Interest rate cut to leave Birmingham council with huge pensions deficit bill
Last week’s cut in interest rates could present Birmingham city council with another financial headache by pushing up even further the cost of funding local government pensions.
The Chancellor’s decision to cut the cost of borrowing to a quarter of one per cent and expand the quantitative easing programme will depress gilt yields which are used by fund managers to work out the cost of meeting pension liabilities.
The last valuation of the huge West Midlands Local Government Pension Scheme in 2013 forecast a £4.2 billion deficit. A further valuation is taking place and the results will be known in March 2017.
At the moment Birmingham city council is in line to pay about £40 million to help plug the pension funding gap – money that Labour council leaders would far rather spend directly on providing public services.
In 2014, the city council was presented with an £80 million bill by the pension fund and is paying the sum off at about £23 million a year.
Next year’s deficit demand from the West Midlands Local Government Pension Fund will be examined in fine detail by Birmingham council leader John Clancy, whose book The Secret Wealth Garden exposed the huge administrative costs of keeping the UK’s 100 separate public sector pension funds in business.
The funds pay investment managers a total of almost half a billion pounds a year for financial advice, but most of the schemes are in deficit and demanding more and more money from hard-up councils.
Cllr Clancy argues that the deficits are “illusory” because the cost of poor investment advice is eating into the funds unnecessarily. The WMLGPF is paying £73 million a year to investment managers and the figure is expected to rise to £88 million a year by 2020.
Cllr Clancy said investment managers were hitching a ride on a “merry-go-round” and were paid huge sums regardless of performance.
The investment managers simply cream off about 0.26% of the funds pretty much every year, come rain or come shine. The funds take a dive: they get their 0.26%. The funds have a spike: they get their 0.26%. Performance of the fund really is irrelevant.”
The Birmingham council leader has described the funds as “healthy and wealthy”, pointing out that the West Midlands fund alone has more than £11 billion invested – enough to meet pension payments for many years. He has also questioned the legitimacy of working out liabilities based solely on the price of gilts.
He has urged the Government to take a radical view and to encourage the pension funds to invest their money in local government bonds, giving millions of pounds to cities like Birmingham that could be used for house building and infrastructure projects.
Cllr Clancy stated recently that he would challenge WMLGPF if the council is presented with a £40 million bill to top up the deficit.
He told a scrutiny committee:
There comes a stage when the top-up fees councils pay into the fund are so big that the whole situation gets out of control.
I will robustly challenge the next actuarial valuation if that is necessary.
With over £11 billion in invested assets, 270,000-plus members, and over 500 contributing employers, the West Midlands Local Government Pension Fund is one of the largest in the country with 288,000 scheme members.
Unusually for a public sector pension fund, the West Midlands appears to be overweight in stock markets with 60 of its funds in equities and 23 fixed interest gilts and bonds. The portfolio is exposed to two highly unpredictable sectors, oil and banks, with the top 10 equity holdings including SBC, Lloyds Bank plus Royal Dutch Shell, British American Tobacco.
The market value of the fund’s assets at March 2013 was £9.8 billion which represented 70 per cent of the accrued liabilities of £14 billion at that date, allowing for future increases in pay and pensions in payment. The deficit at the valuation date was therefore £4.2 billion.
From 2018, the West Midlands fund will merge with seven other funds across the Midlands to become LGPS Central, investing about 335 billion of assets on behalf of members.
LGPS Central says its aim will be “to deliver cost savings, to build on the existing investment expertise of its member funds through increased scale, resilience, and sharing of knowledge, and to have in place strong governance and decision making arrangements”. It will also aim to make the best use of “a blend of internal and external investment management”.
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