The UK’s local government pension schemes (LGPS) should move from defined benefit to defined contribution (DC) by 2018 to escape an impending funding crisis, according to a leading think tank.
“It would be a tragedy if the LGPS were to be forced to make the move to DC.”In a report published yesterday, Michael Johnson, research fellow at the Centre for Policy Studies (CPS), claimed the 89 public pension funds in England and Wales that make up the LGPS faced a “cash flow crisis” and remained unsustainable in the long term—despite plans to increase efficiency through pooling.
The LGPS’ cash flow “faces a perfect storm,” Johnson wrote, due to pressures resulting from underfunding, declining prospects for future returns, an aging membership, and a “crippling” accrual rate.
According to March 2013 valuations, the 89 pensions were roughly 80% funded on average. However, individual funding ratios ranged from 56% to 101%—and the pensions are not all valued in the same way.
The LGPS was overhauled at the start of 2014, moving from a final salary to a career average defined benefit (DB) system. But Johnson argued a defined contribution structure, with individuals taking on investment and longevity risk, was the only way to ensure local authorities’ pensions were sustainable. He cited the National Employment Savings Trust as a potential provider of DC services: “There should be no need for taxpayers to fund another administrative structure.”
“The LGPS has been allowed to become a staggeringly inefficient, self-serving empire.”Karen Shackleton, consultant to a number of local authority pensions with AllenbridgeEPIC Advisers, agreed that the LGPS’ funding situation had to be addressed, but said it would a “tragedy” if local government workers lost out on DB guarantees.
“There comes a point where we have to ask, ‘What are we going to do about this?’” Shackleton said. Some LGPS funds face the prospect of a negative cash flow in the near future, she warned, as job cuts lead to lower employee contributions while demographics push liabilities higher.
“DC is the obvious answer,” Shackleton added. “But it would be a tragedy if the LGPS were to be forced to make that move. We are talking about [employees] that are not paid a lot of money.”
The prospect of smaller DC pensions for such workers could put pressure back on the government through the welfare system if pension savings are insufficient, Shackleton argued.
“It is likely that the outcome would be much worse for pensioners if the LGPS moved to DC, but better for the government,” said William Bourne, director at consulting firm City Noble. “I understand that the world is moving that way but pensioners will lose out.”
“Why is the LGPS where it is? It’s largely down to government policy over the last 20 years.”Bourne agreed with Johnson’s assertion that LGPS funding was unsustainable, but claimed there were other solutions than the radical move to DC, including a change of accounting measure. Using the government actuary’s methods of calculating unfunded pensions, Bourne said, would reduce much of the shortfall in local authority pensions.
Johnson also claimed that collaboration between LGPS funds was “not necessarily the panacea that many believe.” While he supported UK Chancellor George Osborne’s plan to create six large “British Wealth Funds” from LGPS assets to lower costs and improve economies of scale, Johnson said such a move would not bring about the “transformational change necessary to put the LGPS on a sustainable footing.”
“The LGPS has been allowed to become a staggeringly inefficient, self-serving empire,” Johnson wrote, “the interests of those who work within it, or provide services to it, riding roughshod over the interests of its membership, employers, and taxpayers, as well as common sense and economic rationale.”
AllenbridgeEPIC’s Shackleton defended local authority pension funds, however, arguing that in most cases the investments had been well run despite limited resources.
“Blaming the situation on the authorities is misplaced,” Bourne added. “They have done a pretty good job. Why is the LGPS where it is? It’s largely down to government policy over the last 20 years. If you look at the numbers, the returns have been pretty good.”
Read Johnson’s report, “LGPS (2018)”, in full.
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