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Is the Universities Superannuation Scheme caught between a rock and a hard place?

Jeremy Harris, partner at Fieldfisher LLP and expert in HE pensions, explains why the scheme is under pressure to change

Changes are afoot for the Universities Superannuation Scheme.

The deficit of the UK’s largest private sector pension scheme has more than doubled to £13 billion since 31 March 2020. Then, in the same month, the scheme was forced to report itself to the Pensions Regulator because the value of its investments plunged on the stock market.

The fallout from the Covid-19 pandemic has put huge pressure both on universities, who’s revenues will likely take a severe hit from a fall in international student numbers, and on the USS, which has been plagued by continued low interest rates – a phenomenon only likely to continue in the post-pandemic economy.

These factors, combined with the resistance from universities and the University and College Union (UCU) to increased contributions, means further benefit reductions have become even more likely.

At the end of March 2019, the USS deficit on its funding monitoring basis was £5.4 billion. The increase to £12.9 billion at the end of March this year was mostly attributable to an increase in the scheme’s liabilities. In other words, its weaker funding position was for the most part due to the increasing cost of the scheme’s benefits, due to low interest rates, rather than poor investment returns.

Why does next year matter so much for the Universities Superannuation Scheme?

The weaker USS funding position at 31 March 2020 on the monitoring basis is particularly unfortunate because that is the effective date for the next USS triennial actuarial valuation: it is the funding position that will determine the rates of contributions and benefits in future.

Contributions and benefits will be determined either as a result of agreement on these matters in the USS Joint Negotiating Committee (JNC) or under the USS cost sharing rule.

In other words, if the JNC does not agree to reducing benefits within three months of the valuation, the USS rule would automatically increase contributions for employers and employees to cover the schemes increased costs. This includes the cost of meeting the deficit.

This will put pressure for universities and UCU to agree on benefit reductions, rather than incur such steep increases in contributions. The USS rules mean employers and employees would both pay more, with increased contributions split on a ratio of 65:35.

The previous USS actuarial valuation led originally to a proposal to terminate all defined benefit accrual under the scheme and to change USS into a defined contribution scheme for all future service.

That proposal was ultimately dropped in the face of industrial action by academics, but only by the trustee company weakening the USS actuarial funding assumptions, seemingly to the limits of what would be tolerated by the Pensions Regulator.

The eventual position that was reached last year involved maintaining the existing level of USS benefits, but increasing employer and member contributions to 21.1% and 9.6% of salary respectively. Even that structure has given rise to further industrial action by UCU, which has not yet been abandoned.

But, following the economic damage caused by Covid and lockdown, it seems that industrial action will be unsustainable – at least in the face of public opinion – and particularly when the costs of lockdown in terms of wider society and the economy at large are made manifest.

It is likely that the more than doubled deficit of £13 billion, if confirmed by the full USS actuarial valuation as at 31 March 2020, would lead to significantly increased employer and member contributions under the USS cost sharing rule, considerably higher than the current 21.1% and 9.6% of salary rates. It does not, however, appear to be plausible that such increased contribution rates would be affordable.

‘Doubtful’ the benefit structure will continue

UK universities are faced with threats to their income as a result of Covid from, among other things, a likely fall in overseas student numbers. In May, the UK government granted universities financial support by bringing forward tuition fee income and public funding for research, but that support fell short of what Universities UK had requested.

Then, in June, the government announced a further £280 million of funding to support research, but with most of the support being in the form of long-term, low-interest loans to be available from the Autumn.

On 16 July, the government set up the Higher Education Restructuring Regime to enable institutions to continue to provide higher education, where they are at risk of failing and exiting the market due to Covid. This regime is backed ultimately by loans from public funds. These government measures emphasise the financial threats being faced by the higher education sector.

There has already been a marked trend for academics – particular younger staff – to opt out of active membership of USS, seemingly because of the high cost of membership contributions at the existing rate. It is probable that further increases in member contributions would lead to even greater opt out rates. This threatens the concept of USS as the exclusive pension scheme for academic and comparable staff. That exclusivity principle is laid down in the USS rules, but is subject to a general discretion of the trustee company to allow employers to depart from it.

A greater number of members opting out could also lead to employers that have small numbers of active members in USS ceasing to participate in USS by default, thus triggering potentially large employer debts. Such debts may not in turn be affordable by, or recoverable from, those employers.

It is doubtful that continuing with the current USS benefit structure at a significantly higher cost is a sustainable position.

Those current USS benefits include defined benefit career average revalued earnings provision up to a salary threshold (originally £55,000 per year, but revalued each year), plus defined contribution benefits based on employer contributions of 12% of salary above the salary threshold. At a time when most private sector UK defined benefit pension schemes have been closed to future DB accrual and most employees have DC pension benefits, it is likely to be difficult politically for the Universities Superannuation Scheme to continue without any major benefit changes.

The alignment of a number of powerful factors is militating against the feasibility of maintaining the current USS benefit features. Those same pressures may mean that it would be difficult for UCU to gain the support of academics for renewed industrial action to resist pension benefit changes in the current economic climate.

It seems likely that DB accrual itself may ultimately no longer continue under the Universities Superannuation Scheme.

Jeremy Harris is a partner at Fieldfisher LLP and an expert in higher education pensions

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