Housing associations should engage with LGPS funds in surplus

Tim GIlbert, 22 February 2024

Tim Gilbert, Partner in LCP’s Social Housing practice, looks at the key considerations for housing associations with well-funded LGPS schemes and what steps can be taken now to better manage LGPS risks.

Recent market movements have led to significant improvements in the funding positions of many LGPS funds. Rising long-term interest rates have reduced the value of the pension liabilities, whereas the assets, which are generally invested to deliver long-term real returns, have performed well. This means that many funds find themselves in a very strong position, with surpluses - assets in excess of liabilities - significantly higher than would have been expected at the 31 March 2022 valuation.

This is clearly welcome news for many housing associations that participate in LGPS funds. However, some housing associations are finding themselves subject to a ‘postcode lottery’, whereby their particular funds do not provide sufficient flexibility to take advantage of the current funding situation. There are three areas where we would like to see greater consistency across the different LGPS funds, and better engagement with the employers.

Greater flexibility of investment strategies

The LGPS funds are predominantly invested in a range of assets targeting long-term real returns. These asset returns are expected to generate funds to pay future pensions. Recently the investment strategy has performed strongly and is a key reason for the current strong funding position.

However, there is a potential issue for employers that are only participating in the LGPS for a limited time period, such as a housing association with a closed group of employees in the LGPS who will cease participation when the last employee leaves.  At the point of exit, these organisations will typically have their liabilities measured on a ‘low risk’ basis which is often derived in a way which is independent of the assets, creating volatility between the assets and liabilities. 

This approach makes it difficult for employers to set long-term financial plans with any certainty.

We are calling for LGPS funds to allow employers to individually move their share of the fund’s assets into a portfolio, which would be expected to move more in line with the value of the liabilities and significantly reduce this volatility. The consequence would be to protect any surplus and reduce risk for housing associations.

Consistency of policies on exit credits

For some employers, the value of the assets will be greater than the value of the liabilities at the point of exit from their LGPS fund. This can lead to an ‘exit credit’ being payable from the LGPS fund to the employer. 

Currently, there is a wide range of variability between different LGPS funds on the circumstances under which exit credits will be paid, the extent to which they would be paid, and indeed the calculation methodology for determining the exit position in the first place.

We would like greater consistency in LGPS funds’ policies to paying exit credits, to allow housing associations to make long-term financial plans with greater certainty.

In the meantime, we recommend that housing associations with funds in surplus seek to understand their funds’ approach to exit credits.

 Wider adoption of ‘subsumption agreements’

A ‘subsumption agreement’ allows an employer to pass LGPS assets and liabilities back to the relevant council, potentially in return for a cash payment.

This can be a good outcome for all:

  • The council receives additional funding (at a time when it is much needed).
  • The employer can reduce exposure to pension scheme risks at a lower cost than a full exit, freeing up funding to spend more on providing affordable housing.
  • The security of member benefits is not affected.
  • This does not always require a full exit, so employers may be able to continue to offer LGPS benefits to some employees.

This might sound too good to be true, and the truth is that this is a complex process to negotiate between the employer, the LGPS fund and the council to reach an agreement that is commercially acceptable to all. But it can be worth exploring if you wish to exit an LGPS fund at a price below the full exit cost.

We would like to see further clarification from the LGPS Scheme Advisory Board and the DLUHC confirming these arrangements are acceptable and setting expectations on the terms that would be expected. This would allow those councils and employers who wanted to engage with subsumption to do so more efficiently, offering housing associations a recognised alternative to a full exit.

Don’t forget accounting

There is a potential impact on a housing association’s Income and Expenditure statements when it exits an LGPS fund. If you are expecting to exit in the next few years you should consider this issue at an early stage, and determine whether there are opportunities for mitigating the impact.