As the government’s call for evidence on LGPS reform closes, Nick Martindale explores why mergers of all shapes and sizes have been widely suggested and whether this really will improve LGPS efficiency
The issue of the cost and efficiency of public sector pension schemes has been in the spotlight for many years, and was a major driver behind Lord Hutton’s review into the topic in 2010-11. The review ultimately recommended The Pensions Regulator take over responsibility for overseeing the governance and administration of public sector schemes; something which is currently scheduled to come into force in April 2015.
The Local Government Pension Scheme (LGPS) has been seen as particularly in need of reform, both in terms of its operational and administrative effectiveness and its ability to deliver sufficient investment returns to make up for the considerable deficits that exist across its various component plans; a factor that marks it out from other – largely unfunded – public sector schemes.
This summer the government announced a review, which finished at the end of September, into how it could reduce the estimated £471 million annual administration and management costs, after revealing employer contributions to finance pension arrangements had risen from £1.5 billion in 1998 to £5.9 billion in 2012. The results have yet to be made public but many of the suggestions are likely to have centred on consolidating the 89 regional funds that make up the LGPS into a smaller number of larger funds.
“This would reduce duplication of costs such as actuarial and investment managers and provide the benefits associated with larger investment funds’ purchasing power, allowing further diversification,” says Dentons law firm partner Andrew Patten. “Larger funds will have additional opportunities for specialisation within the fund. The regulator is likely to use its powers to nudge LGPS funds along this route if the savings that are being suggested by early adopters can be realised.” The London Pension Funds Authority has already suggested that savings of £120 million per year could be realised if the London LGPS investment funds were consolidated, he adds.
Ultimately this could lead to the creation of a number of super-funds, which could create significant economies of scale, suggests business law firm DFW head of pensions Martin Jenkins. “UK-wide, this is a colossal fund of £150 billion, with annual contributions of £8 billion, but investment and monitoring is currently carried out in 40-plus regionally-based funds, with many local influences coming into play,” he says.
Yet there is also potential to achieve substantial savings by pooling administrative resources and sharing services, without having to merge funds. JLT Employee Benefits director Margaret Snowdon says these could be achieved in areas such as procurement, management information, data management and calculations, where each individual fund currently tends to have its own resource.
Aries director Ian Neale says there is particular potential around combining buying power and centralising shared services. “Discussions have already taken place between some of the London local authorities, and also between three of the Home Counties,” he says. “There are probably considerable savings to be made, but the principal barrier might be loss of control felt by individuals and individual schemes.”
Such a set-up may prove to be a less controversial and difficult arrangement than combining entire funds, believes Grant Thornton UK partner and head of local government Paul Dossett. “Merging funds would require significant structural change, which would be time-consuming and costly in itself and meet a lot of resistance from local funds,” he says. “Once undertaken, there would be no going back. The sharing option is easier to implement but requires effective partnership working, which again takes time and is not always successful.” Further information is needed around just what the costs and benefits could be, he adds.
Another potential concern with full-scale mergers revolves around the political reaction, says Stephenson Harwood pensions partner Fraser Sparks. “There is a view among some people that it would be wrong for council taxpayers in one location to fund a pension deficit in relation to another council’s employees,” he points out.
“It’s more likely that LGPS funds will seek economies of scale through the aggregation of investments and sharing administration resources rather than by full mergers.”
It is this kind of best practice – as well as ensuring the appropriate governance structures are in place – that The Pensions Regulator will be looking to facilitate, at least indirectly. “We are focused on making clear the requirements for good standards of governance and administration in schemes,” says The Pensions Regulator head of public service pension schemes Bob Scruton. “However, a scheme that is well governed and administered is likely to cost less to run. We are confident that we can work with the schemes to help them make improvements where necessary and to meet the legal requirements and standards we expect.”
Not everyone is convinced this will lead to lower costs, though. “The regulator’s focus will be on good administration and governance,” points out KPMG head of public sector pensions Steve Simkins. “This could in fact conflict with the cost-cutting agenda, as it may require more people and more work. It might also incur costs to rectify matters where problems arise, for example with historic member data.”
However this develops, there is also potential here for pooling of expertise, as well as resources, which could also have an impact on costs. “Increased collaboration and knowledge-sharing between administering authorities should be a priority,” says DLA Piper partner Claire Bell. “By comparing strategies and resources, the administering authorities can make more informed decisions, leading to cost savings and greater efficiencies.”
Another issue that will enter the debate is investment strategy, and whether the LGPS could do more to generate returns that could impact on deficits. “There is a wide range of practice and performance across the funds,” says Dossett. “Some are much more proactive than others in reviewing their strategies and looking at alternative markets. But only a minority are considering using some of their investments to reduce their liabilities around longevity. This requires a different level of expertise which many do not have access to.” The return funds get on their administration costs should also be evaluated alongside investment performance, he adds, giving the example of a large fund that reported administration costs of £15 million in 2012-13 but also gains of £656 million from investment income.
Patten, too, believes this investment criteria will have to be adjusted to meet the new economic realities. “According to the NAPF the average recovery plan for an LGPS fund is 21 years,” he says. “Given the sensitivity of LGPS members to increased contributions, often leading to opting out, investment becomes key. It may be that further loosening of the statutory limits on the sorts of investments that LGPS funds can make will need to be considered.”
There are other areas where the LGPS could draw from the experience of the private sector, too. Sparks points to the use of professional advisers; something the public sector has traditionally resisted. “In the private sector, it would be usual for a scheme to have the full range of advisers, including a legal adviser and benefit consultant in addition to an actuary, auditor and investment manager,” he says. “In our experience, there is a reluctance for administering authorities to appoint professional advisers, unless there is a statutory requirement to do so, on the grounds of saving costs. But professional advisers can assist with efficient governance and can provide a check on other providers, such as the scheme’s administrators to ensure that the scheme is being run efficiently.”
In the longer-term, The Pensions Regulator too is likely to get drawn into the debate around deficits, says Simkins. “With a wider push for transparency and for more central information on the current funding position of the LGPS and the inconsistencies across the funds, The Pensions Regulator will struggle to keep out of the debate around deficits,” he says. “It will take time, but it is likely that the regulator will at some stage have a wider role, to include funding and investment in the LGPS.”
Written by Nick Martindale, a freelance journalist