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31.08.16

May you live in exceptional times?

Source: PSE Aug/Sep 16

Helen Forrest Hall, policy lead: Defined Benefit at the Pensions and Lifetime Savings Association, looks at the political and economic impact of Brexit on the Local Government Pension Scheme (LGPS).

The old adage “may you live in interesting times” has felt like it is a curse rather than a wish of late.

Since the result of the EU Referendum we have lost our prime minister, and shortly after most of the shadow Cabinet. In keeping with the resignation spirit, the leader of UKIP, Nigel Farage, resigned and Boris Johnson abandoned his leadership bid. Andrea Leadsom also quit, anointing Theresa May our second female prime minister. May promptly appointed a new Cabinet, with Johnson as foreign secretary, David Davis as Brexit secretary and Liam Fox as secretary for international trade. Arguably the only point of consistency has been Jeremy Corbyn clinging on as leader of the Labour Party. 

The economic situation has been no less turbulent. The pound has fallen sharply and gilt yields are at record lows. Most commentators anticipate a UK recession later this year or next accompanied by a currency-driven increase in inflation. The Bank of England may well choose to cut interest rates still further and has made clear that further quantitative easing is on the table. 

More political consistency than expected 

You might argue that we do not live in interesting times, but exceptional ones. So what do these exceptional times mean for pensions, and in particular the LGPS? 

In political terms, there is perhaps more consistency than you might expect given the events of the past few weeks. The local government minister is one of only a handful of ministerial posts to survive the reshuffle, with Marcus Jones MP still in charge of the brief. However, the DCLG does now have a new secretary of state in Sajid Javid. 

This new appointment may be no bad thing. Javid has some experience of pensions and financial services from his time as economic secretary to the Treasury. And he has most recently been involved in the development of proposals to address the challenges facing the British Steel Pension Scheme. 

There is also an element of continuity in HM Treasury, which usually has a thing or two to say about public service pensions policy. David Gauke has been promoted internally to chief secretary to the Treasury giving him specific responsibility for “public sector pay and pensions”. As the man who saw through the implementation of George Osborne’s pension freedoms he is no stranger to pensions policy. 

Such continuity is important as the LGPS in England and Wales currently faces the delivery of arguably one of the biggest reforms to the running of the scheme, pooling the LGPS’s assets into six investment pools in an effort to drive down investment costs and enable funds to develop their ability to invest in infrastructure. The expectation is that the new investment pools will begin to be used for collective investment from April 2018 onwards. This is a challenging timescale and it is vital that government ministers give the pools the necessary assurances that they can continue to invest in these new structures in order to stick to this deadline. 

ThinkstockPhotos-509051302

What about the economics? 

As for all funded defined benefit (DB) pension schemes the last decade has seen an increasingly challenging environment for the LGPS’s funding position – with a number of factors, such as increasing longevity and low gilt yields, contributing to a weakening of the scheme’s funding position, and a rising deficit. 

In 2013 the market value of the funds’ assets under management stood at approximately £180bn. Its liabilities on the other hand stood at £227bn, resulting in a funding position of 79% and a deficit of £47bn. 

Following Brexit, DB liabilities have increased by an additional 9.8%, and it is estimated that aggregate schemes could be hit with a 10% drop in funding levels depending on the level of liability hedging in place. This has been predominantly driven by expectations that we are in a longer term low-interest environment, potentially exacerbated further should the Bank of England decide to undertake a further round of quantitative easing. 

Now, not all of this will impact negatively on the LGPS. As an open DB scheme, with a greater proportion of its investments in equity markets, it may also benefit from the bounce in the FTSE. And we have been at pains to stress that it’s important that we don’t bake hasty responses to short-term volatility into schemes’ long-term funding plans. 

Impact on employers 

That said, there will be other impacts of the decision to the leave the EU that local government funds may need to take account of, in particular the impact of Brexit on the strength of employers who pay the bulk of the contributions into the scheme. 

Over 13,000 employers of all shapes and sizes participate in the scheme. These employers range from local authorities to universities and academies to those delivering public services, including businesses, charities, and housing associations. 

The LGPS provides a positive benefit for its members; however, participation in the scheme comes with substantial financial commitments for these employers. And how much they contribute to the scheme in any one year is, in part, determined by their financial strength as an employer. 

The decision to leave the EU has already led to four councils having their credit rating outlooks downgraded from stable to negative by ratings agency Moody’s, a reflection of the downgrading of central government’s sovereign rating. In addition, the potential end to European funding of bodies such charities is likely to impact on the covenant strength of employers who participate in the LGPS through their contracting arrangements. This could lead to increases in required employer contributions reflecting funds’ concerns about the employer’s ability to meet these long-term liabilities. 

While it is too early to call the medium- and long-term implications of the referendum there are some clear issues to navigate here and now. It looks like we shall continue to live in interesting, possibly exceptional times.

Tell us what you think – have your say below or email opinion@publicsectorexecutive.com

 

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