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Glyngas Glyn Gaskarth says a radical but fair solution is needed for the unsustainable Local Authority Pension Schemes.

Council Chief Executives have won their battle to keep their pension details secret. However, the conflict concerning the divide between gold plated public pensions and paltry private pensions seems set to endure. We need to devise an alternative. One that preserves the best elements of Local Authority Pension Schemes (LGPS) but ensures that LGPS become more affordable, sustainable and defensible.

There are over 3.9 million members of the LGPS (including the author). To join entrants must be under the age of seventy five, have a contract for more than three months and belong to an employer who offers the scheme. Eighty nine regional pension funds administer the scheme. Private sector employers can opt to belong to the scheme by purchasing years in a Local Authority scheme.

The system has considerable advantages:

  • Entitlements are part funded through investments purchased through member contributions: LGPS members contribute to a fund to receive their pension benefits. The scheme is eighty three per cent funded and is one of the only funded public pension schemes. The civil service pension scheme has no fund. Members are simply paid by the Exchequer. Their contributions are counted as income to the Treasury. The trade union Unite estimates that existing Local Government pension funds are
    sufficient to pay for existing pension liabilities for an additional twenty years without further employee contributions. This estimate was based on a March 2008 estimation of LGPS fund assets of £120 billion. The March 2009 valuation figure is now lower at £97.3 billion. Whatever the funds ultimate value (share values may recover) the existence of this sizeable fund should help meet the transition costs to a new sustainable pensions system.
  • Employee contributions are high: LGPS employee contributions are dependent on pay level. They range from those who earn £12,600 who contribute 5.5 per cent of their pay to those who earn over £78,000 who contribute 7.5 per cent. By contrast new civil servants contribute only 3.5 per cent of their wages towards their pension. Private sector workers with defined contribution schemes pay less than three per cent on average.
  • Employer contributions are high: LGPS employers currently contribute 15.7 per cent of members pay per annum on average. The civil service contributes 19 per cent. This compares with an average 6.5 per cent contribution by private sector employers to defined contribution schemes.
  • Enrolment is high: The majority of public sector employees including low paid workers join the pension fund. The Pensions Policy Institute (PPI) found that twenty of private sector employees earning between £100 and £200 a week were members of an occupational scheme, compared to seventy per cent in the public sector.

However the scheme also has significant drawbacks:

  • Unsustainable: Life expectancy at birth in the UK is increasing at a rate of one year extra every four years. The ratio of workers to pensioners will decrease from four to one (2004) to two to one by 2056. LGPS are based on the final salary of the employee not on average life expectancy, fund size and projected investment returns as is the case with private sector annuities.
  • Unfunded: Existing pension funds appear healthy because the local authority workforce has expanded massively in the last ten years. It numbers over two million people. This cannot continue indefinitely. Fewer employees will mean fewer contributions. Pension fund deficits will only increase over time.
  • Inflexible: The scheme provides no incentive for an employee to manage the transition from full time work to retirement by dropping down pay grades or assuming less intense junior positions. This is because pension entitlements are based on final salary. If a worker reduces their final salary pre pension then they cut their pension entitlement.
  • Crowding out of the private sector: Private enterprise is increasingly constrained particularly in the north east. Employers cannot equal the generous pay and conditions provided by the public sector. Nine out of ten private sector final salary schemes have been closed to new members.

The Conservatives have suggested we put an arbitrary cap on the benefits pension scheme members can receive. This is a short term fix not a long term solution. The Labour party have decided to place the costs of what little reform they have achieved entirely on new pension scheme members e.g. the increase in pension age from 60 to 65 applies only to new members. This is deeply unfair to younger pension scheme members. Instead we need to manage the change from a final salary LGPS to a more flexible personal accounts system equitably sharing the transition costs between the generations.

Policy Recommendations:

  • Honour existing pension accrued entitlements: Existing pension scheme members have accumulated legal entitlement to payments based on a formula of 1/60th of final salary in pension for each year worked. Existing accrued entitlements should not be altered.
  • Freeze all existing local authority pension entitlements at their current level: There is no legal right for workers to continue to receive the current pension deal for future year’s payments. Each pension member’s existing entitlement should be frozen. At the age of sixty five they should receive a pension based on their last year of earnings before this freeze occurred (increased by the retail price index) times the number of years they worked prior to the freeze.
  • Open new Personal Accounts Pensions for all existing pension scheme contributors: Default all new employees and existing local government pension scheme members into a new local government personal accounts pension scheme. Offer all employees the chance to leave if they
    formally request this.
  • Increase employee contributions: A default employee contribution rate of 8 per cent of salary should be set for all personal account pension scheme members. This represents an increase in the existing personal contribution level which currently ranges 5.5 per cent to 7.5 per cent (this is dependent on income level). The new default rate would compare well with the level of employee pension contributions in the police which ranges from 9.5 per cent to 11.5 per cent.
  • Match employee/employer contributions: Local Authorities should match employee’s personal contributions up to a specified rate e.g. twelve per cent.
  • Use existing pension funds and the savings on reductions to employer contributions to meet existing pension payments: All savings made from the reduced pension contributions employers make to the personal accounts system (they would be paying between 8 and 12 per cent of salary rather than 15.7 per cent on average) should be used to service existing pension liabilities.

By converting local authority pensions from a final salary scheme to a defined contribution scheme value for the taxpayer will be ensured because long term liabilities will be curtailed. By maintaining a relatively high level of employer pension contributions the new system will still be attractive to local authority employees. Allowing employees to invest their own pension funds will ensure that the division between public and private pensions is broken down. Local Authority pensions could become a model pension system which private sector providers would wish to follow.

The views expressed above are my personal views and not those of my employer or any other organisation with which I am associated.

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