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Local Authority Pension Funds

Volume 567: debated on Tuesday 10 September 2013

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.

I thank my hon. Friend the Member for Cities of London and Westminster (Mark Field) for raising the important matter of the effectiveness and efficiency of the local government pension scheme. It is a hugely important issue for local government, as well as for taxpayers and beneficiaries of the scheme, and it is good to give it an airing. It often does not get the coverage it probably should, and I am disappointed Opposition Members are not here to discuss it.

My hon. Friend said the funded nature of the scheme ensures better financial discipline and recognition of the cost of pension obligations, and I thoroughly agree. Since taking responsibility for the scheme, I have been hugely impressed by the performance of many of the 89 individual pension fund authorities in England and Wales. I have been particularly impressed with the work some of them have been doing since we started this more public debate on working together. As my hon. Friend outlined, Northamptonshire, Cambridgeshire, authorities in London and others are looking at what they can achieve.

When I meet the schemes’ representatives, and when I speak at conferences, it seems that all the schemes share the view that we need to look at whether 89 is the right number or whether it should be lower. Equally, however, every one of them is clear that, even if the number is reduced, they should be one of those that remains, because they all claim to be the best fund in the land when I speak to them. I understand and appreciate that passion, but I have also seen enough data and evidence to be equally concerned by the mixed performance across the board, with inconsistency in investment performance and variation of fund management costs across the 89 funds.

That is not to say that the scheme as a whole is inefficient in any way, but I accept my hon. Friend’s point that there is room for improvement. That is why, on 21 June, I made a call for evidence on the scheme’s future structure. That call for evidence runs until the end of September, so I am sure my hon. Friend will forgive me if I say there is a limit to what I can say in response to his points. I appreciate he is seeking a firm and unequivocal response from the Government, and rightly so, but I am sure he recognises that it is important for me and the Government to keep an open mind during the call for evidence. It would, therefore, be inappropriate for me to express any determined preference or to give an indication of the Government’s position at this stage in the consultation process, but I will respond to some of my hon. Friend’s more general points and explain in more detail why I have made a call for evidence. I hope that will go some way towards answering some of his points.

Members will be familiar with the work of the public service pensions commission chaired by Lord Hutton of Furness. His final report, which was published in October 2011, made 27 recommendations, and one related directly to the local government pension scheme. In recommendation 23, Lord Hutton said:

“Central and local government should closely monitor the benefits associated with the current co-operative projects within the LGPS, with a view to encouraging the extension of this approach, if appropriate, across all local authorities.”

I fully support the work being undertaken by the LGPS fund authorities on working in partnership in the way Lord Hutton envisaged, including in the areas my hon. Friend mentioned. I will continue to encourage and assist any initiative designed to offer better value for money for local authority employers and taxpayers.

We are asking the whole public sector to live within increasingly difficult financial constraints, and local government, as Members know, is no exception. Within the LGPS, between 1990 and 2012, the contributions paid by scheme employers as a proportion of total scheme income increased from 37% to 51%. The level of investment income going towards that cost has remained steady at around £3 billion, which means that, in percentage terms, it has actually decreased from 43% of total scheme income in 1999 to just 25% in 2012. It does not take a degree in rocket science to realise that costs are escalating at too fast a pace and that too much of that cost is falling to employers and taxpayers. The LGPS currently costs taxpayers £6 billion a year in employer contributions.

I can also report that the reform package agreed by Government for the LGPS will ensure that the cost of the new scheme to employers and taxpayers, when it is introduced in April, will not exceed 13% of pensionable pay. If, at future scheme valuations, that cap is exceeded, steps will be taken to recoup the excess cost, back to the agreed 13% cap.

There are, as has been noted, other costs associated with the scheme, which must be subject to rigorous examination—in particular the cost of scheme administration and fund management. For example, in the year ending March 2012, those costs were £127 million and £381 million respectively. I repeat my belief that there are many excellent fund authorities, both small and large, delivering first-class levels of service at a fair cost to the taxpayer, but we need to go further to ensure that every fund authority in England and Wales performs at the same high level that we know is possible, with none of the inconsistencies or variability that are so evident today. That is why I made the call for evidence on structural reform of the LGPS.

In taking that decision, I recognised that improving the efficiency and effectiveness of the current arrangements through collaborative and partnership working might result in a saving of some kind. Recent evidence from funds that have already formed partnership agreements suggests that that might be in the region of 10%, but it is open to question whether that range of savings will be enough, given the tight financial settlements that local authorities face in the time ahead. That is why I am determined to explore new and fresh ways of working, and why I have invited a wide range of interested parties to come back to me with ideas on how we can best take forward structural reform of the LGPS.

In his speech, my hon. Friend said that the Government’s preferred option was pooling, with independent funds merged to produce cost efficiencies. As I have said, I cannot comment today on the Government’s preferred option. As I said at the National Association of Pension Funds local authority conference in May, and repeated in the call for evidence, I am not ruling anything in or out. At the same conference, I made known my views on fund mergers. I made it clear that I am not wedded to the existing number of funds—89—in England and Wales, and that remains my view. I have also said on a number of occasions that I would not shy away from reducing the number of funds if that is what it takes to improve the efficiency and cost-effectiveness of the scheme. There is one thing I would rule out: it is almost certain that we would not be thinking about having one scheme. Apart from anything else, I know that the market would have strong views on that.

My hon. Friend went on to make the important point that, because of their size, some fund authorities do not have the staffing structure or resilience that some of their larger counterparts enjoy. Some fund authorities are experiencing recruitment and retention problems at a time when many long-standing and experienced staff have retired or are close to retirement. I suggest that one way of resolving those concerns would be to base the scheme around a smaller number of fund authorities, which, in time, could develop as centres of excellence in the way that my hon. Friend has outlined this morning. He gave examples of a couple of authorities that are moving that way already.

My hon. Friend raised some different options for change, including fund mergers, the pooling of funds or assets and collaborative working. I commend my hon. Friend for his thorough analysis of the potential pitfalls and I will of course ensure that his comments are taken on board. I invite him to come and see me at the end of the call for evidence, for another meeting to consider where we are, with a view to using some of his expertise to avoid such pitfalls. I assure him that I am happy to explore any alternatives and ideas if it can be shown that they could achieve the desired result of improved efficiency and better cost-effectiveness. That is why in the past few months I have happily kept my door open—and will continue to do so—to anyone in the sector with ideas for moving forward, and options for the scheme’s future.

I share my hon. Friend’s view that we must guard against rushing headlong into a wrong alternative, risking unintended consequences. That is why, in the call for evidence, we invited comment on the specific question of data and, in particular, the type of data that are needed, so that we can better assess the current position of the scheme and the 89 individual fund authorities that administer it and manage its investments. I am sure that hon. Members will agree with me when I say that we must understand the problem before attempting to resolve it. We need a better analytical tool to determine what makes the difference between a bad pension fund and a good one, and better data to help us assess the size of fund that achieves optimal economies of scale.

Structural reform of the scheme will not be easy, and I do not underestimate the challenge that the Government have taken on, but I am determined to make progress as quickly as possible, for the benefit of the scheme, the beneficiaries, and the taxpayer. When the call for evidence has closed, on 27 September, we will work in conjunction with the Local Government Association to analyse the responses. We intend then to issue a consultation paper on the options for change very early in the new year. I hope that hon. Members will agree with me that the call for evidence on structural reform of the LGPS in England and Wales represents a key stage in the process of improving the efficiency and cost-effectiveness of the scheme and ensuring that it remains sustainable, affordable and fair to those who pay its costs.

Sitting suspended.