LGPS: It isn’t running out of money

The LGPS should be open to scrutiny and challenge. However, observations should  be based on credible evidence and interpretation of data or incorrect conclusions risk being drawn, argues Barry McKay.

Barry Mckay, Hymans Robertson

The LGPS is undergoing a period of unprecedented change. The 89 England and Wales LGPS funds recently submitted initial proposals to the Government on how to pool investments to deliver cost savings through economies of scale and better governance.

The response to the Summer Budget announcement around the need to pool investments was swift. One initiative worth noting, Project POOL – the biggest and most authoritative study ever undertaken of the LGPS, proved that the chancellor’s ambition of creating six pooled funds across England and Wales is achievable and that significant cost savings can be made over time – around £300m per annum on conservative estimates, but potentially more.

In the midst of all this, the Centre for Policy Studies (CPS) has made claims about the sustainability of LGPS – claims based on shaky foundations.

In January it issued a note leading with the headline that LGPS “is rapidly running out of cash to meet pensions in payment, because of excessive pension promises relative to contributions”, with claims that LGPS was entering a “cashflow perfect storm” and was “unsustainable”. 

To say that LGPS is running out of cash to meet pensions is simply not true.  When you look at the LGPS in aggregate its cashflow position is positive – the contributions received are more than enough to pay current pensions.

LGPS is paying £10bn per annum in pension payments, but receiving contributions from employees and employers of more than this. As well as being cash flow positive, the LGPS has £200bn of assets set aside to pay benefits to scheme members.

Even without further contributions that’s enough to meet benefit payments for 20 years. It is not running out of money and is the only fully funded public sector scheme – the other public sector schemes have no assets set aside to pay future pensions.

Overhaul

The CPS report put forward two radical proposals with the aim of “overhauling the LGPS to create a more sustainable scheme”.

• British Wealth Funds

The first was to group funds into British Wealth Funds (BWFs) based on funding levels. This would be the wrong thing to do. Different funds use different assumptions to determine funding levels.

Using funding levels is not the best way to establish pools. It’s more important for like-minded funds with shared investment objectives to work together.

The current consultation on investment pooling has been a catalyst for the formation of pools. Project POOL facilitated this and the LGPS funds should be commended for the speed at which pools have been formed to deliver cost saving and efficiencies over the long term. These are bound to be far more successful than forcing funds together using arbitrary metrics.

• Moving the LGPS to a DC scheme 

The second proposal put forward was to move the LGPS to a Defined Contribution (DC) scheme. It’s hard to see how this would benefit the taxpayer or scheme members.

It costs more to deliver the same pension using a DC scheme than it does using a DB scheme. Presumably contributions would therefore need to be set at similar levels to maintain the level of benefits for members. Lower contributions means lower benefits.  The membership profile of the LGPS is not suited to a DC scheme.

If we look to the private sector typically people aren’t saving enough. While auto-enrolment is helping people to start saving, saving rates are typically way too low. Our analysis of almost half a million DC plans shows that two thirds of people will be short of an adequate income in retirement.

Moving to a DC scheme means that inevitably members will rely on the State.

With freedom and choice clearly there is the option to take cash. Added to that annuities have fallen out of favour. Very few people are opting for investments that guarantee an income to last to the end of their lives.

This crunch in the private sector is undoubtedly going to add pressure on the state. How would DC in the public sector be structured differently?

Primary role

Another idea put forward was “incentivizing BWFs to invest in infrastructure by providing a Treasury-funded ‘Social Premium’ paid in acknowledgement of the BWFs socialising the benefit of their assets across the whole of society.”

We need to remember that the role of the LGPS is not to support infrastructure investment across the UK. It exists to enable local authorities to pay pensions promised to its staff.

Some infrastructure investment is an appropriate and attractive investment for pension schemes, but the costs of investing in infrastructure are currently too high.  Through pooling, the hope is these will come down.

Aside from costs, the supply of, and access to, the type of infrastructure investment LGPS funds need – i.e. assets generating income streams linked to inflation – is limited.

The government has a role to play in ensuring there is a pipeline of projects that are suitable for investment by LGPS.

Clearly, it would be a win-win if the right opportunities arose to allow infrastructure investment that also met the risk/return criteria of funds, helping them meet pension promises.

We’re confident the current consultation will help facilitate greater investment in infrastructure. However, we need to remember it is important that local government pension funds can invest in a range of different investments to deliver the best outcomes for taxpayers, members and employers.

Way forward 

Before jumping to conclusions on the best medicine you have to understand how the LGPS works and the root causes of the challenges it faces today. Project POOL is an example of evidence-based analysis that is helping the LGPS to figure out the right way forward.

Barry McKay is a partner at the actuaries Hymans Robertson.