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The Actuaries’ View – Do differences in assumptions matter?

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In order to assess the health of pension schemes, actuaries make a series of assumptions about the life expectancy of members, the rate of inflation and the expected growth of assets and liabilities, usually based on gilt yields.

However, the assumptions actuarial firms use vary. Some analysts argue this makes a significant difference to the deficit reported, and therefore, to the rate of contributions demanded.

KPMG UK head of public sector pensions Steve Simkins has gathered data on the difference in assumptions between actuarial firms.  

“There is a 20% difference between the most cautious and most optimistic actuarial assumptions,” he said.

“Actuaries do different things with the results. Hymans Robertson reports big deficits and high liabilities, but then says it doesn’t matter because in the long run it will all come good. Mercer is the most cautious with assumptions, and asks for the deficit to be paid back quickly.”

Steve Simkins

Steve Simkins

Mr Simkins argued that assumptions about employers’ ability to pay down their deficits should not be left to chance based on the administering authority’s choice of actuary, nor should the same assumptions be applied bluntly to all employers within the local government pension scheme.

Charities, for example, will be particularly penalised by the conditions of LGPS 2014. Due to generalisations made about the age of workforces and what employers can afford to pay, the new scheme will increase the amount of pension income members earn each year (the accrual rate) from 1/60th to 1/49th.

Employees at the end of their careers, who generally have fewer pay rises, get larger pensions than they would have under the old rules. This will cost more in contributions for employers that have older workforces, such as charities, than for employers with younger workforces, such as local authorities.

As an alternative, Mr Simkins said the LGPS should be reorganised so that it is not run along geographical lines, dividing the funds into county or city segments, but categorised by employer type.

“When discussing merging the LGPS, everyone assumes it would be done along regional lines. You would end up with five funds with vast complexities. Horizontal integration would be to take slices based on who the employers are – academies, housing associations, etc. Then their assumptions would be calculated on how the organisations work,” he said.

Graeme Muir

Graeme Muir

However, Barnett Waddingham partner Graeme Muir said the difference in assumptions does not have enough of an impact to be of concern.

He said that his firm, which carried out around a fifth of LGPS valuations in this round, bases its assumption about the growth of schemes’ investments (the discount rate) to that used by rival firms.

“Barnett Waddingham uses an economic discount rate, rather than just basing it on gilt yields, because returns on investments are a function of the market and not necessarily the same as gilts.

“On a gilts basis, funding levels are up 5-8%, but on an economic discount rate, it hasn’t changed as much since 2013.”

However, he added: “It doesn’t matter really on a long-term basis. It’s like a Top Gear Challenge. All four actuarial firms have got to get their clients from London to Glasgow. They will get there in different ways, but will all get there at about the same time.”

Steve Simkins, head of public sector pensions, KPMG UK

Graeme Muir, partner, Barnett Waddingham

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