An innovative funding structure has been agreed for Croydon Pension Fund. However, there are some concerns about the arrangement. Stephanie Baxter reports
An innovative funding structure that involves transferring a set of residential properties has been agreed for Croydon Pension Fund so the council can pay less in employer contributions.
The asset-backed funding structure, which is very rare in the Local Government Pension Scheme (LGPS) sector, was ratified on 28 January at an extraordinary meeting of the council, where Labour has a majority.
London Borough of Croydon is promising to transfer residential property valued at around £104m to the defined benefit pension fund between 2057 and 2059, which will reduce its annual employer contributions by 2.5% or £3.5m from 2019/2020, based on assumed growth of the consumer prices index plus 1.7% in the properties.
It comes as the council must find £25.9m of cost savings over four years to 2022.
The 346 homes are leased by the Council to two limited liability partnerships (LLP) called Croydon Affordable Homes and Croydon Affordable Tenures, which manage and maintain the properties and collect rent while the freehold remains with the council.
After 40 years (from 2016 to 2056), the council can use a break clause in the lease to receive back the properties debt-free, and intends to transfer ownership to the pension fund, which could decide to sell the assets or continue to lease them to the LLPs and receive any rental income.
According to council documents, as Croydon is providing the pension fund with both future asset value and future ongoing revenue stream, it can reduce its liabilities as an employer. The pension fund and pension committee received external actuarial advice from Hymans Robertson, investment advice from Mercer and legal advice from Eversheds Sutherland.
There will be certain safeguards to mitigate future risks on the valuation of the assets, according to the documents. Regular valuations of the homes will be built into future actuarial valuations to ensure the assumptions on capital appreciation remain reasonable with a commitment from the council to adjust its contribution rate in the event of any shortfall. Also, if the council does not resolve the transfer of the benefit of the lease or, in the future, reverses the resolution to transfer the benefit to the fund, the contribution rate would be adjusted to compensate the fund.
Cabinet member for finance and resources, and vice chairman of the pension committee, Labour councillor Simon Hall, believes this structure works for both the pension fund and the council. "One of the reasons is to help the council while leaving the pension fund in either the same or actually a better place than it is now. If there's a change in the value of properties or potential future value then there will be an automatic change to the contribution rate every three years."
He adds: "I accept some people may be unsettled by this as it's different - but I think it's a creative way that gives extra protection and extra assets for the pension fund while helping the council in terms of the amount of cash contribution it needs to make into the pension fund."
While asset-backed funding arrangements have been used in private sector pension funds for years, local authority pension funds have not followed suit.
A similar structure was implemented for Bromley Pension Fund in June/July 2016, whereby 400 properties owned by the council will be transferred to the fund after 40 years in return for Bromley paying £1.7m less into the pension fund each year. PP understands a complaint has been raised with The Pensions Regulator regarding the plans for Croydon.
Last November, the local pension board raised some concerns in a letter, seen by PP, written by its independent chairman Michael Ellsmore to the scheme's section 151 officer.
Although most members on the pension committee have supported Croydon's arrangement, some are concerned.
Pension committee member, Conservative councillor Luke Clancy, says it is a bad deal for the pension fund and voted against it on 28 January. "The council's intention of reducing its pension contributions to help it fund its revenue budget is a conflict of interest, because as a trustee I can't stand up and say this is in the best interests of the fund. It's in the best interests of the council. If it all goes wrong in 40 years' time and there's a big deficit in the fund, then it's leaving it for future generations to sort out so it can spend its priorities in the near term."
He also thinks this structure poses much less of a risk to Bromley's pension scheme as it is much better funded, with its funding level reaching 91% in the last triennial valuation in 2016.
Conversely, Croydon's funding level was 73% funded at its 2016 actuarial valuation, although up from 66% in 2013.
Ex-policeman Peter Howard, who has been a pensioner representative member on the committee for more than 20 years, is also unconvinced and thinks 40 years is a long way into the future. "If you look back at all the things that have come and gone in the past 40 years, so much has changed; it's almost half a century. It's like saying ‘can you lend me £2m and in 40 years I'll give you a Maserati?' We've got to wait 40 years before we get our money back in the form of housing. Will there be councils in 40 years? What will the housing market look like? Will we have had a war? Unless you have a crystal ball, you just don't know."
"I couldn't recommend this to my members. If it goes pear-shaped, the council picks up the bill, but it'll actually be taxpayers who will pick up the bill," he adds.
However, Hall says there is a safeguard. "Unlike commercial pension funds, the council stands as guarantor for the pensions so if at some point way down the line in the future there were to be a problem for some reason with the pension fund, then the council stands behind that, has a legal obligation, and if for some reason any council generally wasn't there, then the Ministry of Housing, Communities and Local Government stands behind the council's guarantee."
Clancy has concerns about these properties providing true diversification in the pension fund's investment strategy.
Clancy: "It is a pretty low-performing asset, concentrated in this small corner of London, and does not achieve the basic tenets of pension scheme investment, which is diversification where you don't put all your eggs in one basket. Pension funds also tend to invest in commercial property or a more established sector rather than residential property."
The pension fund currently has a 9.6% allocation (£109.1m) to property, and 2.2% (£25.2m) to private rented sector property, according to its 2017/18 report. Clancy says he would also expect investment in the private housing sector to deliver returns in excess of the 4% that this investment would generate, up to 6%.
However, Hall says it is important to see how big this is in the context of the overall pension scheme.
"The present net value that's been attributed to the assets is £50m, which is about 4% of the £1.2bn pension fund. That's right because we're not getting the benefit of those assets for the next 40 years. Therefore, that has been properly discounted.
"The independent actuary has done a prudent assessment of what the pure capital growth would be over the next 40 years in those assets. If you assumed a 6% return, actually the net present value would have been that much higher and the reduction in the deficit contributions by the council would have been a lot higher. We've quite rightly been appropriately prudent on capital growth of these assets over the next 40 years to ensure we don't end up in a situation where triennial valuations occur and we have adverse movements."
He adds: "I don't think one particular class of asset for 4% in a diversified portfolio is excessive. If I had transferred properties at today's value with no encumbrances, you could argue there's a lot of concentration in that asset class. We have a target of having 6% of the pension fund in private rented sector anyway - we're actually underweight on property at the moment."
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