter half of 2022. However, we acknowledge that the risk it persists has increased significantly in recent months. LGPS funds benefit from high allocations to equities and real assets which have historically provided good protection against high inflation over the long-term. However, we would expect funds to devote considerable time to managing inflation risk in the year ahead. Indeed we expect the monthly inflation releases to become the most closely monitored economic statistic during 2022.

Action: Assess your fund’s exposure to inflation and the likely effectiveness of the protection built into your asset portfolio.

Right risking - 2022 is valuation year in England and Wales, and many LGPS funds are expected to reach full funding (see above) for the first time in many years. Aside from being a reason to celebrate, we expect this to prompt funds and their stakeholders to review their funding and investment strategies with the aim of determining the optimal level of investment risk and contributions going forward. This will require funds to revisit their risk appetite, take stock of rising benefits costs and assess what level of contributions is affordable. All this will take place against the backdrop of a new market regime - one characterised by a normalisation of interest rates and asset prices, and by emerging risks such as the geopolitical and economic competition between the US and China and new opportunities such as decarbonisation.

Action: Review the balance of investment risk/return and contributions in light of your improved funding position and the changing market context.

Governance, Administration and Projects

Good Governance - we are looking forward to DLUHC action following conclusion of the English & Welsh Scheme Advisory Board’s ‘Good Governance’ project last year. At the same time, we anticipate the launch of a new consolidated Single Code of Practice from TPR. Most of the key changes will be known to you already as they have been well rehearsed. What has been newer territory in 2021 has been the increased discussion at Boards and Committees on cyber risk which in turn is starting a wider conversation about risk, training and good decision-making. 

Action: Review your Fund’s current governance position against the expected changes to identify any necessary actions before the implementation date. To make sure business plans for 2022 and beyond are as comprehensive as possible, feed in the outputs of this review together with a review of your current risk register and training plans.

Data - if there was one word for the challenges ahead in 2022 it would be hard to think of a contender more worthy than data. We expect consultations on phase two of the McCloud remedy to commence next year. The stage two consultation will be about the choice of benefits available during the period between CARE introductions to 31 March 2022. As with all things McCloud related, the focus will be on the availability and quality of data. We can also expect data quality and availability to be key considerations as we move closer to the launch of the Pensions Dashboard.

Action: Employer communications should be at the forefront of planning to make sure everyone knows exactly what data is needed, when it is needed and what the consequences of poor or unavailable data will be.

Projects - funds will all have their own priorities and projects but it is reasonable to assume they will include data remediation programmes to meet the challenges of McCloud and the Pensions Dashboard, in addition to projects to improve governance, meet future administration needs, and improve technology. All of this needs to be considered alongside business as usual work. For those funds delivering the valuation, it could all add up to a challenging year.  

Action: Prioritise, plan and make sure you have resource and tools to deliver your key programmes of work.

If you have any questions, or would like to discuss anything further, please get in touch.