Phil Triggs: Pension fund mergers could be on Labour’s radar

LGPS practitioners need to act swiftly to determine their own fates, writes the tri-borough director of treasury and pensions at Westminster City Council.

Phil Triggs will speak at the 30th anniversary LGC Pension Insight Symposium at the Norton Park Hotel, Winchester, on 11-12 July. View the programme and book your place here.

The aggregate funding level for Local Government Pension Scheme funds in England and Wales rose to 106% in the first quarter of 2024, with asset values hitting a record high of nearly £400bn, as per Isio’s latest low-risk (gilts based) funding index.

The index showed that, of the 87 participating funds, 55 have funding levels of 100% or higher, with levels ranging from 68% to 159%.

Surpluses are nice things to talk about, regardless of just how real (or not) they are, but it could have the unintended consequence of waving a big flag at HM Treasury. One of the original LGPS defences against its defunding was the significant level of deficits, i.e., government would get more liabilities on its balance sheet than the total of any assets they may be able to liquidate, so why do it?

Additionally, some LGPS national admitted bodies have expressed the wish to remove pensioners, deferred members and active members from LGPS administering authorities, to either ‘lock in’ or take ownership of the supposed surpluses.

Record funding levels have arisen from a unique economic situation over the last couple of years, where LGPS liabilities have been measured in a way that could be regarded as divorced from reality. Gilt yields have much less to do with the LGPS in terms of liability valuation than is the case in the private sector, who are looking toward buyout: it is all about future CPI inflation. Aside from the inflationary pressure, LGPS funding levels have improved dramatically.

Conversely, what has happened to the asset side of the balance sheet since the last actuarial valuation in 2022? Have asset values risen markedly? Not really. Has the long-term global economic outlook since the 2022 valuation got significantly better? No, it’s worse. So why are we reporting LGPS funding levels at significantly enhanced levels since the 2022 valuation? It’s all down to the rise in the discount rate.

Recent high levels of CPI inflation already ‘baked in’ to pension payments and benefits will cause higher liabilities, resulting in significant increases in future monetary outflows. Accepted actuarial science regarding fund valuations seems to be at odds with practical thinking concerning the LGPS’s ability to pay its pensions in full and on time 20 years and more henceforth.

Contribution rate cuts

Despite some scepticism as to the rising discount rate providing a true indication of healthier LGPS funding levels, various consultants, including Isio, have called for substantial reductions in current and future LGPS employer contributions rates.

We do not want to ever return to that misery

For those, including this author, who have spent two decades plus in the quest for eradicating LGPS deficits through tight governance in asset allocation decisions, excellent investment performance and hefty additional contributions, such pleas will always fall on stony ground.

From the early 1990s debacle, where the government allowed the LGPS a 75% funding level pension contributions holiday (at the time of the introduction of the ill-fated community charge), it took over a generation to recover the damage caused. Local authorities knuckled down to the challenge, did not go to government with cap in hand and, admirably in the majority, recovered the deficit funding. We do not want to ever return to that misery.

The section 13 reports from the Government Actuary’s Department, due this summer, will put all the LGPS funds on a level playing field, with uniform actuarial assumptions applied throughout all the funds’ actuarial calculations. This will provide the definitive comparison of funding levels.

Future Labour government

Shadow chancellor Rachel Reeves has established a taskforce, comprised of leading figures from the UK’s investment and financial services sector, including former Bank of England governor Mark Carney and Barclays chief CS Venkatakrishnan. The taskforce will advise the Labour party on how best to implement its national wealth fund.

LGPS assets are not public funds to be utilised as government might decree

The party has pledged to invest £7.3bn in a national wealth fund to help create jobs in a zero-carbon economy, utilising different models and approaches and consulting with private investors. The attractiveness of LGPS funding surpluses and a readily available money pile within a future government’s grasp could result in primary legislation that utilises some of the £400bn for such initiatives.

LGPS assets are not public funds to be utilised as government might decree. A watertight Supreme Court case has already said that LGPS assets exist to pay the LGPS’s beneficiaries, while minimising the call on local taxpayers.

Alternatively, a future government could look at the outcome of the various current LGPS debates and discussions and conclude: “We’ve had enough of the pooling/fund mergers impasse. Let’s just take the problem – and assets – away from the LGPS”.

This could lead to the Royal Mail option.

Royal Mail option

With effect from 1 April 2012, the government assumed responsibility for both the Royal Mail Pension Plan (RMPP) deficit and the majority of its liabilities. Following this transfer of responsibility, the Royal Mail Statutory Pension Scheme (RMSPS) was established to provide retirement and death benefits to former members of the RMPP and their dependants, in respect of their service up to 31 March 2012.

In the worst case loss scenario, a 30% loss is a possibility

Approximately £28bn of pension assets were transferred from the RMPP to the government. Liquid assets were realised in the first few months following their transfer, resulting in a net gain to the taxpayer. The rest of the portfolio was realised over a much longer timeframe to optimise value for money.

At what point do we within the LGPS start addressing the possibility of something similar being done to the LGPS? Should we already have our argument sorted out as to why it is not a good idea? Apart from the fact it is not the government’s money to do with as it pleases, what other case could we make?

The main factor is how much it would cost to transition the whole LGPS into liquid form that the government could spend. When you take into account not just the physical transition costs, but also the lost value that will be realised, valuations could be markedly affected.

The government could think it is taking up to £400bn. The LGPS would be announcing to the world that it was selling somewhere in the region of £200bn in equities, and after that all of the long-dated and illiquid assets where a huge amount of value will be taken, unless there is an outstanding secondary marketing operation, or the transition takes place over a prolonged time period.

In the worst case loss scenario, a 30% loss is a possibility. Ahead of a possible discussion after the general election, we should be discussing the scenario now and making clear the threat to the future security of the LGPS.

What is more likely?

The Royal Mail option is a very extreme risk. Labour is far more likely to focus on other efficiencies rather than the nuclear option of removing the entirety of assets from the one funded public service pension scheme left in the UK.

Is Rachel Reeves thinking of one merged set of funds attached to each pool?

The more likely outcome is a look at tightening up on the governance of the 86 LGPS administering authorities, with a view to reducing that number, possibly via fund mergers. In 1972, over 400 funds became 88, which was regarded as contentious at the time. There are whispers within the LGPS community that shadow chancellor Rachel Reeves believes eight LGPS funds would be an optimal number. When LGC put this to Labour, the party did not respond.

If the number of funds was reduced to eight, it could mean some efficiencies in reduced governance and administration costs, but this would result in significant disruption to member administrative services and, with cost efficiencies being marginal at best, one would have to ask whether the administration upheaval would be worth it.

One might assume that the LGPS pooling operation could continue, although it has to be asked whether pooling would still be necessary or desirable with only eight LGPS funds being served. If Rachel Reeves has eight merged funds in mind, is she thinking of one merged set of funds attached to each pool – in other words, basically rounding up funds into larger super-funds according to their current pool membership?

Or does the logic go further: would there be a good reason to have one super-fund attached to each pool and keep them as separate entities, or would it make more sense to effectively merge each pool with its members funds?

Get ahead of the curve

Alternatively, the use of shared services, such as the tri-borough model (four funds) and Kingston/Sutton (two funds) could be stepped up significantly and similar cost savings could be achieved.

With this scenario in mind, LGPS practitioners need to get ahead of the curve in terms of looking at the plethora of fund merger possibilities. Could administering authorities come up with reasonable and responsible ways of voluntary mergers which enable a level of sovereignty and accountability to be retained, rather than having an unknown and unanticipated fate bestowed upon us by government?

In other words, comply under our own terms, or be compelled under someone else’s.

The London Pensions Fund Authority, with advice from Hymans Robertson, has emerged from nowhere and is currently looking hard again at the 32 London boroughs for a possible takeover operation.

Various county council funds are said to be in negotiations with a view to a form of collaboration or merger, whereby more than one LGPS pool might be accessible to the merged entity.

In a similar fashion to 2015 – when LGPS pooling was first scrambled – the dance cards are being proffered. To determine their own fates, LGPS funds need to get their dance partners nailed down quickly and definitively.

To all LGPS practitioners, nota bene. It is that urgent.

Phil Triggs, tri-borough director of treasury and pensions, Westminster City Council

Phil Triggs will speak at the 30th anniversary LGC Pension Insight Symposium at the Norton Park Hotel, Winchester, on 11-12 July. View the programme here and book your place here.