The Government’s Green Paper, entitled Security and Sustainability in Defined Benefit Pension Schemes, comes at a critical time for decisions about the future of the Universities Superannuation Scheme (USS) and other pension provision in the higher education sector. Under incoming rules, the costs of making good pension deficits will need to be shown on organisational balance sheets for the first time, revealing the full extent of the pension time bomb.
The defined benefit pension sector is significant and important: there are nearly 6000 schemes (but many now closed to new members); 11m people in membership; and £1.5tn invested (the equivalent of 75% of annual UK GDP). Universities will now be fully engaged with their institutions’ forecasts and analysis of the key elements to their financial sustainability. Much to the fore in these deliberations must be the question of pensions.
Alongside the much-discussed factors of uncertainty and change that all institutions are grappling with, those who are members of USS in particular will be deeply concerned about the triennial valuation due as at 31 March 2017, the proposed strategy for coping with it, and whether and how this will secure the agreement of employees and employers, and of course the Pension Regulator. Currently USS universities contribute 18% per employee to USS – of which 4% is for deficit payments, arising from the settlement after the 2014 valuation. However, notwithstanding the most significant worsening of benefits in the scheme’s history following that valuation, the deficit has continued to grow and could be >£10bn in the forthcoming valuation.
A recent review of the employer financial covenant carried out by USS suggests a strong covenant for the next 30 years (a longer period than arose from a more fundamental review in 2014). This should mitigate the need for precipitous changes. But other indicators of financial health suggest that the 2016 review should be viewed with some scepticism. Further increases for employers and staff may well be required unless further changes to benefits are agreed instead. A settlement that merely raised contributions from the employer and the employee, and did nothing to tackle the underlying risks and fundamental questions about USS, should raise serious concerns.
Any further changes that may be required to benefits will be hotly disputed by the principal trade union, UCU, and many members. They will question whether the assumptions behind the calculation of the deficit by the Scheme actuary are too prudent or just wrong, thereby exaggerating the scale of the problem. They will further argue, now supported by the Green Paper, that a scheme like USS has many decades before it during which “normal” economic conditions will restore equilibrium between investments and liabilities and that no urgent action is required.
Universities will now be fully engaged with their institutions’ forecasts and analysis of the key elements to their financial sustainability. Much to the fore in these deliberations must be the question of pensions
Perhaps the bigger questions hanging over USS are whether it provides a fair deal for all its members and whether the costs of maintaining it inhibit the ability of universities to provide competitive remuneration packages for all their staff. The current members in service are paying disproportionately to fund the income of pensioners and the more generous benefits accrued in the past by those shortly to retire. In addition, the scheme is insensitive to the marked changes in the demography of employment in universities since it was established in the mid-1970s. For example, many more staff now come from overseas – with different requirements for pensions. Many move more frequently between academic and the private sector, or are on short-term junior researcher contracts for which a defined benefits scheme is not necessarily the best solution, especially if they leave at the end of those contracts to work overseas or out of the university scene altogether.
There are few simple solutions to the dilemmas this set of circumstances presents. If USS became a defined contribution scheme, whereby a cash pot is built for members rather than a guaranteed income, the existing liabilities do not vanish. It is also very difficult and expensive for a member university to leave USS since it will have to pay for all its existing liabilities in full at that point. If, in extreme circumstances, USS went cap in hand to the Government to take on its liabilities and assets, the tribute exacted for its intervention is unknown but could be profound and weaken the sector’s autonomy further.
Crucially, universities and other bodies must act now to minimise any damage and disruption that such pensions revelations are likely to cause. Leadership is required by USS and employers so that an equitable, affordable, and resilient solution to pensions is reached over the next three years. Kicking the can further down the road after March valuation is no longer an option for members or institutions, especially if the Green Paper heralds further changes for DB schemes.
Dr Jonathan Nicholls is director of strategy and policy advice for education at law firm Shakespeare Martineau.