LGPS futures: An opportunity for greater financial efficiency

LGPS has done well. But Brexit, the 2020 funding settlement and actuarial valuations next year all present a challenge. Steve Simkins argues there are ways of preparing for the future.

It is fascinating that despite all of the major changes local authorities have been through in recent years, pension arrangements remain untouched.

This is not about getting rid of them — for many members these benefits are essential, and the scheme is an important recruitment and retention tool.

However, in many cases financial efficiency and ensuring the benefits meet the needs of the workforce have not been considered to the extent they have by many other employers.

There are opportunities to make significant revenue savings, cost and risk reductions, and there are various reasons why now is the right time to look at transforming the local authority pensions landscape.

“Rainy day”

Right now, the investment markets are strong. LGPS assets have performed well and, to use a football analogy, at the mid-point of the current valuation cycle most funds were effectively 2-0 up at half time. However, as Japan, England and others have painfully learned from the World Cup, the only score that counts is the one at full-time.

Thinking ahead to the next valuation we want to make sure we are winning and that might mean hedging out some risk temporarily as we enter a potentially choppy economic period.

Consider that the next LGPS valuation date is effectively the same date that the UK is scheduled to leave the EU. Secondly, 2020 is a crucial year in many respects as there is a degree of uncertainty over funding settlements. It is also when the contributions following the March 2019 actuarial valuation will kick in.

Finally the LGPS is not necessarily right for everyone, particularly the most senior and the lowest paid. It is possible that up to 20% of the workforce would prefer a lower cost, more flexible alternative given the chance.

The most significant benefits would come from the revenue savings which can be made from re-financing pension contributions. The contributions currently being paid by any council to the LGPS are calculated by the actuary to be a prudent amount — in other words, contributions are expected to be more than enough to provide the benefits over the long term.

There is effectively a “rainy day” fund being built up within the scheme. For some councils this is adequately funded through drawing down of reserves or cuts to services.

Landscape

The challenge we have addressed is whether cutting services or drawing on council reserves is necessary and we don’t think it is. It is possible to redesign the approach to pension contributions so that the prudent part of the contributions is taken out for the first three years.

Depending on the circumstances this could be around 25% of the current contributions. This is paid back if it is needed in year four. If it is needed, this payment is made through a long-term income stream (established at outset through the sale and leaseback of a property).

This does not change the ultimate funding target for the particular LGPS fund and allows a capital asset to support the revenue account. This innovative approach to pension contributions has the potential to free up a significant amount of cash which could be directed to services which may otherwise be cut.

Further, many councils consider alternative delivery models for services and where this model uses a subsidiary company it is possible to change the pension benefits offered to new staff joining this company, and this can often be the right commercial approach depending on the nature of the service.

This creates the possibility of establishing an alternative which could be opened up as an option to all council employees. This alternative could be designed to be lower cost (and risk) for the council and less expensive (and possibly more flexible) from the employees’ perspective.

The alternative need not even be a pension. For many staff, additional cash, savings options or assistance with debt may be more appropriate.

Making such an alternative available could empower staff to make choices in relation to their benefits. It could also give some staff — currently excluded from pensions provision because of the cost — something they value and so increase the motivation and even wellbeing of the workforce.

The landscape is shifting and utilising that change to increase the financial efficiency of local authority pensions and offer members a better deal needs to be top of the agenda.

Steve Simkins is a partner in the pensions practice at KPMG.