The Local Government Pension Scheme (LGPS) is in crisis, according to a report by the Centre for Policy Studies.

Local government pension scheme: opportunity knocks, authored by pensions analyst Michael Johnson (pictured), found that these pension schemes are so under-funded, they are consuming their assets to meet pensions in payment.

Using evidence drawn from some of the world’s most efficient public sector pension schemes and allied databases, Johnson estimates that a restructured LGPS should be able to cut costs by at least £860 million per year.

The LGPS is the largest funded pension scheme in the UK, with total assets in excess of £200 billion, around 5.2 million members and more than 7,000 participating employers.

The report found that the 101 funds comprised in the LGPS are under funded. The average funding ratio for the 89 English and Welsh funds was 77% on the last reported valuation date (31 March 2010) and 94% for the 11 Scottish funds (31 March 2011).

The report also includes a cost comparison of the LGPS funds, which shows a strong negative correlation between administration costs per fund member and fund scale: the larger the fund, the lower its costs.

Fund administration costs per member range from £13.70 a year (Nottinghamshire) to £139.40 a year (Durham). The range of investment management costs is even wider, from £7.60 per member (West Yorkshire) to £317.30 (City of London).

Johnson’s proposals to cut costs are based on three steps:

  • Improving transparency and adopting widespread standardisation, essential prerequisites for the digitisation required to centralise all LGPS administration.
  • Redesigning the investment process, emphasising investment in passive, not actively managed, funds.
  • Facilitating fund mergers, preferably using a dramatically improved governance framework.

Johnson said: “Ministers are aware of the need to restructure the LGPS, and are taking steps to set this in motion.

“Support for such an initiative would come from across the political spectrum, as well as from many within the public sector unions. They understand that fund mergers would best serve the interests of their membership.

“Reduced costs, akin to improved fund performance, could be used to slowly restore funds’ financial health, as well as potentially leaving some scope for sharing the benefits between members and employers through, for example, lower contributions.”

Tim Knox, director of the Centre for Policy Studies, added: “Badly managed LGPS funds are bad for both local government employees and for taxpayers.

“Grouping small funds together, while preserving competition, will achieve both substantial savings for the taxpayer and better pensions for council employees.”