UK university pension scheme deficit widens to £12.6 billion

‘Drastic action’ required to fix multibillion-pound shortfall in Universities Superannuation Scheme, expert warns

July 26, 2017
hole in ground
Source: Alamy
Black hole: a pensions expert said he believed that ‘drastic action’ was required to address the multibillion-pound shortfall in the USS scheme

Almost 200,000 staff working in UK higher education face major changes to their future pensions after the deficit of the sector’s main provider soared to £12.6 billion, an expert has warned.

Despite achieving investment returns of more than 20 per cent in the past financial year – adding an extra £10.2 billion to its assets in 2016-17 – the Universities Superannuation Scheme has seen the hole in its balance sheet increase substantially.

According to its latest annual report published on 25 July, the USS had assets of £60 billion on 31 March 2017 against liabilities (the value of its pension promises to staff) of £72.6 billion, which increased by £12.8 billion. This put the scheme’s “funding level” at 83 per cent, significantly worse than the 89 per cent valuation in March 2014 that precipitated the closure of final salary pensions for future service.

If the latest mortality figures are used, reflecting improved life expectancy among USS members, the deficit rises to £17.5 billion, the company's annual report also states.

About 184,000 university staff – mainly at pre-1992 universities – currently contribute towards a USS pension, as do another 6,500 non-university staff working in the higher education sector.

The latest report on the health of USS – the UK’s largest private pension scheme – is significant because it gives an indication of the size of deficit at the next triennial valuation, which is likely to be announced later this year.

To ensure that the pension scheme remains solvent, the USS will be required to submit a plan to the Pensions Regulator to reduce the deficit. This could include proposals for universities to increase their contributions from 18 per cent of salary, staff to pay more towards the cost of pensions, the value of future pension payouts to decrease, or a mixture of all three options.

John Ralfe, an independent pensions adviser, said he believed that “drastic action” was required to address the multibillion pound shortfall in the USS scheme.

“Money will need to come out of teaching and research for many years to shift this huge deficit,” said Mr Ralfe, who added that “new future pensions will have to change to reduce cost and risk”.

The £12.6 billion shortfall is more than twice the £5.3 billion deficit measured in March 2014 and includes savings from the closure of final salary pensions for future service. USS members now receive a defined benefit pension up to a £55,000 salary threshold, with a new defined contribution scheme available for contributions on salary above this level.

Commenting on the USS’ latest results, Bill Galvin, its chief executive, explained that “historically low gilt yields and reduced expectations for future investment returns present challenges, which we are working with stakeholders to resolve”.

“We don’t yet know the outcome of the 2017 valuation but I have no doubt that USS will continue to provide high-quality pension arrangements tailored to the needs of the sector,” he added.

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Reader's comments (8)

Those who wondered why the 'Investment Builder' part of USS was set up after the last review now have their answer, all contributions are likely to go into it as a result of this review, so the end of a defined benefit scheme ('Income Builder').
Apparently this scheme was in the black in 2008. What has happened since then? why risky investment and not safer bonds? Then the early commentators suggest the students will, in some way, pay for it. Well, maybe first of all they need to see how much they can raise from senior pay. By senior i am talking about those earning between £100,000 - £500,000 per year like Vice Chancellors and Pro Vice Chancellors etc etc. I was reading an article yesterday that suggested the number of positions paying these salaries has dramatically increased in the last decade. Surely there is enough fat at the top to plug this hole and if they chose to move abroad as opposed to loosing their salary to fix the pension mess then let them go. Do we really want such self obsessed egomaniacs running our universities? Personally, i would rather my children avoid putting themselves in a lifetime level of debt (up to £70,000) for a degree obtained through the traditional HE route (3 year full-time undergrad) as i fully believe a parent should protect their children and children need protecting from the financial abuse that is sweeping through our nations HE institutions. They are charities and it sickens me.
and while i am on the subject i will also say this.......Under no circumstances should this burden too be placed on the shoulders of our children. If senior staff can be made to pay then all universities should loose the £1.4 billion that Government contribute towards the cost of tuition. This is on top of the £9,000 fee’s paid by students. So, I believe this should be diverted for the next 12 years to plug the whole and universities should be made to target their own monies to meet STEM and other priorities that are pump-primed by Government teaching funding. Simply, our HE institutions have had their cake and eat it at the same time and now they need to be held accountable. It is easy to succeed in boom times but can these fat cats of HE succeed in tough times and justify their obscene pay packages, I very much doubt it.
"Well, maybe first of all they need to see how much they can raise from senior pay. By senior i am talking about those earning between £100,000 - £500,000 per year like Vice Chancellors and Pro Vice Chancellors etc etc." Wouldn't touch the sides. "Under no circumstances should this burden too be placed on the shoulders of our children." I don't even understand how the 'increase the tution fees' argument works? Why would someone studying at a post-92 (where the vast majority of staff are in TPS) pay towards a private pension scheme for staff somewhere else?
This article is very misleading and might cause some people to lose confidence in the USS. The USS is not actually in deficit in the ordinary meaning of the word. It is actually very cash rich - it made investment income around £1.5bn last year on top of paying its pensions. The deficit is a notional shortfall between estimated liabilities and assets. The whole issue is about how these figures are calculated. The article reported the liabilities and deficit as if they were solid facts rather than estimates based on particular assumptions. A more nuanced discussion would have reported the difficulties that beset estimating liabilities and that there is the wide range of estimates in the report depending on the assumptions about investment returns. Your article was one-sided because your pensions expert is somebody with a very strong neoliberal point of view who favours one particular approach. The figure you gave assumed a gilts discount rate. Why the USS should use this method is not clear because it ignores the fact that the scheme invests mainly in assets such as equities that generate a high rate of return. (The scheme has just invested massively in Thames Water for example.) Since gilt rates are currently very low, this is the reason liabilities are so high. But the Report also states near the end that at the 2014 valuation, the liabilities on a BEST ESTIMATE basis were £38.1bn, giving a surplus of £3.5bn. It is likely that this surplus will still be there when the 2017 valuation is done. The best estimate liabilities figure is surely a lot more appropriate for the USS than the gilts-based value. Members need to be aware that the valuations are being done using an outmoded mark-to-market methodology that is not fit for purpose any more in the world of quantitative easing and associated low interest rates.
Thanks to D Leech for the explanation, which takes some of the heat out of the issue. I think USS uses gilts because this is normal practice of all defined benefit pension schemes? Although - as this Money week article points out, it is not compulsory to do so... The problem is that if they all carry on like that they will be pushing every scheme towards defined contribution.
Here is a very good discussion of the USS that all should read: Is the University Superannuation Scheme suffering fantasy deficits?
Why we should question the USS deficit... Everybody should keep calm about the universities superannuation scheme. Contrary to sensational press reports last week in the THE, Financial Times and BBC, the USS is not actually in deficit - not in the usual meaning of the word ‘deficit’ anyway. If it were truly in deficit it would not have enough money coming in to pay its outgoings. It would be forced to sell some of its investment portfolio to keep going. But in reality it has an annual surplus each year of about £1.5 billion available for new investments. It has just bought a large stake in Thames Water, for example. The scheme is cash rich and can remain so for many years. Membership is increasing with over 29,000 new members joining last year. What, then is the problem? The headline figures quoted are theoretical numbers based on particular hypothetical assumptions about the future, whose realism is in doubt. Many members, the UCU, some universities and some actuaries are questioning whether they really give a true picture of the health of the scheme. The ‘deficit’ emerges as the difference between the scheme’s assets (its investment portfolio) and liabilities (the value of future pensions benefits). The press reports are sensational because they quote raw figures baldly without any context. The liabilities are estimated to be £72.6 billion, which, with assets of £60 billion, means a shortfall – the ‘deficit’ – of £12.6 billion. Reporting figures like that as raw numbers, expressed as billions of pounds, without putting them in context is misleading. (It is reminiscent of the way that government debt and deficit are reported in absolute numbers in order to frighten us into accepting cuts in public spending.) Given the size of the USS, with almost 400,000 members, it is actually not surprising that the figures are so large. They need to be put in proper context before any conclusions can be drawn. They represent a funding ratio of 83 percent: the assets are currently worth 83 percent of the liabilities. So is that high or low? Compared with the funding levels of the almost 6,000 private UK schemes, of which the USS is the largest, it is not out of line. Its funding ratio is fairly typical. The average for schemes in deficit is 83 percent, according to the Pensions Regulator Scheme Funding Statistics 2007. The BT pension scheme funding ratio is 64 percent. So it is not fair to say, as the FT article claimed, that the USS has the largest gap between assets and liabilities of any scheme in the UK. It is only large because the scheme is very large. While the USS ‘deficit’ is not out of line with other privately funded schemes, we still need to ask where it comes from in the first place and what it means. The main reason for pension scheme deficits – not just USS – is that the accountants tend to insist on an assumption that schemes be invested only in bonds (even though that may not be true). In this they seem to be following a herd mentality and advocating something which is irrational. Why anyone would believe that investing in gilts at the present record low real interest rates, which entails expecting to make a loss, reduces risk is hard to understand. But gilt interest rates have really very little to do with the USS pension scheme. After all, the pensions that members will receive are not paid out of the meagre returns from gilts but the much better returns from the long-term investments the scheme actually has, that it has built up over the years, mostly equities and other high-return assets. Such assets – if held for the long term - yield a high return with minimal risk. [The USS uses this best estimate rate of return to value liabilities but with a substantial – some say excessive – margin of prudence to allow for market volatility of equities and other assets (the technical provisions). However they update this figure regularly using gilt rates, and it is this that appears in the accounts.] The report also gives an alternative figure for the deficit if liabilities are valued using the actual rate of return from its assets but without the large dollop of prudence and without the gilts updating. This ‘best estimate‘ for the liabilities figure is £38.1 billion, which means the scheme would be in SURPLUS by £3.5 billion! Of course the necessary degree of prudence needs to be applied here, but it does show that this is not a scheme that is in trouble. We are due the consultation on the triennial valuation in the next months and it seems likely that the best estimate valuation will have improved. Members should stay calm and insist that the scheme remain open to new members and accrual. The biggest threat to the scheme is closing it.

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