101 superannuations: five super funds would be plenty
10 April 2012
The LGPS comprises 101 separate funds with a total of some £150bn in assets. Many of them are of sub-optimal scale, delivering sub-optimal performance. It would make eminent sense to bring them together into, for example, five funds, each with £30bn of assets. This would put them on a par with two of the largest UK pension funds – the BT Pension Scheme (£37bn) and the Universities Superannuation Scheme (£29bn).
A single fund of £150bn would be unwieldy, not least because of the difficulty in efficiently investing very large sums of money. Investments in the major companies would predominate, missing out on the opportunities in smaller (mid-cap) stocks. A single fund would also lack the diversification benefit of five separate funds, notably in respect of investment strategy, which helps protect members and taxpayers alike.
Large pension funds enjoy substantial economies of scale, including commercial clout when transacting with the financial services industry. The unions are in favour of LGPS fund consolidation; witness their submissions to Lord Hutton's commission. They understand that the subsequent improvement in fund performance – and lower costs – would justify a significantly smaller increase in employee contributions than is currently being sought by the coalition, perhaps by 50 per cent. This would ease the current negotiations.
The new funds would be large enough to have significant internal investment management and research capabilities, with a professional staff compensated at private sector rates. All administrative and procurement activities should be consolidated into a single unit, with the need for externally procured services (such as actuarial input) substantially diminished, a major cost saving. That said, some focused, cost-effective outsourcing could continue to be part of the overall investment strategy.
The commonly aired objection to fund consolidation is that because the funds' financial health (ie funding status) varies widely, membership should not be comingled. There are several ways of achieving this without risking membership consternation, including unitised schemes and segregate cell structures. In any event, the issue is a non sequitur because all the funds are, ultimately, state-backed. And this latter point facilitates the complete separation of LGPS assets from liabilities, which could significantly simplify the whole framework.
Fund consolidation would be consistent with the NAPF's call for "super trusts", and such a move would also resonate with the direction of travel of a number of pensions minister Steve Webb's initiatives (including the amalgamation of personal pension pots).
In parallel, the LGPS's governance framework is in desperate need of redesign. It is an ineffective tripartite of employers and central and local government, with a marked absence of clear accountability and responsibility. This bears all the hallmarks of the now-defunct Bank of England/FSA/HM Treasury oversight of the banks. In addition, there needs to be a radical improvement in the LGPS's operational transparency.
Evidence of the consequences of lax governance is furnished by the catastrophic financial condition of a number of the LGPS funds; certainly Hackney, Haringey and Waltham Forest are beyond the point of no return. They are now so underfunded that they are adopting the characteristics of PAYG schemes. In the meantime, their consumption of assets (to meet the cashflow demands of their pensioner membership) is accelerating; these funds are in a death spiral.
The funds' deteriorating cashflow makes for difficult decisions concerning asset allocation. Fund managers could be inclined to reduce their holdings of growth assets (notably equities) in favour of income-generating (predominately fixed income) assets, but such a move would then compromise funds' ability to recover any deficits, as the latter does not produce capital growth.
In its deliberations over the LGPS, the Department for Communities and Local Government could follow the model of the Ontario Teachers' Pension Plan. OTPP is an independent corporation overseen by a nine-member board free of political interference. With well over $100bn in assets, its in-house investment managers have produced an outstanding average annual rate of return of 10 per cent since 1990.
Other public sector pension schemes are now adopting OTPP's approach. For example, Mayor Bloomberg recently announced that New York City's pension scheme would move out of the city's administrative framework to become an investment management corporation with one independent board atop the new structure. The city currently sponsors five defined benefit plans covering 700,000 participants, with pension fund assets totalling $110bn. There are five separate boards, 15 consultants, 58 trustees, and 362 asset managers. As the first deputy comptroller observed: "It is tough to tell who has accountability and authority." The LGPS is no different.
Collectively, the 101 funds are currently cashflow positive, but the LGPS is now approaching maturity (after which pension payments will exceed contributions). A cashflow surplus of more than £3bn in 2007/8 shrank to £1.3bn in 2008/9, and the cashflow is expected to be negative by 2016, and deteriorating rapidly. An update on the Audit Commission's lucid 2010 paper Local Government Pensions in England is urgently required, perhaps by the Office for Budgetary Responsibility.
Women make up 75 per cent of the LGPS membership, and 59 per cent of active members have an annual income of less than £18,000. Ninety per cent of incomes are below £30,000, so it is no surprise that pensions are relatively low, averaging around £4,000 a year (£2,600 for women). Consequently, well under half of all employees would be affected were Lord Hutton's proposals to be implemented. Subsequent concessions further reduce this number significantly.
Objections to any LGPS change are accompanied by the stench of vested interests; this should not be allowed to overcome the national interest. The Pathfinder project has dismissed plans to merge the 11 Scottish local government pension schemes – with the exception of Strathclyde, none of them are large enough to harness any meaningful economies of scale. Six of the other 10 funds have assets of less than £1bn and four are smaller than £0.5bn. The project is being led by the Convention of Scottish Local Authorities, but whether it is on-going is unclear; repeated requests to Audit Scotland have been met by silence.
The minutes of meetings of its financial audit and assurance committee make reference to reports concerning the project, but none are in the public domain. The project reeks of political considerations and vested interests having ridden roughshod over clear-cut economic rationale and, ultimately, the interests of the LGPS membership (and taxpayers, who fund the employers' contributions).
The public sector unions' stance over pensions reform is wholly unrealistic, but they are absolutely right to request a fundamental review of the structure and governance of the staggeringly inefficient LGPS.
The DCLG should show leadership and initiate such a review, which would, hopefully, then put the panoply of smaller private sector schemes under a spotlight. Pulling these together into a few giant funds would dramatically increase the pressure on the industry to address its high charges and commissions, and lack of transparency.