Archive for September 2018

David Davison

In June 2018 the Scottish Local Government Pension Scheme Advisory Board launched a consultation on the future structure of the Scottish LGPS. The Board’s consultation sets out four options for the future structure of pension funds in Scotland. The review provides excellent background for all LGPS in the UK as the range of scheme sizes provides a microcosm in which to review the options presented more widely.

There are 11 Scottish Funds with total assets of around £42Bn and liabilities of about £55Bn. Scheme sizes range from the largest, Strathclyde Pension Fund, with around £20Bn of assets and 210,000 members to the smallest, Orkney Islands, with only £335m of assets and just over 3,600 members. The four options being explored along with the key considerations are shown below.

  1. Retain the existing structure

Retaining the status quo is likely to mean that inefficiencies will remain as most funds will not achieve the benefits of scale such as improved bargaining power, access to greater resources and reduced duplication of efforts in administration, governance, spending on advisers and fund management. Larger funds are also likely to be able to better access infrastructure investments. Maintain the existing approach is therefore likely to mean that costs per member are likely to be higher than necessary.

A potential negative would be the loss of local input and oversight and the regional diversification of resource such as staff as it may be difficult to access specialist staff in a single location. However the existing structure does potentially also create a key person risk as there is less available resource to cover key roles as well as budgetary and staff risk due to other competing local priorities..

Clearly any savings made or improvements achieved would need to outweigh any initial transition costs but all research to date would tend to support a move away from the status quo.

  1. Promote co-operation in investing and administration

There have already been some examples of collaboration particularly in the investment area and around procurement. This approach would allow the current governance structure to continue, allowing for continued local oversight, although requiring some sharing of control. There would also have to be some adaptation of governance.

Approaches to date seem to have been relatively informal which results in a degree of uncertainty over their future persistence so a more formal structure may be of value to assist with planning as well as the distribution of costs and returns. To date this sort of co-operation has been pretty limited despite its obvious benefits which would suggest that without strong vision and direction it will remain  something of an outlier. I can’t help feeling that greater structure and compulsion is needed to really drive change.

  1. Pool investments

This option would see all assets pooled in one or more asset pools managed centrally on behalf of a number of Funds. Schemes would retain their governance, administration and back office functions and continue to appoint and manage their advisers. This is very similar to the approach currently being adopted in England and Wales.

A single pool would double the asset size to about £42Bn over the largest Fund which has assets of just under £20Bn. At this size it would be of a similar size to 3 of the English pools and larger than the 3 others.

Fund assets and liabilities would still be allocated in the same way to ensure specific employer responsibility for liabilities.

A move of this type would be likely to result in lower cost investing though subject to some initial cost increases to manage a transition. It would also be likely to mean that the asset pool was of a significant enough size that more of the investment and administrative tasks could be undertaken in house.

From a governance perspective each Pension Committee would retain responsibility for asset allocation and managing the legislative structure however day to day investment management would be delegated to the pool. Each Fund would also maintain its Pension Board.

As has been shown in England and Wales this approach is very achievable and its hard to deny the value so would seem to be a minimum required step.

  1. Merge funds in to one or more funds

This option would see the creation of a Scottish ‘superfund’ which would manage all LGPS benefits in Scotland. Such a move would benefit from the asset pooling advantage s in 3 above but also allow for merging of the administrative and governance functions.

Such a move, whilst ultimately desirable from a cost and consistency perspective is not without its challenges. Each of the Schemes is funded at a different level and there would have to be a recognition of this and a mechanism to resolve it to ensure there was not a cross subsidy between different regions and even potentially employers. There would also have to be clarity in terms of governance, priorities and costs. There are also political drivers as well as a need to ensure that the right level of resource is available to the new consolidated scheme.

None of these challenges however are insurmountable and really just need commitment to achieve the objective and a clear plan to do so over a reasonable timescale.

The Funds all provide consistent benefits based upon a single regulatory framework. Consolidation would remove regional variations and inconsistency. Legacy arrangements would have to be clearly documented and honoured but future practice could be implemented on a wholly fair and consistent basis. Undoubtedly given the size distribution of schemes in Scotland a number of them would be likely to benefit from cost savings and improved governance very quickly. Market buying power in terms of services would be improved and greater investment possible in staff, technology and scheme communications.

Conclusion

Research carried out by Deloitte in 2011 suggested that costs per member in Scotland compared favourably with funds in England and Wales and that a single operating model and common administration system may have a greater benefit than formal administration mergers though research by APG concluded that administration costs decline with larger funds and certainly this seems to be the model being employed across UK defined contribution businesses.

It also needs to be considered that the number of employers participating in LGPS in Scotland is falling so less resources are needed and greater consistency of practice can be achieved. In addition with greater employer consolidation there will undoubtedly be increased demand for larger employers to have all benefits consolidated in a single fund rather than across multiple schemes.

In addition the benefits of having a single scheme which is not accountable to a local authority and can operate in an autonomous way based on its agreed priorities should provide greater flexibility in staff terms and conditions and therefore provide the opportunity to attract a much higher calibre of staff.

There are clear benefits which can be achieved through investment pooling and even further benefits through a consolidated single scheme for Scotland – it just needs vision and commitment to achieve them.

Hugh Nolan

The Pension Regulator’s Powers

Something must be done! So says the work and Pensions Select Committee chaired by Frank Field MP in the wake of high profile cases like Carillion and BHS. Knee jerk reactions in Parliament rarely lead to the best laws and I suspect that this habitual problem will only be exacerbated with laws made while everyone is distracted by Brexit. What are the chances of the Government actually improving the pension’s landscape?

Well, firstly, there are some changes that can be made which are at least harmless in principle and may even do some good. It’s hard to find a compelling reason to argue against strengthening penalties for wilful or grossly reckless behaviour by trustees and employers, for example. On the other hand it’s only ever been a tiny minority of schemes that have suffered from such behaviour so it’s unlikely that making it a criminal offence will improve things much. There’s also the likely unintended consequence that some diligent trustees will be prompted to err too much on the side of caution rather than run any risk at all of being accused of recklessness.

The problem is that the Select Committee is extrapolating to the wrong conclusion. The Pensions Regulator had been involved with Carillion before it collapsed, but had still not managed to avoid the current problems arising for its pension schemes. The dilemma was though that Carillion was already struggling and the Trustees and the Regulator were in an invidious position. They could have encouraged (or even tried to force) the employer to pay higher contributions at the expense of dividends. If so, that could well have driven investors away and led to a collapse sooner. With the benefit of hindsight the Committee is convinced that the decisions made were wrong, but who really knows what would have happened otherwise. In any event, the problems at Carillion were with the company itself and the pension scheme was just collateral damage. Companies will always be at the risk of going bust and it’s unrealistic to insist on full solvency funding for every scheme at all times just in case it happens to be one of the unlucky ones. Perhaps we just need to be honest about the fact that sometimes bad things happen and it’s not always possible to completely protect people.

Secondly, I happen to have liked the practical way that the Regulator worked in the good old days. They encouraged trustees to do the right thing and explained when they were getting it wrong, only using their formal powers as a last resort. Sometimes they got it wrong but mostly the Regulator found a good balance in a difficult area. Now that something “must be done”, the Regulator has used its enforcement powers in 22% more cases in the second quarter of 2018 than in the first quarter. Have there really been 8,000 more cases where the Regulator needed to step in or are we just seeing a reaction to the unfair criticism for past performance?

Finally, there is definitely a bright side. The Regulator has historically been slightly nervous about using some of its existing powers even when they are clearly justified, possibly due to a fear of being over-ruled later. In the latest quarterly report, the Regulator has used its information gathering powers 31 times, taken action against 25 schemes for failing to submit an annual return and appointed 162 trustees to protect member benefits. The Regulator also exercised powers for the first time ever under the Proceeds of Crime Act 2002, Section 10 of the Pensions Act 1995 and the Computer Misuse Act 1990 (which by my reckoning has been in force for 28 years so far). That certainly seems to support the claim that the Regulator already had more powers if it wanted to use them!

In particular, the Section 10 fine of £25,000 for the Trustees who had failed to produce two actuarial valuations is a welcome wake-up call to the handful of trustees and employers who behave badly. However, I still hope (and expect) that the Regulator will limit the toughest stance to those that deserve it and continue to support hard-working and dedicated trustees to do their best – without leaving them terrified of being sent to jail or the poor house if they ever make an honest mistake or things go wrong for their scheme.

David Davison

If you’re one of the lucky admitted bodies who benefit from a council or other guarantee for your LGPS membership then this is likely to mean that you are currently disclosing a much more negative position on your balance sheet than actually should be the case.

In most cases transferee admitted bodies, and community admission bodies with guarantees, benefit from preferential exit terms should they leave the Fund, with the debt payable on exit calculated on an on-going basis (as per that used to calculate Fund contributions) rather than the more stringent cessation basis. This is good news of course as it means the likelihood of having a large debt on exit is much lower.

However, there is no correlation between the assumptions used in the calculation of the on-going funding position and those used when compiling the FRS 102 disclosures for company accounts. Under FRS 102 the discount rate must be set in line with the yield available on high quality corporate bonds. At the moment, corporate bond yields are low and so the discount rate used in the FRS 102 calculations is likely to be much lower than that used for the on-going funding basis, resulting in higher liabilities and a much larger deficit (all other things being equal), which therefore reduces balance sheet value.

I recently witnessed an example of this where, on an on-going basis, the organisation was in surplus but on the FRS 102 basis the organisation had a £100,000 deficit. The organisation had a guarantor and so was able to exit the Fund at any point paying off any on-going funding deficit (which in this case was nil). The FRS 102 deficit cannot be correct in this case as the worst case scenario is the on-going position. This meant that the charities balance sheet was £100,000 worse than it should have been, which, for the charity in question, was very material.

A further difficulty from a disclosure perspective are the recent changes to UK wide LGPS Regulation which now permit the return of surplus on exit from schemes. To date where a surplus has existed this has been discounted and a net neutral position assumed as any surplus could not be recovered. This however is no longer the case and the position will vary depending upon whether the organisation has a guarantee and whether their ultimate exit position is based upon an on-going or cessation position.

The disclosure position has therefore become much more complex and employers need to be considering their position well in advance of their company year end to leave enough time to take any remedial steps necessary. So if you have a guarantee or are very well funded on your exit basis, discuss this with your auditor. It may be possible to add a note to the accounts to provide greater clarity or better still, update your accounts with disclosures on a basis more consistent with the value of the liabilities actually owned.

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