Audit Commission calls for larger employee contributions in LGPS reform

Raising employee contributions – but tapering them to discourage members from opting out – is one option for putting the Local Government Pension Scheme “on a better financial footing”, the Audit Commission said.

In its report Local government pensions in England, the Audit Commission said recent investments by the LGPS had failed to deliver anticipated returns and the funds currently only cover about three-quarters of the scheme’s future liabilities.

Other actions the Audit Commission said could be taken in relation to the LGPS include:

• Making savings by raising the normal retirement age and reducing the rate at which pension benefits are earned
• Allowing local pension funds more discretion to adjust the level of benefits offered to pension fund members, and
• Local government employers keeping liabilities in check by controlling wage costs.

The LGPS is the UK’s largest public sector pension scheme by membership, with 1.7m active members, 1.15 members with deferred pensions and 1.1m people receiving pensions. The scheme is comprised of 79 separate funds in England.

The Audit Commission report revealed that LGPS funds have a positive cashflow, in that more money is going into the funds than is coming out of them. A high proportion of the pension costs of current employees are also paid up-front, which reduces the reliance on future generations to fund pensions in payment.

But the Audit Commission added that “the current approach cannot continue indefinitely because unfunded liabilities are being deferred into the future, to make the scheme more affordable to employers in the short term”.

It said the cost of providing pensions for local authority employees is rising in absolute terms and as a proportion of pay “because of increasing life expectancy and action needed to recover funding deficits”.

Other factors that mean action is required include lower than anticipated investment returns; the fact that the cost of pensions affects the amount of money available to fund services and influences council tax decisions; and recent reforms to the LGPS have addressed some underlying affordability issues but will not guarantee long-term sustainability.

“The LGPS needs further reform to address the growing mismatch between liabilities and the resources available to fund them,” the report said.

The Audit Commission warned that some radical options that might appeal to policymakers would not serve local government well in the short term. These include merging funds, reducing the target level of funding for the scheme, and taking on the whole of the liabilities and running an unfunded scheme. “The cost of such changes might outweigh any benefit,” the report said.

Incremental reform would put the LGPS on a more secure footing, the Audit Commission argued. It said reforms should take into account the LGPS’ membership, with its high proportion of part-time and low-paid workers, and the interaction between occupational and state benefits.

The spending watchdog prepared the report to inform Lord Hutton’s inquiry into public sector pensions.