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Impact Investing

IPE special report May 2018

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Tackling local government funds

IPE asked three pension services - in Finland, Germany and the UK - the same question: ‘Do we need several local government funds or is one enough?' Here are their answers:

Ari Huotari, chief investment officer at the Finnish Local Government Pensions Institution (KEVA) which has AUM of €24bn

The law requires the Finnish local government scheme to cover all municipal employees and those of joint municipal organisations, with the exception of some teaching staff. Other entities, such as companies, associations and foundations controlled by municipalities, are able to choose between local government and private sector schemes.

Before the formation of KEVA in 1964 several municipal organisations had their own separate schemes but they did not cover all municipal employees. Municipalities also decided to join forces after the foundation of a common scheme for private sector employees in 1962 and they established KEVA as the administrator and central organisation of the common scheme (KuEL). For the first 24 years the financing was organised on a pay-as-you-go basis and it was only in 1988 that a buffer fund was established.

Perhaps the most important argument for a single local government pension provider is the nature of funding. Since KEVA was established as a buffer fund it has had no actuarial connection to the liabilities. Therefore, it would be impossible to divide the fund into pieces.

In addition, the outsourcing of the investments of the buffer fund to several management organisations is not regarded as cost-efficient. One of the reasons behind KEVA's foundation was to offer all local government employees similar pension coverage in order to improve the mobility of local government staff within the country. For example, the flexible movement of hospital staff, such as doctors and nurses, throughout Finland is extremely important to the healthcare system, which is mainly organised within the municipal sector.

Currently a reorganisation of the Finnish local government is underway through the merging of municipalities and there is a widespread rearrangement of services under larger regional service providers. And a highly flexible common pension scheme is required to avoid this having negative consequences for employees.

Substantially reduced costs also played a role in the move to a centralised pension provision. Most Finnish municipalities are small in terms of staff numbers and the organisation of a pension scheme with all the attendant administrative and investment issues would be very demanding. The IT systems necessary for pension administration and service provision, for example, are very costly. In addition one should take into account the cost of investing. As a large pension fund, KEVA is able to use economies of scale when negotiating fees with investment service providers, which would not be possible if the pension assets were divided among smaller funds.

 

Wolf Thiel, president of the pension fund for German non-civil servant federal and local government employees, VBL, which has AUM of €12bn

he first local pension providers emerged at the start of the last century. Under the federal structure established in Germany in 1871 each federal state, or Land, made its own provisions for its civil servants and employees. But the expansion of cities and conurbations saw a rapid increase in both the tasks required of the sovereign administration and the number of employees that wanted protection for sickness and old age. This led to the foundations of many more municipal providers.

The country's federal structure precluded the establishment of a central institution for all German municipalities and it was not until the Weimar Republic that the first large pension funds - for the post, the railways and the non-civil servant government employees - were founded.

VBL now provides occupational pensions to non-civil servants working for federal and local authorities, the Bund und Länder, across Germany - with the exception of Hamburg and Saarland - as well as for around 1,700 participating municipal, 90 social security and 3,600 other employers. It is Germany's largest additional pension provider with around 4m members. Of these, 1.8m are active and the others are non-contributory members whose entitlements remain but are no longer employed through a contributing employer.

In addition to VBL there are 24 municipal pension providers - in larger cities such as Cologne, Hanover and Frankfurt - and pension providers for church employees that sometimes also cover employees of other regions. These work closely together under an umbrella organisation, but a merger has not been debated.

Employees of the Bund und Länder as well as employees of municipalities have collective pension agreements, the Tarifvertrag Altersversorgung and Tarifvertrag Altersvorsorge Kommunal, which ensure the same level of service and benefits. That ensures a basically homogenous occupational pension scheme for employees despite the various providers and different laws in the individual states. This is a major advantage for the employees and facilitates their mobility.

The administration costs of German public sector occupational pension providers are generally very low. But they could be further reduced through more co-operation or through the provision of services for other pension funds. VBL, for example, executes the voluntary pension provision of non-civil servant employees of the German Federal Railways.

However, the public sector pension providers employ different financing methods. Occupational pensions are partly financed on a pay-as-you-go basis and partly as funded schemes, which is why mergers between or takeovers of pension funds could have a severe financial impact on their members. In such cases, just how the liabilities and already existing capital would be administered in the incorporating institution would need to be clarified.

But federalism remains an important element of German constitutional law and the application of the civil service law is in the hands of the individual Länder. Given these special circumstances, the current occupational pension system works well and a fundamental change of the system is not under discussion.

Andy Nutter, assistant director of finance at the London Borough of Islington Pension Fund, which has AUM of around £600m (€€860m)

he national pension scheme for local government employees in the UK is the Local Government Pension Scheme (LGPS). Most authorities have their own separate funds. However, that is not prescribed and we could run a fund jointly with other authorities should we wish too. At Islington we have a number of other organisations - mostly bodies with a link to the Council - who are members of our fund. We administer their benefits and invest their assets as an integral part of our own operations.

What we do in our local authorities is to administer the scheme as the LGPS instructs us to do, both in terms of the members and their benefits and the collecting of their contribution. The LGPS lays down what contributions to collect from the individual employees and what benefits they will receive. But we make the investment decisions locally.

The London Borough of Islington, for example, will run the scheme for all the Islington members who are currently working for us, have previously worked for us and moved on, or have worked for us and retired. But another authority will run exactly the same scheme with exactly the same rules and regulations and payouts for all the people who have worked for them. Apart from operational variations and the investments, there are no differences; it is effectively one scheme. That allows individual members to move between local authorities without changes to their pension terms and conditions and with no breaks in service.

To ensure the same level of local service, we benchmark the administration of the pension service in our authority with other authorities via the Institute of Public Finance benchmarking clubs, including, for example, the cost of providing the service, response rates and customer satisfaction. We also do a lot of collaborative working.

As part of local governments' continuous drive towards greater efficiency we are always looking at new ways of working, and shared services is something we periodically explore. Currently we are analysing pensions administration schemes on a London-wide basis to see whether there are benefits to shared working. However, this is focussed on the administration side of the pension fund; we are not actively exploring any sharing or collaborative arrangements on the investment side.

There is no requirement for the investments to be done on a local basis. A big issue on the investment side is about the risk to a local authority and its elected political leadership because if the investments in our pension fund fall short, the balance has to be made up by the local authority. As such it falls on the local taxpayer, which would be a significant issue for the elected political members in that authority because they have to go out to the electorate on the basis of that performance.

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