Why pension governance matters

Now that the Public Service Pensions Act has completed its parliamentary stages it's time to look at one of the successful amendments that we welcome. The Act strengthens the governance of pension schemes and funds as recommended by the Hutton Report. I don't often give credit to the Liberal Democrats, but they were instrumental in this positive measure.

The new requirements are for a scheme advisory board and pension boards for local funds. The Scottish Local Government Pension Scheme (LGPS) already has an advisory board called SLOGPAG, so this isn't a big change. However, its role is considerably strengthened by the Act including its relationship with each of the 11 funds in Scotland that invest some £24bn. The biggest change is at fund level, with a requirement that each fund shall have a pension board with half the members being member representatives.

For those familiar with private pension schemes member representation doesn't sound very radical - indeed it is a legal requirement. However, the LGPS is probably the only funded scheme in the EU not to have effective and statutory member representation. In the main they are administered by a pensions committee made up almost exclusively of employer representatives i.e. councillors from the local authorities covered by the fund. The funds are also, in most cases, closely linked to the organisation of a lead council in a way that would not be acceptable in a private pension scheme.

While the changes are driven by primary UK legislation the Scottish implementation will be the subject on secondary legislation in the Scottish Parliament. There may well be a need to amend other primary Scottish local government legislation. All of this will be covered in the current negotiations over a new Scottish LGPS.

Why does this matter? Well it matters to the scheme members because the Act also imposes a cost cap and badly administered funds could result in lower benefits or higher contributions. It even matters to members not in the scheme because employing organisations have to pick up the cost of failure and that could cost jobs. That's not just councils, because one-third of the members work for admitted bodies like NDPBs, voluntary and private sector organisations.

It also matters to the wider public, not just because of the taxpayer cost. These funds could be an important contributor to the Scottish economy. Sadly at present they rarely are with 45% of the £24bn assets invested in overseas equities. I recently prepared a paper with assistance from SFHA, supported by Shelter, that proposed investment in social housing. A modest pilot plan, but there is still resistance from traditional fund managers, despite this being common practice elsewhere in Europe. A UNISON pension trustee covered this issue in his blog this week:

"I suspect that the real problem is that property fund managers and advisers are use to what they know. One adviser told me that the excuses put forward by such managers is just "lazy thinking". They are experienced in investing in shiny new retail parks, hotels and warehouses. Investing in Social Housing is outside their comfort blanket. Also Housing Associations are not use to sharing the capital appreciation of their assets either."

Investment strategy is not the only issue that would benefit from stronger governance. There is insufficient separation in the treasury functions of the lead authority and the pension funds. Something that would not be acceptable in a private sector scheme and is specifically disallowed under the EU IORP Directive. The UK government has tried hard to keep the LGPS out of the provisions of IORP Directive. However, being included might be the funds saviour, because otherwise the Solvency 2 Directive will apply and that requires funds to come into balance within a year. A cash flow problem Scottish employing authorities could do without.

Then we have the issue of fund mergers. Does Scotland really need 11 separate funds? Our research indicates that bigger funds would have performed better over the last ten years and it should save some fund management fees. I understand that this is a live issue in England where the minister has indicated that the status quo is not an option. And on the subject of fees there was a very interesting presentation by Dr Chris Sier  to a recent TUC conference. His work shows just how much money is going in fees and suggests that there are other 'covert' costs that are not being fully disclosed.

So pensions fund governance really does matter on so many different levels. The legislative changes are just the start of a process that needs to change the culture of pensions governance in Scotland. There are also significant issues for trade unions in supporting pension representatives and taking members through this complex business.