Mike Hedges says local government reorganisation would enable us make better use of our collective public savings
With the Williams Commission on Public Service Governance and Delivery due to report early in the New Year, one area that would benefit from a reduction in the 22 Welsh local authorities would be in the operation of their pension funds.
In Wales we have eight local authority pension funds based on the eight former county councils. In each case one of the successor authorities is the lead authority, with the exception of Powys whose boundary is the same as that of the former council. In most of Wales, therefore, one council manages the pension fund for the other councils in the former county area. In addition, community council staff and people who previously worked within local government, such as college administrative staff, have also been allowed to continue their membership of the local authority pension funds.
The overall result is that there has very little change in the way the pension funds have been managed since the 1996 local government reorganisation. The pension funds are probably the one area of Council responsibility that was unaffected by the 1996 reorganisation. The funds continued under the same fund managers and were invested for the same people.
The market value of the funds at 31st March 2012 are shown in the table below, where with the exception of Powys they are all between £1 and 2 billion.
Value of Welsh local authority pension funds (March 2012)
| Flintshire UA (Clwyd) | £1,060,823 |
| Carmarthenshire UA (Dyfed) | £1,400,606 |
| Torfaen UA (Gwent) | £1,682,593 |
| Gwynedd(Gwynedd County) | £1,049,671 |
| Rhondda Cynon Taff UA (Mid Glamorgan) | £1,785,254 |
| Powys UA | £372,443 |
| Cardiff UA (South Glamorgan) | £1,150,523 |
| Swansea UA (West Glamorgan) | £1,118,780 |
| Total value | £9,620,693 |
The total value of more than £9.5 billion of the combined Welsh local authority pension assets is greater than the £8 billion managed for the Dutch public sector pension. With this level of funds there is potential for significant financial benefits from economies of scale – increased flexibility and reduced investment and administrative costs. The obvious opportunity for us is to create a single scheme for all of Wales as a whole. This would be relatively straightforward to achieve and would bring the following advantages:
- Larger funds can access external management at lower costs.
- Historically, internal management has provided superior returns. Larger fund size would give local authorities the opportunity to use internal management to a greater extent than they do at present.
- Larger funds may provide the potential for improvements in scheme governance.
- Larger fund sizes may provide better opportunities for investment in certain asset classes.
- Larger funds will have bigger governance budgets, enabling better decision-making.
It is not surprising that smaller funds are more volatile than larger ones as they are less diversified. Although they do not necessarily perform less well because of this, their relative volatility can seriously affect employer contribution rates.
Local authority pension schemes invest in bonds, commercial property (if big enough), British, European, Japanese and emerging equity markets as well as cash. Obviously the size of the fund dictates the ability to spread both investment and risk. A scheme of the size of an all Wales pension fund would be able to invest in a way that is not possible by the present eight funds.
In the UK we have 14 defined benefit pension funds comprising four local authority and ten corporate funds. At the end of March 2013 the average size of the latter was just over £20 billion, ranging from £10.8 to £41.3 billion. The striking feature of this group is that eight of the ten are principally managed on an internal basis. This means they have benefited from reduced internal management costs against the more expensive employment of external fund managers, as is the case with the Welsh Local Government funds.
Over the past decade these funds have shown a strong long-term performance that is generally better than average – although the absolute level of return is driven by the investment into different assets and asset classes strategy undertaken. Interestingly, regardless of structure or asset strategy, every one of the funds has a risk level below that of the median.
In Canada there has been a clear move towards increased level of internal management within their public sector pension funds. And their performance has improved markedly as a result, not least because they are able to attract and retain top investment professionals. They have set themselves up as quasi-independent entities that allow the decoupling of salaries of these professionals from existing public sector pay scales. Whilst this has pushed up the cost of internal management, it remains well below that paid by external funds whilst, at the same time seeing an improvement in net performance
Current local government pension schemes have a range of employer funding levels which, although determined to some extent by the date of the last actuarial calculation and are therefore not directly comparable, do indicate the success of each authority in meeting its own funding targets.
Any merger of fund assets and liabilities would need to reflect current actuarial values in the resulting employer funding levels (and therefore deficit contribution rates) of the merged fund leading to different employer payments by different Councils.
This is not an insurmountable problem as this is already being dealt with on a smaller scale by the current pension funds, with many of the ‘smaller’ employers paying in different sums. Whilst primary legislation would be required to create a single fund for Wales, the case for doing so is overwhelming. If there is the political will this can be achieved and would be of benefit to both council taxpayers and the people of Wales as a whole.
Thank you Mr Hedges for a very timely contribution to the debate around the future of the LGPS in Wales. Both Northern Ireland and Scotland both have their own pension schemes, so the changes to the England and Wales LGPS (such as a cap on employer contributions to the funds) are not happenning in Scotland for example.
As the LGPS is a statutory scheme, defined by by legislation, the neccessary changes to the legislation required by the proposed 2014 scheme is currently being worked on, so there is an opportunity now to legislate for a separate Welsh LGPS, the detailed statutory underpinning of which could be then devolved to Wales. It would be great to see the Welsh Government taking a quick initiative on this in order to build a consensus and organise an in house managed and representative LGPS for Wales as outlined by Mr Hedges above. Even were the pension fund(s) of Wales to remain in the England and Wales Scheme, it would still be possible for them to merge and change their governance and management structure as is suggested (something incidentally that Unison, who represent the majority of scheme members, is calling for across England and Wales).
Such an in-house scheme would provide very welcome well-paid and skilled jobs within the finance sector here in Wales, and play a big part in expanding our national expertise and resources in this important sector. A well managed and responsible Welsh pension fund could also provide an important source of investment into the welsh economy (Welsh Government infrastructure bonds, real estate, direct investments, etc), which is also a matter of strategic importance for Wales.
Jumping slightly ahead of things, if an All Wales LGPS fund on the lines outlined above could be established, it may provide the basis for establishing more pension funds based here in Wales (perhaps also with the Welsh Government as a lead stakeholder) now that auto-enrollment is here, in order to ensure that peoples future incomes are looked after, but also so that those savings and investments can be put to good use through (at least partial) investments in the welsh economy.
Given the lack of other sources of institutional investment in Wales the Senedd needs to look very carefully at the opportunities and role that pension funds can play. As a member of the LGPS I therefore very much welcome Mike Hedges contribution to the debate on this issue.
What a timely and well articulated contribution. The present schemes all operate at sub-scale. With a combined asset value in excess of £9.5 billion as Mike says, a Welsh local government pension fund could become a powerful Welsh financial institution. And nobody should be in doubt that Wales needs more of these.
I am particularly interested in the fourth of Mike’s bullet points covering the advantages of a pan-Wales scheme. He is absolutely correct to draw our attention to the possibility that by operating at scale there is the potential for greater diversification of asset classes. One of the things Welsh industry needs is a variety of sources of long term development capital. This has been highlighted by Dylan Jones-Evans recent report on access to capital and the role of Finance Wales as a provider of debt and equity.
There are a number of international precedents for public pension funds acting in this role. One I would encourage readers to research is the Ottawa Teachers Pension Fund: http://en.wikipedia.org/wiki/Ontario_Teachers'_Pension_Plan. It is incredibly well managed and has played an important role in spawning a wealth of technology companies by its early stage investment activity. Interestingly and closer to home its investments include Birmingham and Bristol International Airports.
If we create a mega Welsh fund and get it managed in-house, the pressure to tip money into whatever fashionable local scheme crops up will be great. Why would the returns be any better than those managed by Finance Wales when investing in Welsh businesses? Anyone care to compare Finance Wales returns with what you get in the stock market? Glad I’m not a local government pensioner – people are too keen to start nation-building with their post-retirement income. Use your own money!
R.Tredwyn makes a good point. There may be tacit or even overt pressure to make investment decisions which are not justified by market fundamentals. But by operating at scale, an internally managed fund taking an active management role would have a fair chance of attracting some seasoned managers and trustees who would instinctively know what was the best course of action to protect the pension beneficiaries interests.
As to the comments about the relative performance of Finance Wales and the stock market and nation building, well that’s just rhetorical nonsense. The Ottawa metropoloitan area is about the size of a projected Cardiff Capital Region and its Teacher’s Fund owns some prized Uk infrastructure assets. Just goes to show what the combination of imagination and talented individuals can produce.
Firstly the pension payments are protected
Secondly we have the ‘Scargill judgement’ that states that the first duty of trustees is to maximise return.
Thirdly there would still be four larger local authority funds in Britain.
Fourthly the return from internally managed has been higher as indicated in the article.
Fifthly this is not about nation building it is about reducing costs and improving returns.
I hesitate to comment again because this is not an area where I have experience, unlike Messrs Hedges and Trichet (!) but I am puzzled. If a fund of £1 billion makes, say, a 5 per cent return that is £50 million. How much does it cost to employ 3 or 4 internal managers – a million a year? That is a tenth of one per cent of the fund. So if it is such a good idea most of the LA pension funds could do it now, easily. Moreover my financial adviser seems able to diversify my little nest egg and we are not talking about a billion, more’s the pity, but something thousands of times smaller. A billion pounds is big enough to support any diversification you want. So I still don’t see the argument for creating a monster fund more remote from the pensioners.
There seems to be a significant oversight in some of the thinking associated with the Local Government Pension Fund – current deficits. Due to the manner in which this scheme has been set up there is now a requirement for pension contribution by Local Authorities to be approximately 25% of current salary level — 8% current and 16% deficit. For every £100k of local government salary paid £24k is being paid into the fund.
This is likely to increase in the next two years by approximately another 5-7% as a direct result of Local Authorities significantly reducing the number of staff contributing into the fund.
The changes coming into effect from April will deal with the issue of new staff being appointed it does not however deal with the deficit.
How can we as a nation afford to have 24%+ of the limited funding for Public Sector in the future going towards paying historically generated debt.
As long as the investments increase due to ftse and other investments increasing then the actuarial defection will increase. I remember when councils took a pension holiday