Reforming the LGPS

It is rare you see the mention of the Local Government Pension Scheme (LGPS) without the words “gold plated” preceding it. This is because local government schemes still enjoy the rare privilege of having a final salary arrangement in place. Some find it unfair that against a backdrop of escalating deficits and scheme closures public sector employees have the luxury of guaranteed healthy pension pots, while those in the private sector have to make do with a more diluted offering.

Whatever people say, the general consensus is that reform to the LGPS is needed even though the new look scheme only came into force in April last year. In May this year, former local government minister John Healey promised a consultation on the current structure of the LGPS, addressing sharing administration arrangements and merging some of the local government funds. Healey said this would follow “within months”, but seven months down the line nothing has transpired.

Now, with a general election looming next May, it is highly unlikely the government will reveal a radical shake up to the system between now and then. But whoever takes office after the election will have the ideal opportunity to positively review the LGPS situation. The question is around how this should happen.

Why is reform needed?

The main debate revolves around the escalating costs of the LGPS and the need to find an appropriate system for cost sharing – something easier said than done.

Former West Midlands Pension Fund chief pensions officer and public sector pensions strategist at Wragge & Co, Mike Woodall says the department for communities and local government has not been able to agree a cost sharing mechanism with the unions. “I can’t see it expected by April 2010 when it was attending to occur – particularly with an election on the horizon.”

A large part of scheme funding comes from central government grants and local council tax, which some people believe is not fair on the taxpayer.

But Unison head of pensions Glyn Jenkins dismisses this as “nonsense” saying people “grossly exaggerate” how much council tax goes into this. Added to this he says is the fact that retirement age has increased to 65 and contributions have gone up.

“A very large proportion of a council’s money comes from central government; well over a third comes from members and some from investment income – independent of tax bills.”

In fact, Jenkins believes the LGPS is flawed because the contribution thresholds in place do not fairly reflect individuals’ earnings, which hits part-time workers particularly hard.

“If you are earning up to £12,600 you pay 5.5% but if you only work half time and your pay is £12,000 you go into the £24,000 band in which you pay 6.5%,” says Jenkins.

Norfolk County Council director of finance and Chartered Institute of Public Finance and Accountancy pensions panel chairman Bob Summers says reducing the level of pension saving only pushes the problems of today onto future generations. “Should the taxpayers of the future pay for the costs of today?” ponders Summers. “Costs that might have been met by pensioners will not be accounted for.”

So if employers and employees do not contribute enough to good pension provision during employment it is possible the government and hence the taxpayer will pick up the bill from means-tested state benefits when people retire.

It is worth noting however the average annual pension paid out to the public sector at present is £4000, which relatively speaking is not a lot. In fact, at the West Midlands Pension Fund 71.64% of pensioners receive an annual pension of under £5000 (see chart below).

“If you say LGPS is gold plated and unaffordable then the stats show basically we cannot afford to pay a small pension to the vast majority of people in the LGPS,” says West Midlands Pension Fund director of pensions Brian Bailey.

Even former local government minister Healey admitted during his time in this post that not having a pension scheme is a “recipe for social instability and the fastest way to fill up the benefits and health care systems”.

Summers adds: “People focus on the here and now of the costs of the employer’s contribution but not the long-term consequences if people do not save enough for the future.”

What should be done?

Most commentators suggest a career average revalued earnings (CARE) scheme is the best provision looking ahead. In fact, a recent poll conducted by Mercer showed 53 out of 100 LGPS managers believe the LGPS will become a CARE scheme.

More telling however, is the fact than only one manager thought the future of the LGPS is final salary. Elsewhere, 22 opted for it being a hybrid arrangement, 12 people thought defined contribution, and 12 thought another alternative.

West Midlands’ Bailey says moving to DC would produce some saving, but costs have to be upfront. “At the moment all the funds building up are not needed for 20 or 30 years,” he says. “If you move to a DC there is a real cost now.”

Mercer head of local government consulting unit Chris Hull says CARE is a likely candidate although he does not think DC is right. “For what is predominantly a low paid workforce a whole scale dumping of risk on the employees by moving to DC is a massive switch,” he says.

Woodall believes a CARE scheme is fair because a retiree gets out of the scheme what they have paid into it.

“It would stop those moving to a massive salary suddenly having all their previous service based on their new salary,” says Woodall. “If you compare that to the private sector where you go for a promotion at another company and want to transfer your pension – you will only receive in your pension what your previous service has bought.”

Bailey however, describes a potential move to CARE as “a sledgehammer to crack a nut” as it would produce an enormous problem in record keeping. “Not only have you got to keep an accurate record of length of service but also of what pay they have had and then inflate that each year. How do you deal with information you have not collected?”

Unison is open to negotiations on an alternative. “If we have a debate on career average let’s have it,” says Jenkins. “But we cannot keep changing the scheme every five minutes as it doesn’t save money or sort out the benefits structure – it will lead to chaos.”

Whatever the future of the LGPS, it should be affordable, viable and fair to all and the industry awaits progression with baited breath. “If there is a change of government next year a newly elected government will be in a stronger position to be authoritative about the changes needed,” says Woodall.