As an avid reader of FT Alphaville you’ll recall our previous explainer on UK native authority pensions. You’ll know that the Native Authorities Pensions Scheme is the biggest funded scheme within the nation, the fifth largest on this planet, and that UK native authority pensions account for around £458bn of property. You’ll do not forget that somewhat than being run as one giant fund, the property are run by 87 different administering authorities (aka native authorities our bodies) throughout England and Wales, and an extra 11 schemes in Scotland.
However what do these schemes really put money into, what sort of returns have they delivered, and why may any of this matter to us? We’re right here to reply these hitherto unnoticeably burning questions.
Shopping for what?
Every administering authority has a pensions committee accountable for the massive asset allocation calls. Elected councillors are the last word arbiter of every fund’s strategic asset allocation, and it’s these selections that almost entirely determine returns.
Strategic allocations differ, and never simply on the margin. For instance, Kensington & Chelsea’s method, outlined in MainFT, is to have a variety of equities. Camden is huge into business property. East Sussex leans closely on intelligent Mayfair-types operating hedge funds and personal fairness. Clywd is lengthy infrastructure. And Barnet loves bonds.
To state the plain, they’ve made ridiculously totally different asset allocations selections in pursuit of a broadly related funding goal. Are any of those asset allocations optimum? Perhaps one in all them is, however with out a crystal ball, all we are able to do is have a look at the efficiency.
How has this all labored out?
Right here’s a chart displaying the one-year returns for the yr ending March 2023. We’ve grouped the administering authorities by the pooling firm of which they’re a member for a combination of (a) comfort (in the event you’re a LGPS nerd looking for a fund) and (b) prettiness (in the event you’re not). As you’d have guessed given the number of asset allocations, returns are fairly disparate:
One quick takeaway is that the numbers look horrible. However keep in mind, these have been for the yr through which international shares fell, property bombed, and the much less mentioned about bonds the higher. We’ve thrown some index returns in on the backside for context. Hover your mouse over the dots for more information.
Don’t use the chart to evaluate how good the swimming pools are at producing good returns. It’s the executive authorities — and never the swimming pools — that resolve every fund’s general asset allocation, and this choice is the foremost driver of general returns. To take an excessive instance, the dot displaying the worst absolute return represents the ‘Environmental Agency – Closed’ fund, which dropped 18.3 per cent within the yr ending 31 March 2023. It was the Company’s pension committee that selected the strategic asset allocation (long-dated inflation-linked gilts), not Brunel. In actual fact, whereas it’s a member of Brunel, the worth of property pooled with them is exactly zero.[1]
Do the numbers even out over the long-term? We scraped manually copied from a PDF some information we present in a PIRC LAPPA report on Hounslow’s website — inspecting efficiency over the previous decade for a big subset of the total information set.
In keeping with PIRC, Kensington & Chelsea are streets forward of the remaining, with an annualised return of 10.8 per cent over ten years — simply behind international inventory indices in sterling phrases. The laggards are Waltham Forest and Cornwall, with 4.8 per cent and 5.3 per cent annualised returns respectively. To state the plain, the variations between the very best and lowest numbers are giant.
Cui bono?
Past bragging rights, for whom does this really matter? It’s got to matter for some combination of the LGPS’s six million present / future pensioner members and its twenty-one thousand employers. And, by extension, all native taxpayers.
Workers members are promised an outlined profit, and this doesn’t differ with fund efficiency. So stonking returns from shares (or lack thereof) shouldn’t actually contact them.
Certain, based on a legal opinion published on the LGPS Board’s website, native authorities pensions should not really assured by central authorities. So possibly there’s a case for saying that the sturdy returns will profit members by enhancing the safety backing these pension guarantees made by the council. And it’s true that councils have been going bust issuing 114 notices with alarming frequency.
However it’s laborious to think about a political situation through which pensions are allowed to go unpaid. In actual fact, the KC paid for his revealed opinion that LGPS pensions should not assured felt compelled to down instruments mid-opinion and write:
I need to say that, from a political versus a authorized perspective (and for what my views from such a perspective could also be value), I discover it well-nigh inconceivable that central authorities would permit issues to succeed in the stage of an entire collapse in native authority funds, and default upon authorities’ authorized obligations, with out endeavor some type of intervention.
If present and former native authorities staff profit solely on the margin, who else takes a direct hit in a downturn or advantages from a market upturn? Employers. These are — largely, however not completely — public sector our bodies, backed by taxes.
We are saying largely, as a result of maybe 1,750 of the roughly twenty-one thousand employers included within the LGPS aren’t really public our bodies. They’re so-called Tier 3 employers. (Tier 1 employers being public our bodies with direct native tax-payer backing, Tier 2 being the hundreds of academy trusts.) Should you’re working for a charity to whom the council has outsourced some contracts, are a non-teaching member of employees for a post-92 college, or somebody working in a housing affiliation, you’ll probably have a LGPS pension by way of a Tier 3 employer.
OK, however why ought to *I* care?
Employers largely really feel the impression of various funding returns via modifications to the contribution charge, which they stump up every time they flip the payroll deal with. Payroll that (largely) will get paid for by your central and local government taxes, by closing down libraries, or chiselling away on the cost of providing adult social care.
Contribution charges are estimated solely as soon as each three years by actuaries, and are the sum of what are often called the first and secondary contribution charge. The first contribution charge is to pay for the long run price of name new pension guarantees. Variation between administering authorities is surprisingly giant provided that that is the efficient worth they’re charging themselves to offer the identical LGPS pension to their staff.
The very best main (employer) contribution charges are for the open portion of the Surroundings Company and Lincolnshire funds, coming in at simply over 24 per cent of wage. The bottom are on the London Pensions Fund Authority and Kensington & Chelsea, at solely 15 per cent of wage.
These numbers are arrived at utilizing a complete lot of whizzy maths, locally-specific mortality information, member traits, and so on. We’re not ready actually to unpick the variations right here. However there are two huge hand-wavey numbers that go into the calculation of the first contribution charge which can be fairly vital. These are the pension committee’s expectation for inflation, and the low cost charge they choose.
To get a way as to how vital these are, we examined — for no specific motive — the funding sensitivity analyses for Essex, Merton, Newham and Nottinghamshire as set out of their 2022 triennial valuation studies. In every case, if both (a) anticipated inflation is nudged up by 0.1 share factors, or (b) the low cost charge is nudged down by 0.1 share factors, the first contribution charge will increase by 0.7-0.8 share factors, making it costlier to make use of native authorities folks in money phrases.
We thought we might make a cool dataviz, which might present the funds with the very best low cost charges and lowest inflation assumptions had the bottom main contribution charges. However this isn’t actually how issues work out. Had that been the case the darkest dots (funds with the very best main contribution charges) can be up within the prime left quadrant, and the lightest dots (with the bottom charges) would’ve been within the backside proper quadrant. So there are clearly a variety of different issues happening.
As soon as cash is contributed to the pension fund it will get invested in shares, bonds, infrastructure, and so on. If the property outperform all of the assumptions set out within the triennial valuation, this produces a ‘funding surplus’ the subsequent time the actuaries run the numbers. In the event that they underperform the assumptions, the fund will look ‘underfunded’.
So how did they appear the final time actuaries turned the triennial valuation deal with?
Pleased days! Except you’re dwelling in E17 or Havering, your native authority’s pension fund was both in surplus or solely a modest deficit. Which is presumably good, as a result of it signifies that your Council Tax has little prospect of spiking to bail out your councillors’ unwise (or unfortunate) asset allocation selections.
However hold on, these triennial valuations are additionally based mostly on the identical bunch of hand-wavey assumptions used to calculate the first contribution charge. And because the Authorities Actuary’s Division wrote in a terrific report on the variation in assumptions used:
Our evaluation confirmed that there was no clear affect as a result of asset combine, prudence, funding degree, kind of employer or maturity in isolation on the low cost charge adopted.
Gulp! That is how an actuary says ‘you’ve simply pulled these out the air’. They usually have the charts to show it (in Appendix B of this document).
Fortunately, there’s a strategy to examine all of the funds on a like-for-like foundation. That is the so-called funding degree on a SAB foundation (utilizing some standardised assumptions present in desk G1 of this document). And funds are obliged to report this stat within the Part 13 dashboard behind their triennial valuation.
So, how do issues look on an SAB constant foundation? Truly, marginally higher:
Once more, Kensington & Chelsea comes out on prime — however not by a lot — with a SAB funding degree of 164 per cent. In actual fact, whereas calculations utilizing SAB standardised assumptions come out with a solution that’s on common round ten per cent greater, that is removed from uniform. Whereas West Sussex reported a 125 per cent funding degree in its triennial valuation, this funding degree jumps to 159 per cent when widespread assumptions are used — we expect indicating that the assumptions they’ve chosen are comparatively conservative in comparison with their friends. And utilizing the mixture of scheme assumptions and standardised assumptions we are able to see that it was actually Waltham Forest, Brent, Havering and Berkshire that regarded most underfunded in 2022.
So what might Waltham Forest, Brent, Havering and Berkshire do with this data? Do they only pray for booming funding markets?
No. In addition to a main contribution charge (reflecting an estimate as to how a lot must be put apart to pay for the pension being promised), LGPS funds may also cost employers a secondary contribution charge. It is a charge added to payroll to get the fund to wherever it desires to be (eg, fully-funded, 105 per cent funded, 110 per cent funded), over a horizon determined by the fund (possibly 15 or 20 years). And this charge could be optimistic or unfavourable.
So that you’d anticipate all of the funds that have been in surplus to have unfavourable secondary contribution charges, and all of the funds in deficit to have optimistic contribution charges. That will at the very least be logical?
Ahem.
This chart of secondary contribution charges and funding ranges reveals that this isn’t the case. Certain, underfunded Waltham Forest, Brent and Berkshire led the pack in secondary contribution charges with 9 per cent, twelve per cent and eight per cent respectively. And Kensington & Chelsea has been reaping the rewards of its over-funding by knocking seven per cent off payroll prices. However Staffordshire? Staffordshire’s 2022 valuation put it twenty per cent over-funded. And but somewhat than cashing in via payroll reductions, it appears to be like like it’s chucking an *further eight per cent of payroll* into the pension fund, on prime of cash it reckons will likely be wanted to make good on its guarantees.
We truthfully couldn’t perceive why this was the case, so we acquired in contact with Steve Simkins, accomplice on the funding consultancy Isio. He pointed us to the existence of LGPS funding technique statements, and the idiosyncrasies of the methodologies pursued by totally different actuarial companies. Every fund publishes one in all these and it lays out why and the way it’s a bit totally different from the others. We lasered in on the assertion revealed by Staffordshire Pension Fund.
The explanation why the Staffordshire fund levies upon its employer members a hefty secondary contribution charge regardless of its chunky surplus seems to be as a result of it has in place a ‘stabilisation association’. Because of this the full (the sum of the first and secondary) contribution charge employers pay can change solely be +/-1 per cent of wage every year. No less than, that is the case for native authority employers, in addition to opted-in academies.
We will see the place they’re coming from. If the worldwide financial system takes an absolute dive — dragging asset market values down with it — native taxpayers won’t take particularly kindly to large will increase in Council Tax to cowl for the resultant gap in LGPS pensions. And again in 2016, Staffordshire’s funding level was solely 78 per cent — requiring chunky secondary contribution charges as a part of the deficit restore course of. However, it appears a bit bizarre to us that native taxpayers are chucking more money into the fund as a result of it was, as soon as upon a time, in deficit. Particularly with native authority funds strained.
Scandal?
As a terrific piece from the Native Authorities Chronicle on the again finish of 2023 explains, these assumptions summoned out of the air macro forecasts produced by actuaries — and adopted by funds — which can be used to calculate funding ranges should not solely subjective, however could be bent to the desire of the administering authorities. They reported:
[a] senior officer informed LGC “a variety of funds” attempt to tweak actuarial assumptions to “conceal” giant surpluses which may lead councillors to demand a reduce to their council’s contribution charge to liberate cash for different providers.
If tweaking assumptions to make the pension fund seem like it was in higher want of hefty contributions sounds fairly scandalous to you, you’re not alone. In actual fact, John Clancy, the previous chief of Birmingham metropolis council, has began making waves by just about calling it out as such. Or, at the very least, demanding an pressing assessment into the operating of West Midlands Pension Scheme, saying that its calls for for employer contributions have been over half a billion kilos greater than was wanted. And this, he alleges, pushed Birmingham Council over the edge into issuing a piece 114 discover (aka local authority bankruptcy) in 2023.
We haven’t checked his workings however can see that there are going to be tensions between the pension funds seeking to shore up funding, and different spending priorities just like the administration of providers that they’re legally obliged to provide, equivalent to grownup and kids’s social care.
So what subsequent?
Should you’re studying FTAV it shouldn’t be information to you that, in comparison with March 2022 ranges, inventory markets are up round forty per cent and long-dated bond yields are round three share factors greater. Whereas we’ll want to attend for the actuaries to do their factor, we’ve little question that they may finally discover that funding ranges are crazily, virtually unbelievably, stronger.
To get a way as to fairly how a lot stronger the funding positions will likely be, we are able to flip once more to Isio, which has for some time been operating a ‘low funding risk’ index of LGPS funds. They try to reply the query as to how over- or underfunded every fund is by operating two steps. First, they guesstimate the worth of every fund’s property based mostly on their strategic asset allocation and market actions. Second, they guesstimate the current worth of every scheme’s liabilities — not discounted with the funky set of assumptions chosen by councillors however as an alternative discounted utilizing gilt yields.
It is a fairly penal method of discounting liabilities, and one that can inflate them to ranges a lot higher than seen anyplace within the personal sector — even bulk annuity insurance coverage buyout legal responsibility valuation (making the funds look far much less funded than triennial or SAB valuations). However at the very least it’s constant. And it’s additionally reside.
The chart under reveals Isio’s estimates as to LGPS funds’ low-risk funding ratio again in March 2022 (when the final triennial valuation occurred), and in addition at year-end 2024. You possibly can toggle the filter to flip from one to the opposite.
Whereas these numbers are simply estimates, if we are able to droop our disbelief to think about them as credible proxies of the outcomes which may come out of the 2025 triennial valuation spherical, we are able to get some staggering impacts.
We all know that Kensington & Chelsea is just about the best-funded scheme, nevertheless anybody desires to chop issues. The Isio low-risk funding index had them at 94 per cent in March 2022, whereas the triennial valuation places them at 154 per cent and the SAB standardised assumptions places them at 164 per cent. Regardless of the degree of funding, this led to them adopting a secondary contribution charge of *minus* seven per cent.
Quick ahead to December 2024, and each single LGPS fund that’s open to new members (bar Waltham Forest) has an Isio low danger funding index higher than Kensington & Chelsea’s again in March 2022. There’s an vital caveat that councils’ guesstimated legal responsibility low cost charges are — based on actuaries we’ve spoken to — are unlikely to maneuver up lock-step with gilt yields. If guesstimated low cost charges transfer up by lower than the gilt yields utilized in Isio’s evaluation, funding enhancements will look much less dramatic.
However nonetheless, with the typical secondary contribution charge throughout schemes being round two per cent of wage, a transfer to minus seven per cent — or extra — would have a big impression on native authority funds. MainFT quotes Tim Gilbert, a accomplice at Lane Clark & Peacock, the actuarial consultants, as saying that the probably funding enchancment would assist “a major discount within the contribution charges . . . a discount of fifty per cent or so is justifiable given the change of the circumstances”.
Though we all know from taking a look at Staffordshire’s funding technique assertion that some native authorities would wish to tweak their preparations to permit such an enormous shift to happen in a single leap, somewhat than simply permit the contribution charge to say no by one per cent per yr. And there appears to be some chat in LGPS-world about whether or not the funds ought to lock of their huge surpluses by de-risking (aka, shopping for gilts), although LPPI reckon in a brand new report that doing so would make future advantages extraordinarily pricey.
Scotland the courageous?
Apart from within the intro, we’ve utterly failed to debate Scottish LGPS funds. That is partly on account of laziness (their valuations, fund accounts, and so on should not conveniently gathered on the LGPS Board web site). However it’s additionally as a result of they’re on a barely totally different valuation cycle and have already taken a barely totally different path.
Because the Local Government Chronicle reported again in 2023, Scottish funds’ mixture funding regarded more likely to soar to a mean 147 per cent from a mean 106 per cent in 2020. The increase was fairly evenly cut up between contributions from sturdy asset markets and a shrinking in liabilities derived from modifications to assumptions (that we’ll assume means greater bond yields).
What did Strathclyde Pension Fund — the biggest of the Scottish funds — do? It slashed the contribution charge for its important (largely council) employers from 19.3 per cent of wage to simply 6.5 per cent of wage. However it did so with a caveat. They informed employers that the reduce was short-term and would soar again to 17.5 per cent within the yr 2026-27.
We will see the deserves of this method, and why this is perhaps one thing that English and Welsh funds may need to pursue. Certainly, shut evaluation of Kensington & Chelsea’s 2022 valuation reveals that their minus seven per cent secondary contribution charge was scheduled to fall away within the third yr of the forecast, suggesting that they’d gone down the identical highway. Native authorities get some aid and a bit more cash of their pocket at this time, but in addition the information that this isn’t a part of their everlasting finances.
So possibly they will decide to some shorter-term initiatives, or do a little bit of capital spend (if such budgets are even fungible?). If issues prove even higher than anticipated, funds can then lengthen the contribution holidays.
In actual fact, MainFT reported final week that Kensington & Chelsea has determined that somewhat than hike secondary contribution charges, it might use its windfall funding features to chop employer contributions all the best way right down to zero on this third yr. That is regardless of their actuary warning that to take action was “inappropriate” and would foster an expectation “that it is a sustainable charge in the long run”. The actuary agreed:
{that a} zero charge would solely have a marginal impression on future outcomes and shouldn’t have a detrimental impact on the flexibility of the Fund to pay future pension advantages.
However it’s simpler to chop a contribution charge than hike it.
Attending to the purpose
Given the embarrassing riches on the pension facet we are able to even see the chance for one thing radical. Perhaps we’ll see authorities in mixture halving employer contribution charges, and a few even scrapping for the subsequent three years. We hate seeing native providers shuttered or squeezed. And reducing pension contributions will certainly present some aid.
Furthermore, it might be nonsensical to take care of over-contributions to funds which can be in important surplus. However it’s not likely pension contributions which have been the issue for native authority funds.
As MainFT has reported extensively, the massive driver of deteriorating native authority funds has been the ever-rising price of grownup and baby social care. 2025 regarded like a little bit of a crunch year for some heavily indebted councils, and an accelerating number are forecast to problem part 114 notifications, aka go bust. We’re not native authorities finance specialists, however can see {that a} reduce in payroll prices may avoid wasting councils from going over the precipice. And don’t get us improper, that may be an excellent factor. However a nasty side-effect of this good factor is perhaps that it helps authorities kick the political soccer of sustainable social care funding additional down the highway.
So certain, let’s not have native authorities pile unnecessarily giant quantities of money into pension schemes, but in addition please let’s not spend the respite afforded by any reduce in contributions on evermore coverage procrastination.
Bonus content material (!)
We’ve simply sufficient pixels left to deal with you to 2 last dataviz. It’s the one which council taxpayers are most likely most interested by, that reveals the general contribution charge (the cash that truly will get charged as a part of payroll), and the diploma to which that is knowledgeable by secondary contribution charges (the premium or low cost to ongoing estimated price of offering future pensions). We predict it’s a banger. And in the event you’ve caught with this put up lengthy sufficient to succeed in this level, likelihood is that you’ll too.
That is the place the rubber actually hits the highway.
On the far proper hand facet is the London borough of Brent. With a mean secondary contribution charge near 12 per cent of wage, the full employer price of offering an LGPS pension is round 33 per cent of wage.
On the different excessive is Kensington & Chelsea, which has a mean secondary contribution charge of just about minus seven per cent. Provided that they’ve a weirdly low main contribution charge to start with, the full employer price of offering an LGPS pension is a mere 8.1 per cent of wage.
Now, earlier than you get too cocky about your understanding of LGPS, do do not forget that every of the bubbles on the chart is itself a multiemployer fund. And every of the (typically lots of) of employers included in every fund could have their very own individually calculated main and secondary contribution charges. To present an concept of the multitudes any given dot accommodates, we pulled out the numbers for the West Midlands Pension Scheme.
The common secondary contribution charge for West Midlands is 1.9 per cent of wage. However as our searchable dataviz displaying the info for all 787 employers within the scheme illustrates, employers might be paying something from zero to half of wage, largely as a result of variation in secondary contribution charges. And these will differ inside a fund for a bunch of causes.
Our guess is that a lot of the variation might be as a result of some employers could have joined the scheme when property have been flying excessive (and their efficiency subsequently underperformed modelled assumptions) or when monetary markets have been within the doldrums (and the fund’s subsequent outperformance of modelled assumptions imply they’ve greater than sufficient to pay future advantages).
Anyway, congratulations. You’ve made it to the top, and might now formally name your self an LGPS nerd.
[1] It’s an odd fund to be sincere. It’s the smallest of the funds – at lower than a tenth of the median. It’s the one fund closed to new entrants and in run-off (the Environmental Company has an open fund too). It holds solely money, inflation-linked gilts, and a few unquoted shares which have been written right down to nil. It’s acquired a proper assure from central authorities – one thing missing elsewhere. And it appears to be like prefer it’s run on a non-discretionary foundation, with the pension committee giving the fund supervisor specific directions as to which inflation-linked gilts to carry. None of that is regular. This additionally occurs to be the fund that recorded the biggest outperformance of its benchmark (which dropped over 39 per cent for the yr).
Additional studying:
— Sorry, but it’s time to start caring about Local Government Pension Schemes
