Local government pensions need better investment governance

The future of local government pension schemes (LGPS) in London is potentially blighted by weak oversight of investment governance, according to research by the Pensions Institute.

Its report, An evaluation of investment governance in London local government pension schemes, identifies fundamental flaws in the investment governance of the majority of London’s 34 LGPS.

The research found that key data required to evaluate the schemes’ financial health is poor and inconsistent. It also found that schemes are allowed to shop around for the most favourable actuarial assumptions on which funding positions are calculated, while those involved in the management of the funds face potential conflicts of interest. In many cases, therefore, the real value of pension liabilities is understated and repeatedly deferred into the future.

The key findings of the report are:

• Investment practice is frequently poor, with a disproportionate focus on micro issues, such as asset manager selection and individual manager targets, rather than on the broader investment objectives and strategy, and the overall fund performance target. One of the results of this practice is asset manager churn, which adds substantial cost to scheme administration.
• Pension committees demonstrate a strong preference for active, rather than cheaper passive asset manager solutions, which adds cost without evidence of the benefit of long-term performance. Certain committees also allocate substantial allocations to alternative asset classes, which appear excessive relative to the scheme size, again adding to administrative costs, but also increasing risk without demonstrating commensurate rewards.
• Poor oversight by the Department for Communities and Local Government (DCLG) allows London schemes to understate their real funding position. Compared with The Pensions Regulator’s scrutiny of key actuarial assumptions in the private sector, the DCLG appears to be weak and complacent.
• Feeble regulation results in poor, inconsistent and misleading reporting of scheme funding positions.
• Schemes appear to be allowed to shop around for favourable discount rates, which enables them to understate the funding position.
• Many schemes do not publish targets for their overall investment performance, which is a key assumption for well-run defined benefit (DB) pension schemes.
• Schemes repeatedly extend their recovery plan periods to the maximum permitted, so there is no actual recovery.

The authors of the report are Dr Debbie Harrison, senior visiting fellow at the Pensions Institute, and David Blake, director of the institute and professor of pensions economics at Cass Business School.

Blake said: “Given the insecurity private sector employees face as a result of the replacement of DB with defined contribution (DC) schemes, it is shocking to see the government’s complacency in terms of the regulation of the gold-plated local government schemes.

“It is even more shocking when you realise that private sector employees, who are also council tax-payers, will have to pick up the bill for the poor investment governance that has been going on now for many years.

“The London schemes are particularly at risk because they are so small, with funds worth less than £1 billion at the last valuation, and less than £0.5 billion in 50% of cases. This denies them the opportunities conferred by scale, which is enjoyed by many of the non-London schemes.

“The government has a choice: sort out investment governance and regulation in local government pension schemes or make further reforms to the pensions provided by these schemes, bearing in mind that in the private sector DB has gone for good.”