LGPS: the Emperor’s new pension scheme

23 Mar 15

Few will admit to the naked truth, but reforms to local government pensions have left in place a scheme that is wholly unaffordable and unsustainable.

On April 1 last year, the old Local Government Pension Scheme (LGPS) arrangements ended and new ones began – a product of a compromise thrashed out after Lord Hutton’s review into public sector pensions, commissioned by the incoming coalition government. Many members of the scheme will have hardly noticed the change, and those who did probably assume that the scheme is now sorted, at least for a few years to come.

In reality, few people are really on top of the issues facing the scheme. The complexity and jargon surrounding pensions and the LGPS does not help councillors, scheme members or taxpayers to understand the issues. Most councils do not operate their own schemes but are part of a wider one. For example, Coventry is part of the West Midlands scheme. Even finance directors struggle to keep on top of developments.

The truth is, though, that the reforms have left in place a scheme that is still wholly unaffordable and unsustainable for local authorities, and almost no one feels able to say so.

For many directors of finance or resources the escalating cost of pensions, along with grant reductions and pressures on social care costs, will be the top three financial challenges facing their authority. Yet the issue gets very little coverage in discussions and analysis of the impact of austerity. A recent report by Michael Johnson of the Centre for Policy Studies – What price localism? A case study: the Local Government Pension Scheme – robustly challenges the new arrangements, but has been largely ignored or sidelined by the sector.

Measurements of the overall position raise significant concerns. At the last actuarial revaluation in 2013, the overall LGPS was in deficit by £47bn, with an overall funding level across the 89 different schemes of 79%. Over a third of the schemes were cash flow negative – paying out more in benefits than they collect in contributions. To put this in perspective, the Revenue Support Grant for 2015/16 announced in the recent finance settlement totals just £9.4bn.

Local authorities are caught in the vice of two elements of pension costs: historic deficits and future contributions. Pension funds are trying to recover historic deficits by raising the amounts they charge authorities, sometimes dramatically. At the same time, the new scheme remains extremely generous, with employer contributions typically in a range of 12% to 15% of gross pay, and rising.

In any ‘normal’ financial climate, this would be challenging. In the current context it is wholly unsustainable. As local authority budgets reduce, and staff numbers fall, the overhead of pension costs falls on a smaller base and a smaller number of employees. Both in absolute and relative terms this is totally unmanageable.

The position in Coventry City Council is an example (see chart below). On the basis of figures supplied by the West Midlands Pension Fund, and predictions of grant cuts and staffing reductions, total pensions contributions will rise from £22.8m in 2013/14 to £39m in 2019/20. Expressed as a percentage of the gross pay bill for those in the scheme, this shows a rise from 16% to 47% – the combined impact of escalating costs and a falling workforce.

LGPS table

On this basis, by 2020, pension costs would amount to 20% of the council’s net budget and a staggering 34p of every £1 collected in council tax – and rising.

Johnson’s study lays out many of the problems with the LGPS, but he does not expose the affordability issue this starkly. There is no chance that local authorities can deal with this level of cost escalation while facing the other challenges arising from austerity.

There is a policy and equity dimension to this as well. An increasingly large percentage of local authority spending will bring no direct service benefit to residents, the vast majority of whom could never aspire to this kind of pension benefit themselves. This level of outlay on pensions can be preserved only by cuts to services, and we are now at the point where those cuts are really hurting – libraries, social care and environmental services are being lost to support spending on pensions. Surely, some action is required.

Maintaining a fair pension offering to local government staff is important, but there has to be a balance. Schemes resembling the LGPS have been largely abandoned by the private sector because they are unaffordable. The same is true in local government, and we must step up to that challenge. The government and much of the scheme's machinery are carrying on as though these huge issues are not there. Discussions centre on more reform to governance and further centralisation of investment management. The naked Emperor is adjusting his hairstyle.

The analysis above, and some of the points made by Johnson, mean that the incoming government must grasp the nettle of further reform to the LGPS
– the problems are clear and will not go away if we ignore them. There is a range of potential actions that could be looked at, many of which are not mutually exclusive. They include:

  • Revisiting employee contribution rates – the balance between employer and employee contributions is out of kilter. The employee contribution for staff earning £21,000 to £34,000 is 6.5% or 5.2% allowing for tax relief. Depending on the authority’s scheme, the employer rate could easily be 15% or more.
  • Revising the ‘accrual rate’ – this is the way in which pension benefits are earned by members of the scheme. The pre-April scheme accrued benefits at a rate of 1/60th final salary for each year of service. The new scheme has improved that rate to 1/49th, albeit of the average salary over a career rather than final salary. Many were astonished by this, and reverting to a higher accrual rate like 1/60th would have a major impact.
  • Despite fierce defence of the current organisation, is there really any case for 89 local pension funds, with their associated overheads? For most scheme members, taxpayers and Section 151 officers, the most cost-effective arrangements must be the best.
  • Pension funds are currently seeking to recover historic deficits over the medium to long term – for example, in the West Midlands the estimated deficit of £4.2bn is being recovered over the next 20 years. These deficits are based on actuarial reviews and do not suddenly materialise – they are estimates of liabilities for very many years to come at current prices. The government could act to enable funds to recover these theoretical deficits over a much longer period, reducing the costs to councils in the short and medium term.
  • Could the government be even more radical and change the way it looks at LGPS? The current scheme has deficits calculated by actuaries based on private sector approaches. In practice, all that matters is that annual cash flows can be managed. There may be a way that local and central government can thrash out a new approach to the scheme that relieves the financial pressures on authorities, and also contributes to management of the national deficit.

The size and scale of the problems facing LGPS require bold and decisive action. The first step is getting people to acknowledge there is a problem. The Emperor is naked – there you are, I’ve said it. What should we do now?

  • Chris West
    Chris West
    executive director of resources at Coventry City Council and president of the Society of Municipal Treasurers.

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