As the government looks to reform the UK’s complex public sector pension system, Chancellor Rachel Reeves is scrutinising a model inspired by Canada.

The move has ignited considerable debate about potential benefits and challenges, including whether it prioritises the best interests of pension holders or serves as a means to unlock funds for addressing the UK’s infrastructure issues.

Canadian public sector pension schemes are consolidated into large, professionally-managed funds, allowing for significant investments in diverse assets such as infrastructure and private equity. The country’s leading pension funds, known as the Maple 8, manage approximately C$2tn (£1.1tn) for public sector workers.

The Maple 8 comprise the Canada and Quebec pension plans that all working Canadians contribute to, the federal Public Sector Pension Investment Board, the Ontario Teachers’ Pension Plan, British Columbia Investment Management Corporation, and Alberta Investment Management Corporation.

The difference between the UK and Canadian pension models

The UK’s local government pension scheme (LGPS) is one of the world’s largest defined-benefit schemes with £360bn of assets under management and 6.5 million members. In contrast to Canada’s approach, it is divided into 86 independently managed funds. Proponents of consolidation suggest that merging these funds could facilitate greater investment in infrastructure and reduce inefficiencies, potentially saving £1bn annually in fees.

David Petrie, ICAEW’s Head of Corporate Finance, points out: “Unlike Canada, most public sector pension schemes in the UK – for the NHS, teachers, civil servants, armed forces, police and fire services – are unfunded and paid for out of current taxation and so do not have any investments. The exceptions, such as the Parliament, BBC and the Bank of England pension funds, are relatively small in size, leaving the LGPS as the only sizeable public sector pension scheme in the UK with the scale to support major infrastructure projects.”

Potential benefits: consolidation and reduced admin costs

The Canadian pension system is characterised by large, consolidated schemes. By pooling resources and reducing administrative costs, these schemes can potentially offer better returns for their members. Reeves is particularly interested in this aspect, as she believes that consolidating the numerous local authority pension schemes in the UK could improve efficiency.

“Although the introduction of eight investment pools over the past four or five years has seen some consolidation already, the amount available for infrastructure investment remains relatively low in comparison with what might be possible with a single fund,” adds Petrie.

John Gaskell, ICAEW’s Head of Personal Financial Planning, explains why this model is under consideration and how it compares to the current UK system. “One of the key arguments around the Canadian pension schemes, which Reeves seems to be focusing on, is the potential for economies of scale,” he notes. “She appears to suggest that having numerous local authority pension schemes may not be the most efficient model, due to duplication of costs and other inefficiencies.”

Potential pitfalls: complexity and efficiency

However, Gaskell warns that while larger schemes might reduce costs and improve efficiency, there are concerns about the optimal size of these schemes. “It raises the question of whether there is an optimal size for a scheme and whether a scheme that becomes very large could actually end up being less efficient,” he says.

Additionally, the UK’s current pension system is highly complex, both legislatively and from a tax perspective. Frequent government interference and regulatory changes have tended to erode public confidence in pensions as a stable and secure savings vehicle. This ongoing meddling has also increased the cost and complexity of managing pensions, making it challenging for individuals to obtain affordable advice and plan confidently for retirement.

Investment flexibility and infrastructure

A key feature of the Canadian model seems to be flexibility in investment choices, especially in infrastructure projects. Reeves is interested in allowing UK pension funds to invest more in infrastructure, potentially boosting the nation’s economic competitiveness. Gaskell notes that while this flexibility could offer advantages, it is crucial that decisions are made independently by trustees and investment managers, focusing solely on benefits to the scheme’s members.

“The concern is that using pension funds to address public infrastructure may lead to prioritising these projects over the best interests of retirement members,” he says. Historical examples, such as the troubled investment in Thames Water, which is currently struggling with £15bn of debt, highlight the potential risks.

A fundamental issue is restoring public trust in pensions. Gaskell stresses the need for a stable, straightforward and appealing pension system to foster savings and secure financial futures, supported by personal finance education in schools, colleges, universities and the workplace.

Adopting aspects of the Canadian model presents a complex, but potentially rewarding opportunity for the UK. The consolidation of schemes and increased investment flexibility must be carefully weighed against risks of inefficiency and misaligned investment priorities.

While Reeves’ proposal aims to tackle the UK’s infrastructure investment gap and enhance pension efficiency, the transition must be managed with careful consideration of its unique challenges and risks.