Substantial reform of the Local Government Pension Scheme is increasingly looking inevitable. What is more, that reform is not dependent on a different government. Even existing ministers seem determined to instigate major, perhaps even fundamental, change.
In June this year, DCLG began an “informal consultation exercise” in which it invited a limited number of stakeholders to respond to proposals for the next stage in the almost permanent evolution of the LGPS.
The most significant proposed change is to introduce increased graduation of employee contributions. There is already graduation from a minimum of 5.5% staff contributions to a maximum of 7.5%. It is now proposed that there should be much greater use of bands, with contributions ranging from 5.5% for the lowest paid staff (those earning less than £15,000), up to a top rate of 10% for those on £110,001 or more.
Other proposals in the consultation paper include the widely supported suggestion that there should be more transparency in the valuation and management of funds and the contentious, but perhaps misunderstood, recommendations on relaxing funding levels and solvency requirements.
DCLG explains that at the last triennial review in March 2007, LGPS funds were funded at 83% of potential liabilities – an improvement on the 74% funding achieved at the preivious review in 2004. But comments in the paper suggesting that there should not be too much emphasis on ensuring 100% funding have caused pension fund professionals to worry about exactly what DCLG was proposing.
The paper warned that, despite asset values having lifted off their floor in recent months, “there remains the likelihood of an adverse 2010 outcome” at next year’s triennial review. It also points out that while the current regulations do provide a solvency requirement, this is “undefined”, adding that “a uniform 100% funding target can become artificial and impose significant short term cost pressures on employers during times of economic downturn and falling investment returns”.
It is suggested that the solvency obligation should be modified, with “a more flexible model” adopted in its place. There would, though, be a requirement on each LGPS administering authority to have a Financing Plan that demonstrates how it will fund its pension liabilities.
Despite the proposals for a Financing Plan, there has been a widespread interpretation that LGPS was, effectively, proposing a return to only financing a level of liabilities – with assumptions that this could turn the clock back to the old 75% funding level requirement.
Pension professionals believe that DCLG is right to say ‘don’t panic’ over short-term investment downturns, but not if this leads to an acceptance of ongoing underfunding. As consultees began expressing fears that the proposals might lead to a return to major underfunding, DCLG has privately had to reassure consultees that it means no such thing.
Bob Summers, chair of CIPFA’s pension panel, says: “Our view is that it is important that a pragmatic approach is taken. I do feel that it is essential to take a long-term perspective.
“It has to be good practice that all employers are aware of the risks in the fund and the policies that the fund is pursuing. What I would not endorse at all is going back, if that is implied by this, to the regime we had several years ago when the funds were only financed to 75% of their liabilities. That is not something I would think is sensible and [the effect of] that still hangs over a number of funds around the country.”
John Wright, head of public sector consulting at LGPS consultants and actuaries Hymans Robertson, takes a similar view. He believes that DCLG is right to take action now “to avoid sharp increases in contributions in 2010”, which his firm believes can be achieved without any regulatory change. It also supports the move to Financing Plans, more rigorous risk assessment by funders and greater fund transparency.
“We support the CLG’s encouragement for [risk] to be more widely understood and possibly that risk assessment should be compulsory,” says Wright. “Maybe we don’t need regulatory change to do that.
“There are a couple of areas in the consultation we do not support. One is the idea of long-term funding targets. Since then [the publication of the consultation paper] CLG has made it very clear that it doesn’t mean the return of 75% funding targets. We are very clear we must aim for 100% funding in the long-term. We would maintain you must maintain 100% funding target for the long-term.”
Hymans Robertson is similarly definite that all funds should be compared on a like-for-like basis, with clearer rules about the measuring of assets and liabilities and assumed investment returns. The firm does not accept there should be a big increase in the graduation of employee contributions, which it believes over the medium and longer term will merely be incorporated into higher employee pay demands.
Here, though, we begin to move into the area covered by a second consultation process that is about to begin. In its June consultation paper, DCLG said that the then local government minister John Healey had laid down in a speech to the National Association of Pension Funds in May his approach to ensuring the sustainability of LGPS over the longer term.
The good news for local government workers is that Healey repeatedly stressed his commitment to the LGPS and that it provide greater security and better benefits than the typical private sector defined contribution scheme. But he also insisted that council tax payers should be protected by long deficit recovery periods when investment returns fall and also by the need for greater scheme sustainability for employers.
As a counter to these principles, Healey stessed that “the workforce of the future is going to have to be more flexible, possibly working longer, and demanding more personalised benefits”. LGPS needs to be redesigned, he suggested, to reflect those requirements, while also “remaining fair to the taxpayer”.
Part of the likely answer, Healey hinted, will be to reduce the administrative costs of the scheme, through shared administrative arrangements and fund mergers. In addition, he implied, there might be a change in the balance between contributions and benefits.
Hymans Robertson believes this should mean that in place of a final salary scheme, LGPS should adopt both career average pay in place of final salary, plus a mix of defined benefits and defined contibutions, with staff and employers sharing the risks both on investment returns and extended longevity. “We think CLG is open to these ideas,” explains Wright. He believes that this approach is preferable to more graduation of employee contributions.
“At the very least DCLG should move the LGPS retirement age in line with the state pension age,” says Wright. Hymans’ own analysis suggests that at present life expectancy is increasing by two years every decade. On this basis, even the current aim of extending the state pension age to 68 by 2050 is not a sustainable approach to increased longevity. Hymans believes that what is required is something more radical, both for state retirement age and LGPS pensionable age, to move to perhaps 70 and to do so earlier than by 2050.
Bob Summers of CIPFA’s pension panel says he understands why the Government wants to increase the graduation of employee contribution rates. “It’s clearly a political issue,” he says. “You can understand this when the scheme is under attack by other parties.” Summers adds, though, that it is up to DCLG to explain what principles it is applying in order to reach its proposed employee staff graduated contributions.
Even more telling though could be the investment environment, which is different now from when DCLG began making proposals in the Spring. “Things do change very quickly,” stresses Summers.
This point was emphasised just days ago when Aon Consulting said that private sector defined contribution pension funds had recovered by mid August to the values they had recorded in September last year, as many investments substantially bounced back.
Just like the criticisms of army generals, it could be that DCLG is now fighting the last war instead of the next one. Alternatively, though, with a probable Conservative government next year impatient to cut public sector costs, the current proposals may seem like a very attractive quick fix that is simply too tempting to ignore.
Box
92% of public sector workers don’t know the value of their pension
53% of local government workers are worried their pensions will come under the same pressures as those in the private sector
48% are unaware of changes to their pension scheme
21% chose the public sector for its pensions
Source: Hymans Robertson survey