Let’s get together

The merger of Local Government Pension Scheme funds presents a number of challenges, explains John Hanratty.

In April of this year, Bob Holloway, the Head of the Local Government Pension Scheme 2 division at the Department for Communities and Local Government, kicked off a discussion about the possibility of merging some of the 89 Local Government Pension Scheme (LGPS) funds in England and Wales. Similar discussions have taken place around merging some of the Scottish LGPS funds.

Following this, in May, Brandon Lewis, the coalition’s Minister for Local Government spoke at the National Association of Pension Funds’ Local Authority Conference and set out that the Government was to undertake a review of the structure of the LGPS to determine whether the LGPS in its current form is ‘fit for purpose’. This led to the Department issuing a Call for Evidence on the future structure of the LGPS in June, the closing date for which is 27 September 2013.

On the face of it, a consolidation may be sensible for the following reasons:

• Larger funds will have better purchasing power with investment managers and administrators, so could lower investment management charges;
• Each fund currently pays for its own administration, including actuarial services, investment consulting services and wider consultancy services – larger funds would be able to “pool” these services so a smaller number of actuaries, for example, would be needed;
• Different administering authorities do take different approaches to, for example, the exercise of discretionary powers - a consolidation to a smaller number of funds would provide a more consistent approach across the LGPS as a whole.

There is support in the sector for some rationalisation and some of the smaller funds would definitely benefit from the economies of scale which would be enjoyed from a merger. But, is it that simple?

The merger of pension schemes is not a straightforward exercise. For a start, the different funds are all, generally, in different positions relating to their funding. Some are well funded relative to their liability to pay pensions, whilst others have significant deficits against their liabilities to pay benefits.

The disparity in funding could cause issues in relation to merging the funds. If there is simply to be a direct merger, that would mean that better funded funds would be subsidising those that are less well funded.

Similarly, the actual pounds and pence value of the funds could provide an area for debate where, for example, the proposed merger involved a fund of several billion pounds which was significantly underfunded and a smaller fund of, say, several hundred million pounds which is better funded. In that case, the better funding position of the smaller fund would be consumed by the underfunding of its larger partner.

Clearly, the funding of the pension scheme is not, in and of itself, a reason not to merge funds but it does provide a hurdle which will need to be addressed. In the private sector such issues can be addressed in a number of ways.

One way is a differential funding rate for the employers making up the underfunded scheme to a level equivalent to the better funded scheme over a designated time period. Regulation 36 of the Local Government Pensions Scheme (Administration) Regulations 2008 (the Administration Regulations) does currently permit for this approach to be taken through the “adjustment” part of the rates and adjustments certificate.

Another approach would be to have a lump sum paid by the less well funded employers to bring the funding position of the funds closer together, although this may be difficult to achieve for some of the employers in the fund.

A combination of these approaches could be taken, whereby the less well funded fund’s employers are required to make a capital contribution with adjusted ongoing contributions.

Another issue for merging funds to consider is how they would deal with “orphan” liabilities. This is the liability to provide benefits for members whose employers are no longer part of the fund, whether that’s because the employer no longer exists, or because the liabilities have increased in deferment due to changing economic or demographic conditions, and that increase cannot be recovered from the former employer.

By merging funds, the orphan liabilities will fall to the employers of both funds. Where one fund has a disproportionate value of orphan liabilities there may need to be some form of pre-merger apportionment to make sure that authorities are not picking up the cost of liabilities for which they have had no previous liability.

Authorities will need to think carefully about their duties under the principles established in Roberts v Hopwood [1925] before agreeing to take on the orphan liabilities built up by another authority or authorities.

Of course, a change to the legislation to permit funds to merge would enable these issues to be resolved. After all, the overall position of the funding of the LGPS - if not the individual funds - would be materially the same after mergers as it was before.

Alternatives to full mergers

Certain strategic mergers do make sense; the London Boroughs have spoken many times about a merger of their individual funds in to one “super fund” for London authorities. One of these strategic mergers is already being investigated by Oxfordshire, Buckinghamshire and Berkshire county councils, which have announced that they are looking in to combining in a “Chilterns fund” under the LGPS.

The Oxfordshire, Buckinghamshire and Berkshire funds at £1.32bn, £1.32bn and £1.45bn respectively are very similar in size and the opportunity to “…identify potential savings from collaborative working…” would seem to make sense.

In 2011, the London Boroughs of Westminster and Hammersmith & Fulham and the Royal Borough of Kensington & Chelsea announced a “tri-borough” approach to certain back office functions combining some £300m of shared services.

In their 2012 review, “Tri-Borough One Year on” they analysed the first year performance of their shared service approach and targeted an overall savings target of £33.4m by 2014/2015.

We have yet to see administering authorities taking a shared service approach to their pension funds but certain overlaps and economies could be eliminated by using this approach, either instead of or as a pre-cursor to a fully-fledged merger.

Support is not, though, universal and Mark Field, the MP for the Cities of London and Westminster has expressed his concerns that, whilst a “super-fund” for London could lead to the pension funds being seen as a source of capital for infrastructure and social funding, it may be subject to undue political influence so politicising the pension fund.

We are in a time of change for the LGPS and any structural reorganisations will not be effected until the benefit restructure, which will happen in April 2014, has gone through. However, the structural changes come at a time that professional and representative bodies, such as the Chartered Institute of Public and Financial Accountants and the National Association of Pension Funds (NAPF), are calling for an overhaul of the investment restrictions which restrict the LGPS administering authorities’ freedom to invest as other pension schemes do.

There is a natural linkage between the structure of the funds and their investment strategies; as set out above, larger funds have greater power in the investment markets. The question is whether the authorities, both employing and administering, have the appetite for so many radical changes in such a shortened timeframe.

John Hanratty is a Director and Head of Regional Group at DWF. He can be contacted on 0845 404 1734 or by This email address is being protected from spambots. You need JavaScript enabled to view it..