The English Local Government Pension Scheme has 3.7m members, including 1.6m current employees. Although it is administered by 81 regional funds it is a single national scheme set up by the same legislation as other public sector schemes.

Since LGPS pensions are guaranteed by Act of Parliament, central government and not each individual council is ultimately responsible for its obligations.

Unlike unfunded public sector schemes, such as the NHS, which pay pensions from current tax revenues, the English LGPS holds assets – £120bn (€127bn, $175bn) as at March 2008 – built up from employee and employer contributions. Each of the funds had a three-year actuarial valuation as of March 2007 to fix employer contributions for new pension promises and to plug any deficit.

By analysing the published accounts of 55 of the 81 English administering local authorities – 90 per cent of LGPS assets – it is possible to compare the “official” March 2007 deficit with the FRS17 deficit, buried in footnotes, using an objective double A bond rate as required for private sector schemes.

What is the real LGPS deficit versus the official deficit? Is the real cost of new pension promises recognised and paid for by individual local authorities? Is the real overall cost recognised by the Treasury?

The official LGPS deficit at the March 2007 actuarial valuations is about £23bn – £122bn assets and £145bn liabilities. The value of liabilities is calculated by discounting pension payments at the actuary’s estimate of the “expected return on assets” – largely equities – held in the funds.

But March 2007 disclosures show FRS17 liabilities of £165bn, giving a £43bn deficit, not the official £23bn.

By February 2009, with the FTSE 100 at only 4,000, assets will have fallen to about £95bn. Meanwhile, liabilities, even before the impact of quantitative easing, will be about £175bn, with new pension promises and interest – an FRS17 deficit of about £80bn.

For the UK LGPS as a whole, including Scotland, Wales and Northern Ireland the FRS17 deficit is a whopping £100bn – £120bn assets and £220bn liabilities. Assuming unchanged bond yields the FTSE 100 would have to double overnight from 4,000 to over 8,000 to remove the deficit.

Since the LGPS is government guaranteed the correct discount rate is the index-linked gilt rate, not the FRS17 double A corporate bond rate, so even this figure grossly understates the economic deficit.

The LGPS is much worse funded than private sector pensions – only 50 per cent versus 75 per cent. Unlike the private sector, new pension benefits have not been reduced, councils have made no real deficit contributions and the LGPS has a much higher equity holding and has been hit harder by falling share prices.

Meanwhile, the official 2008 annual cost to taxpayers of LGPS in England is £5bn. This cost, recognised by local councils in their accounts, is the cash contribution made for the regular cost of new pension promises and to meet the (understated) official deficit.

But the 2008 FRS17 cost of new pension promises is £5bn, so the cash contribution is just enough to pay for the regular cost of new pension promises, leaving nothing to reduce the deficit.

The annual LGPS benefits changed as of April 2008. Rather than reducing annual costs, as suggested by the political rhetoric, these changes increased taxpayer costs, even after a (modest) increase in member contributions.

Regardless of the size of deficit, holding 70 per cent equities, including hedge funds, is a hidden equity bet for taxpayers. Would the Treasury even consider this bet directly by issuing gilts to buy equities?

The optimal asset allocation for taxpayers is 100 per cent index- linked gilts, to remove the huge equity bet and recognise the government guarantee. Just to pay the £4bn current pensions requires the LGPS to hold £80bn bonds on a 5 per cent yield, requiring a major shift into bonds.

Neither individual local authorities, nor central government, recognise the size of the real LGPS deficit, and thus have no plan to address it. The approach seems to be “keep your fingers crossed and hope the massive equity bet pays off”. However, the deficit will have to be paid, sooner or later, by future taxpayers through higher council tax or a cutback in services.

The Treasury remains in acute denial about the real cost of public sector pensions and the total liabilities.

A proper public debate on the affordability and sustainability of public sector pensions, including for local government employees, requires the government to take the first step of being accurate and transparent about the underlying numbers.

John Ralfe is an independent pension consultant and formerly head of corporate finance at Boots

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