Sorry Surrey

Surrey: Britain's richest county. Yet the investment bankers who populate its millionaire estates such as St George's Hill in Weybridge are in for a surprise. It is their leafy shire, not some radical left-wing authority, which has managed to rack up the worst pension fund deficit of any county in England.

Until now the headlines about the pensions crisis have focused on companies, where final salary schemes are being axed as fast as one can say "executive bonus plan". Companies have decided they are too expensive and too risky, and are giving their new workers second-class "money purchase" schemes instead.

But the pensions crisis is not just about company schemes. Some of the biggest pension schemes invested in the rapidly drooping stock market are those that are supposed to pay the retirement incomes of millions of workers for local authorities.

The council workers of Surrey face a £328m shortfall in their pension fund. In neighbouring Kent, the fund set up to pay workers' pensions is £519m adrift of where it should be, although because Kent has many more council staff, its scheme is proportionately less affected.

According to figures for March 2001, at least 31 other councils from a sample of 98 are in similar difficulties and only 32 can say with their hand on their heart that money in the pension kitty matches the pension fund's liabilities.

But note that these figures, the only official ones obtainable, are for March 2001. Since then the situation has worsened dramatically, with the stock market falling by around 30% over the past 13 months. At least the county councils will disclose their figures. Most of the metropolitan authorities contacted by Jobs & Money refused to reveal their pension fund deficits. Scottish and Welsh authorities were not part of the survey, but are understood to be better-financed than the English county schemes.

Many of the councils have been topping up their funds desperately, with some paying in 20% or more of their entire wage bill into their funds last year. Yet the money has gone into the black hole of falling share prices, and a year later, the deficit in the council schemes has widened even further. A survey by WM Company published last week shows pension values across all local authorities slipped a further 0.5% in the year to March.

It is a grim picture that mimics the private sector's woes. Surrey's £1bn fund can meet only 75% of its liabilities. Kent is in the same position. Its £1.5bn fund needs to grow by a third before it will have sufficient cash to pay its 23,000 pensioners and 43,000 current and former council workers who will want a pension in the future.

For now, no one believes that the councils will fail to meet their pension promises. Nobody is saying that the councils will ditch final salary schemes in favour of the money-purchase arrangements favoured by the private sector.

But behind the scenes, ministers are understood to be under growing pressure from some councils to break the long-established contract between local authorities and workers on their pensions. Under current arrangements, council workers pay no more than 6% of their income into their pension scheme. But some councils are now pressing for that limit to be raised, possibly to 9%.

Coming at a time when council workers are on strike over what they regard as a derisory 1.5% pay offer, forcing them to pay more into pensions could be politically explosive.

A spokesman for John Prescott, the newly installed minister for local government and the regions, says there are currently no plans to hit the wage packets of council staff with pension contribution increases.

Both Surrey and Kent councils deny there is any possibility they will copy private sector employers and shut or downgrade their schemes. Unlike private companies, they cannot go bust. They can also agree recovery plans that run over many years. These bet on the return of booming share prices to rescue them from their current embarrassment. Neither are they obliged to do anything right now, as formal valuation of their pension schemes takes place only every three years - and the next "triennial review" is not until 2004.

But taking the long view still means councils must put in more cash and local authorities are shovelling millions of pounds into their schemes and putting up council tax rates to fill the funding void. In effect, they are using council tax payers in a way that private sector companies have refused to tap shareholders to boost pensions.

Surrey County Council charged local taxpayers an extra 11.4% last year and some of that can be attributed to the millions of pounds extra it paid into its pension scheme.

The council has an action plan that has been running for nine years to shift funding levels back to 100%. The "funding level" [see table] is local authority pensions jargon for the degree to which the fund can meet its liabilities. If the level is 100%, the fund is fully on-track. But in Surrey's case, the funding level is just 75%, in effect meaning that it is 25% short of meeting its liabilities. And remember, that was before the recent market falls.

Surrey traditionally pay a standard 9.5% of each worker's salary into its scheme. When the first signs of an impending deficit became apparent, the contributions level was topped up and this year councillors agreed an extra 10.4% to try to close the funding gap. So every Surrey council worker now has a payment equal to 20% of their salary going into the fund. Add the 6% all British council workers pay into their pensions and Surrey worker contributions are one of the highest in the country at 26%.

More recently, the council points to its position over the past year as one of the better stock market performers in the local authority pension league. But senior pension administrators say it's a drop in the ocean and the council's plan has so far failed. The funding level stood at 75% in 1993 and is stuck there today.

One council pensions manager said: "I'm not commenting on Surrey because every council has its own issues, but however you look at it going from 75% to 100% is a massive mountain to climb."

Contrast the fortunes of Surrey and Kent with Bradford, Shropshire, Westminster and Wandsworth in London. These are among the few authorities that can boast funding levels in excess of 100%. It means they have enough funds to meet all their pension commitments.

Wandsworth saw its funding level stand at 106% last year despite a 2% fall in the value of its investments.

Alan Harrison, who looks after the pension fund for Wandsworth Borough Council says: "We have never been below 92% and planned at the time for a quick recovery of the fund. We believe the current funding level is prudent."

He says the fund dipped in value after the council decided to follow the advice of Tony Dye, the former boss of City fund managers Philips & Drew (PDFM), who argued from the mid-90s that the stock market was overvalued and the internet bubble was just that - hot air that will one day pop. On his advice, Wandsworth converted a large part of its pension fund from shares into cash and bonds. As the stock market continued to soar Tony Dye became a lonely voice and several other councils sacked him as their adviser. Wandsworth fell down the investment performance league tables, but officers and councillors stuck by him. Today, as shares have plummeted and bonds have risen, the lucky tax payers of Wandsworth have one of the best-funded council pension schemes in the country.

But the reason why some councils' pension funds are in danger goes beyond whether they picked the right investment strategy. Surrey's council tax payers can also blame someone from whom they had voted in droves during the 80s - Margaret Thatcher.

When the poll tax was introduced in 1990, the government of the day, led by Mrs Thatcher, allowed councils to run down their pension funds to a minimum 75% funding level. The money saved was switched into subsidising poll tax bills in a bid to make the new tax more palatable.

Surrey was among many councils that took the opportunity to cut pension payments to make the poll tax cheaper. Wandsworth, on the other hand, benefited from big government grants at the time and was able to resist the temptation. The rules changed in 1992 and councils have been under pressure to recover ever since.

Chris Hull of pensions consultants Mercer Human Consulting points out that councils which took pension holidays missed out on some of the best investment returns of the past 30 years. "Since full funding was introduced they have been playing catch-up," he says.

There is also another factor explaining council pension shortfalls - the way that they have been used almost as a slush fund to subsidise early retirement.

Ronnie Bowie of pension consultants Hymans Robertson, which can count on the largest number of local authority clients, says all these factors have made almost everybody who works in local government pension departments slightly nervous.

He adds that the average employer contribution has risen from 13% to 15%. This compares with cuts in the private sector to an average 6% to 8% by those top 100 companies that have ditched their final salary scheme for a cheaper money purchase alternative.

Even Wandsworth has felt the need to increase its contributions from 10.3% to 12%, mainly in response to figures published in 2001 showing council workers lived two years longer on average than previous estimates.

Surrey must build in the costs of increasing life expectancy and raising its fund by a third, which is a tall order. At the moment the county's council tax payers enjoy one of the lowest bills in Britain - £722 for a band D home. Soon it may need to think about another slogan as its tax bill rises to pay staff pensions.

Councils across the country raided their pension funds at the end of the 80s to keep poll tax low. Then in the 90s they took "contributions holidays", paid for by the stock market boom. Now it's crunch-time, with huge holes opening up in pension funds at more than one-third of the county councils and metropolitan authorities in Britain. Who will plug the gap? The likelihood is that council tax payers are set for big bills to make up the losses, while council workers may also be asked to cough up extra payments.

Taking account of early retirement

Councils stand accused of systematically using their pension funds to conceal the immediate impact of early retirement by staff.

The accusation is made by Alan Harrison, responsible for the London Borough of Wandsworth's pension fund.

Under existing accounting rules, councils can spread the cost of early retirement on a pension fund over five years. But Wandsworth is stricter, says Mr Harrison.

"We have tried to control our liabilities by bringing in stronger accounting procedures. When someone takes early retirement the cost must be made up in the year it takes place by the department."

He says the same tough line is taken with requests for ill health pensions - the extra cost must be borne by the departments out of current spending rather than charged to the pension fund. As a result, the Wandsworth pension scheme is less burdened by early retirement costs than most other councils.

Glyn Jenkins, pensions manager at local government union Unison, says early retirements have been used extensively by councils over the past 15 years. "Many of them have been as a result of reorganisations, of which there have been several, local government has gone through over the years."

The reorganisations, especially the contracting out of council services such as refuse collection, has also resulted in a large number of deferred pensions. Most council workers who are moved into the private sector leave behind their pensions. These sit in the fund and increase in line with inflation until the worker retires. The fund must make sure their pension keeps up with inflation without any extra payments, which increases the costs of the fund.

Can your council meet its liabilities?

Authority;Deficit 2001;Funding level (%)

Bedfordshire;£110m;87

Buckinghamshire;£169m;81

Cambridgeshire;+£63m;107

Cheshire; £56m;91

Cornwall; £32m;95

Cumbria;£47m;94

Derbyshire;£169m;88

Devon;£279m;81

Dorset; £127m;87

Durham; £185m;83

East Sussex;Zero;102

Essex;£240m;89

Gloucestershire;£69m;90

Hampshire;£271m;88

Hertfordshire;£159m;90

Isle of Wight;£6m;97

Kent;£519m;76

Lancashire;£22m;99

Leicestershire;Zero;100

Lincolnshire;£21m;97

Norfolk;+£30m;103

Northamptonshire;£74m;90

Northumberland;£48m;90

North Yorkshire;£186m;80

Nottinghamshire;£139m;91

Oxfordshire;£69m;91

Shropshire;+£46m;108

Somerset;£19m;97

Staffordshire;+£55m;103

Suffolk;£133m;84

Surrey;£328m;75

Warwickshire;+£16m;102

West Sussex; £125m;88

Wiltshire;£156m;80

Worcestershire;£91m;90

Average;£104m; 91.26