A senior Oxbridge academic can look forward to a gold-plated, index-linked pension

    A senior Oxbridge academic can look forward to a gold-plated, index-linked pension

    Golden groves of academe

    30 September 2017

    Students, here is your starter for ten. What is the current funding deficit of the Universities Superannuation Scheme (USS), the largest pension scheme in the country? Is it (a) £17.5 billion (terrible); (b) £12.6 billion (bad); (c) £5 billion (OK-ish); or (d) None of the above? You don’t know? Well join a very erudite and professionally qualified club.

    Whether the national university pension scheme is securely funded or not critically depends on which of these numbers you want to believe. For some 390,000 professors, lecturers and senior employees at UK universities and educational institutions, the answer to this question is anything but academic, as it speaks directly to the cost and security of their future pension entitlements. It also has implications for the financial health of the university system, whose budgets are already under pressure, amid growing controversy over student fees and vice-chancellors’ pay.

    The £17.5 billion figure is the one generated by an accounting standard called FRS 102, which all public companies are now required to use. On this measure, the pension scheme’s assets (£60 billion) fall more than 20 per cent short of its liabilities, those liabilities being the generous future pension commitments it has made to its members. The university scheme is now bigger than any public company’s pension fund.

    The second figure, of £12.6 billion, is the one that appears in the USS’s 2016-17 report and accounts, published in July. It is calculated by adjusting the value of the scheme’s future liabilities on a formula linked to the change in index-linked gilts yields since the last formal actuarial valuation in 2014, which gave a figure of £5 billion for the shortfall between assets and liabilities.

    So is that the right figure? Er, no — or not if you believe the managers and trustees who oversee the pension scheme. USS says that on the basis of its latest three-yearly actuarial review, just completed, the scheme’s funding deficit is still only £5 billion, unchanged from three years ago. The in-house experts and outside professional advisers have used a new set of assumptions which (conveniently, some may think) produce a less alarming result than the one included in the report and accounts just two months earlier.

    Historically, university academics (like civil servants) have enjoyed gold-plated index-linked pension benefits. Those benefits are now under threat. Two years ago, after the last round of negotiations, the universities reached an agreement with the unions to start whittling away some of the scheme’s benefits, including introducing a £55,000 salary cap above which contributions go to a less valuable ‘defined contribution’ scheme, switching those still working to a less favourable regime, and raising both employer and employee contribution rates to help fix the deficit.

    A protest in Westminster against rising student debt
    A protest in Westminster against rising student debt

    But a lot more needs to be done. Unlike public-sector pensions, the university scheme is not guaranteed by the government, but is the ‘joint and several’ responsibility of the 350 universities and institutions that make up its membership. Collectively these bodies — now heavily dependent on student fees for their income — pay £2 billion a year to fund the pension scheme.

    And that cost is going only one way: upwards. To meet all its current pension promises, the USS says, would require the combined employer and employee contribution rate to rise from 26 per cent of salary to 33 per cent. If that happened in one go, universities and academics between them would have to find £700 million more a year, equivalent to 8 per cent of the universities’ annual income.

    Given the already toxic issue of student fees, not to mention the furore over vice-chancellors’ salaries, the question of who might pay this bill is the hottest of political hot potatoes. Universities and unions are scheduled to open a new round of negotiations over pensions this autumn. Political sensitivity may explain why the management’s latest lowball assessment of the fund’s deficit raises as many questions as it answers.

    How can it be saying that the deficit is stable (on its own self-selected figures) but that it also needs a huge increase in contribution rates unless changes are made? Intriguingly, the USS is now run by Bill Galvin, who was previously the pensions industry regulator. In that job he oversaw a system that required all pension funds to publish standardised funding deficit figures. Yet his team have chosen not to use those figures.

    John Ralfe, an independent pensions consultant, says bluntly that USS has ‘a huge deficit and is in a mess. But the mess is made much, much worse because USS is creating a smokescreen to try to hide the deficit, rather than addressing it properly’. He blames the scheme’s past investment policy — betting too much on higher-risk shares in the hope of investing its way back into balance.

    That may not be entirely fair. The scheme’s investment activities have not been unsuccessful recently: it has made a compound return of 12 per cent per annum over the past five years. The real problem is that the yield on index-linked government bonds (the standard instrument that pension funds use to match future inflation-proofed benefits) remains stubbornly negative. This has been a major headache for all pension schemes, not just the university one.

    The in-house investment team, which is incentivised to beat a passive liability-matching benchmark, has paid a price for deciding last year not to match its index-linked liabilities in full, and betting instead that interest rates would rise. As well as having half its assets in equities, it preferred to invest in other types of assets, including non-indexed bonds and infrastructure projects. In the past year that bet has not paid off, though it may still do so in future years.

    Forecasting long-term liabilities accurately is no easy task: small changes in assumptions produce very different results. The USS makes some good points in defence of its numbers. Yet to the disinterested observer it seems obvious that, just as almost every private-sector company faced with lower yields and greater life expectancy has had to close its defined benefit pensions scheme on grounds of cost, so contribution rates for university academics are going to have to rise and their index-linked benefits will have to be further reduced. It is only a question of how much and by when.

    That is a political, not an actuarial, issue. Yet the truth is that, with real interest rates so low and unlikely to rise materially for many years, the scheme as currently constituted is unaffordable. How do we know that? Well, at current market rates, if the universities asked an insurance company to run the scheme as currently constituted, it would cost them well over £100 billion, a figure that makes even the gloomiest current deficit projection pale into insignificance.

    But identifying a problem and dealing with it are rarely the same thing. A man called Upton Sinclair once observed that, ‘It is difficult to get a man to understand something when his salary depends on his not understanding it.’

    Resolving the universities’ pension challenges is going to test how vigorously the academic sector is capable of confronting the reality of today’s investment landscape.