Local Authority Pension Funds

Mark Field Excerpts

Tuesday 10th September 2013 Westminster Hall

[Mark Field (Cities of London and Westminster) (Con)]

It is a pleasure, as ever, to serve under your chairmanship, Mr Howarth. It is nice to open this debate in a characteristically packed Westminster Hall.

This is an important debate, because whenever the broader public debate turns to the somewhat thorny subject of pension provision, a contrast inevitably tends to be drawn between those who enjoy generous public sector retirement packages and those who rely on rather more meagre contributions to a private sector pension. The former group is always accused of being insulated from the real world, its members living in a gold-plated retirement heaven for which the taxpayer foots the bill. Or so at least the characterisation goes, because most public sector funds are unfunded and are therefore paid out of general taxation, which is not the case for local government employees.

Across England and Wales, there are some 89 different local government pension funds that invest an overall sum in excess of £150 billion. Technically, those funds are backed by local government, but unlike the unfunded public sector schemes, the running of proper funds better recognises the costs of pension obligations and brings to bear a greater degree of financial discipline. The Government, however, think that the current scheme, with its myriad funds collectively paying out some £350 million in fees annually, is inefficient. They also believe that investment performance could be improved and that a higher level of accountability to local taxpayers should be introduced.

I understand that the Government’s preferred alternative is pooling, with independent funds fully merged to produce cost efficiencies and to open the possibility of investment in bulky, illiquid assets outside the scope of smaller funds. That alternative is not without risks and problems. Well funded schemes might, in effect, be bailing out less well funded schemes. With new bodies appointed to manage pooled funds, there would likely be less accountability and employer-employee representation. It is also a somewhat flawed assumption that larger investment funds will necessarily deliver better investment returns at a lower cost. Of course, there is a broad risk to all of us that politicians of whatever political colour might be tempted to use the large investment funds to pay for economically unsound infrastructure projects. Local council tax payers will end up footing the bill if we get that wrong.

That something needs to be done is not disputed. In running their own funds, local authorities are exposed to pressures to which other public sector employers are not subject. Rarely have public sector schemes been fully funded, which has not been problematic historically because, of course, benefits are paid out over many years. Furthermore, until the financial crisis hit in 2008, strong economic growth, positive investment returns and a rapidly growing public sector work force ensured a net positive cash flow into the local government pension scheme, which mitigated any risk of a benefit shortfall.

The outlook, however, has been deteriorating. In 2010 the average funding level for local authority schemes was about 80%, but many analysts expect that to fall to about 75% when the 2013 valuation is released, with the growth in cash deficits being of particular significance. There is concern that that could prove to be something of a long-term trend. Indeed, a 2012 report by the Office for Budget Responsibility estimated that by 2017 the public sector work force would have shrunk by some 710,000. Of course, a reduction in that number means fewer active scheme members. Also, many of those who are paying in are supplementing constrained household budgets by reducing their monthly pension contributions. Increased life expectancy also proves an additional pressure, as does the current investment climate and the impact of the financial crisis. Indeed, in the five-year period to the end of 2012, the local government pension scheme underperformed against the long-term return target assumed on its assets by an average of some 2.8%.

No one disputes that there are big challenges for those managing the local government pension scheme, and it is right that the Government are proactively considering ways to address those challenges. There is, however, growing concern among local authorities that we are rushing headlong at the wrong alternative, which risks unintended consequences. The Minister has in the past made clear his preference for a pooled scheme that would reduce management fees and result in greater collective investment power for councils, but there are considerable legal, compliance and investment issues that must be addressed when funds are consolidated. Governance can differ and the quality of portfolios obviously varies. Scheme maturity, cash-flow characteristics, investment strategies and deficit positions can all differ considerably. Addressing those issues will inevitably impose further costs, some of which will be borne by local council tax payers.

A local authority that has acted prudently by paying regularly into its pension fund and keeping salaries under control, for example, would likely be asked to contribute more to a pooled fund in order to plug a hole caused by a less prudent authority. A rise in council tax for that responsible authority would inevitably be required, with its residents effectively bailing out councils with historically poorer performing funds, which, at the very least, is democratically dubious. With £1 in every £5 of council tax currently being spent on employer contributions to the LGPS according to figures recently released by the TaxPayers Alliance, the implications for increased liability are clear.

It is also dangerous to assume that very large, pooled funds are necessarily better performing than smaller funds. In investment there are potential diseconomies, as well as economies, of scale. Monopoly providers, more concentrated risk and a lack of diversity may all end up being a significant drag on investment returns. Active managers understand that good investment opportunities are finite, and they will close strategies to new investors if additional inflows risk compromising returns for existing investors. Indeed, many of the best-performing LGPS funds in the long term have actually been the smallest. One such example, which is obviously close to my heart, is the City of London corporation’s investment returns. One might argue that the corporation has expertise close to hand, but none the less, the returns are significantly higher than the average of larger funds over the past three and five years. It is likely that the lower costs that could be gained from pooling are only a fraction of those investment returns.

I will now address a specific London issue of which the Minister will be aware. The London Pensions Fund Authority, currently under the chairmanship of a former private equity specialist, Mr Edmund Truell, has been leading the charge in favour of consolidation and making known its interest in managing the pooled funds of the capital’s 32 local authorities and the City. I believe that bid is backed by the Mayor of London. The Minister will be aware that the bid has become a source of considerable concern among London councils, many of which believe that, if there is to be any merger of funds, it must be conducted by an organisation that better understands the LGPS and its sensitivities. Concerned authorities contend that the performance of the LPFA has been quite poor, and many feel that the LPFA simply has insufficient oversight, governance and representation. In that regard there is already a high level of accountability within the current system. Each administering authority is required to prepare a separate set of audited accounts that are fully accessible to local taxpayers. I wish to put those anxieties on the record, but they are not my primary concern.

Local authority pension holders and local taxpayers alike should be worried about the broader risk of any merged fund being subject to political interference. It might sound superficially attractive for London’s local politicians and Mayor to have access to a new pool of capital, which could support housing and other infrastructure projects across the city, but by the same token, how do we prevent that resource from possibly being subject to undue, partisan political influence? Much has been made of the Government’s desire to promote important infrastructure projects as a means of boosting growth, and I support that goal, but when such projects have stalled the finger has often been pointed at the lack of available private finance initiative funding or at the absence of investor appetite. However, investors tell me that, typically, the problem is not a dearth of available funds. There is, in fact, an enormous desire among large private sector investors to locate British projects in which to invest. The problem, as they see it, is the lack of sensible investment opportunities out there.

With politicians under increasing pressure to deliver sustainable growth, it is all too feasible that the economics will be rigged to justify the investment, with public pension funds siphoned into politicians’ pet projects or ones the private sector has deemed too risky—the High Speed 2 railway project springs to mind. Perhaps the Government are not cowed by the prospect of an unashamedly Tory Mayor digging into the public pension pot, but what if the incumbent Mayor looked and sounded a little more like Mr Ken Livingstone, the erstwhile Mayor? I am not suggesting that local government pension funds should not invest in public projects, but there is a significant risk that fund managers’ sound judgment will be clouded by meddling politicians seeking money for what prove to be uneconomic schemes.

The good news is that pooling is not the only way of making the efficiencies that are close to the Minister’s heart. Some local authorities are moving their funds into a form of joint working. As he will know, Cambridgeshire and Northamptonshire county councils have merged their pension fund administration operations, and the Society of London Treasurers is leading discussions on ways of pooling certain investments and securing a better arrangement for fees that are paid for investment opportunities where scale obviously plays a part. Local authorities that use collective investment vehicles can still use smaller-scale managers for other investment opportunities in a way that is appropriate for their funds.

Closer to home, one of my local authorities, the City of Westminster, works on a tri-borough basis with the royal borough of Kensington and Chelsea and the London borough of Hammersmith and Fulham. As a collective, they have managed to address a whole range of procurement issues—well beyond the issue of pensions—while improving resilience and developing staff expertise. Importantly for the three councils and for local ratepayers, there has been no merging of responsibility or loss of local control. When the team procures investment services, it can ask for a rate based on the combined amount of the three funds—about £2.3 billion of assets—instead of just one, so it can seek a more competitive arrangement and reduce management fees. The important point, however, is that funds can still consider other ideas individually if they are appropriate.

The tri-borough arrangement has so far worked well, and other boroughs and the Department for Communities and Local Government may wish to consider it. There are no legal obstacles or any requirements for primary legislation—other, perhaps, than the need for minor changes to regulations—so the implementation of such voluntary arrangements could be fairly swift, with summer 2014 identified as a potential start date for a pan-London co-operative scheme.

There is consensus among all the parties that change to the LGPS is necessary. However, it is likely the assumed benefits of pooling will not materialise for many years, if at all, or will be outweighed by the downsides I mentioned—time-consuming legislation, the expense of merging, potentially poorer returns and considerable conflicts of interest, which could see money siphoned into politicians’ pet projects. We are heading towards an election season, with local government elections in 2014 and a mayoral election in 2016, and this could be a high-profile part of the campaigning.

In debating this issue, we should not become preoccupied with duplicated management fees alone. Long-term returns, which quality management can deliver, will play a key part in reducing deficits and making the LGPS affordable and sustainable—coupled, of course, with a relentless focus on maintaining membership levels. In that regard, 20 London boroughs have voluntarily expressed their interest in joining a collective investment vehicle, which could deliver efficiency and value for money and be up and running in short order because it would not require legislation. Many local authorities, including those beyond the capital, have begun collaborative arrangements such as those between Northamptonshire and Cambridgeshire, and those arrangements should be given a chance to prove their worth.

The DCLG and the Mayor of London should not be distracted from the arguments against pooling by eyeing up a potential new pot of accessible gold for their infrastructure schemes. I very much hope the Treasury is not pressuring those two parties by suggesting that pooling pension funds and securitising their assets in that way is the only game in town if there are to be new infrastructure projects for the capital. If we lose focus in this debate, local government employees and the local council tax payer will pay the price.