Consultation on the future structure of Scottish LGPS

David Davison

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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.

David Davison

Post by David Davison

Specialist consultant on pensions strategy for corporate, public sector and not for profit employers

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