USS strike: long-term promise on employer contributions may break pensions impasse

Uncertainty over the future of 18 per cent contributions is hampering negotiations, argue Jon Forster, Graham Niblo and James Vickers

March 5, 2018
Danger

The focus of the Universities Superannuation Scheme dispute so far has been on the short-term recovery plan.

Should benefits take the form of defined contributions, determined solely by market returns, or defined benefits, in which payouts retain a link to salaries?

This debate has stolen attention from discussion of a long-term settlement that will be necessary to underwrite secure pensions for members and certainty for employers.

The most problematic feature of the current Universities UK proposal is the reduction, to 13.25 per cent, in the employer contribution to future accrual of benefits. An additional 4.75 per cent of salary will go towards other costs and, in the short term, servicing the existing debt.

As a result, the cost of the increased deficit falls entirely on the employee, via reduction of future benefits, which is entirely against the spirit of the 2011 agreement to share future costs. But, equally significantly, 13.25 per cent sets a benchmark that will potentially result in significantly reduced overall contributions over the long term.

This is important because there is a strong argument that the current problems stem directly from the decision by employers in 1996 to reduce their contributions from 18.55 per cent to 14 per cent.

In short, the most important element of any settlement would be a long-term (20-year) commitment by employers to continue to fund the scheme at least at the current level of 18 per cent of salary.

With this level of funding secured for the long term, the scheme would be more resilient to those aspects over which both employers and employees have little control, such as short-term economic factors and valuation methodologies.

This would allow negotiations about benefits, and in particular the defined benefits/defined contributions split, to be held in a climate where both parties have the common goal of providing the most attractive possible package for members.

The offer by UUK to continue funding the scheme at the current level (18 per cent of salary) until 2023 is a start.

But it also suggests that they might consider reducing that contribution in the not-too-distant future. There is the precedent of the reduction of employer contribution in 1996, which was justified by the argument that it did not lead to a reduction in benefits.

In this current situation, once the deficit has been cleared (possibly as early as 2023) the employers may well argue that they can again reduce their contribution to 16 per cent (or lower) without loss of benefits, having established a defined contribution rate of 13.25 per cent as the norm.

As others have stated, we believe that the current valuation takes an unnecessarily pessimistic view of the funding of the USS as an ongoing scheme.

This is driven by current actuarial practice, encouraged by a hawkish pensions regulator whose only real obligation appears to be to avoid taxpayer bailouts.

Nonetheless, the current regulatory framework and the pressures to de-risk conspire to ensure that returns from a defined benefit scheme are likely to be less attractive than they have been in the past.

In a fully funded scheme such as the USS, both defined benefit and defined contribution benefits are sensitive to market conditions. In each crisis, the defined benefit benefits are eroded to ensure affordability, but there appears to be no real mechanism (or at least no appetite among the employers) to increase them when market conditions allow, so that the risks of weak investment performance are arguably just as great for defined benefit as for defined contribution.

If the history of the past 10 years of the USS teaches us anything, it is that external pressures (in this case from low interest rates and gilt yields) are just as much of a threat to defined benefit as they are to defined contribution.

It is legitimate for USS members to ask why we should believe any commitment from the employers to contribute at least 18 per cent in the long term.

It is, in our view, very much easier to defend a level of contribution than a level of benefit.

We can reasonably only ask university leaders to manage those elements over which they have control. As far as the USS is concerned, that is the amount of salary that they invest in the scheme (across its various elements). They have little or no control over actuarial methodology, inflation, the economy, or life expectancy.

Given the history, it is easy to imagine a future in which employer contributions are steadily eroded, member contributions grow and benefits decrease.

We have real concerns that by focusing on a watered-down defined benefit scheme at present, rather than focusing on the extent of contribution, irrespective of the scheme, we will allow the employers to get away with a proposal that will result in further cuts in future. 

A 20-year commitment by the employers would be a significant sign of good faith that would underwrite the health of the fund and form a strong basis to work together for the benefit of all USS members.

Jon Forster, Graham Niblo and James Vickers are based at the University of Southampton’s department of mathematical sciences. All three write in a personal capacity.

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Reader's comments (5)

A very sensible letter. The key thing is the contribution, not the distribution. By fighting a war on arithmetic we are being duped by the employers. We should focus on the largest contribution possible. A pension scheme should be simple, generous, predictable and progressive. Agree on contribution but tier by salary, those on Professor and above can get smaller employer contributions for salary above the threshold. (Professive) Allow people choice of funds, but have default low cost trackers. All funds to calculate a five year rolling average value, not just daily unit price. (Simple) Thus retirement income four years ahead of time starts to be clear and become increasingly so as date approaches, allowing you to adjust plans. (Predictable) Averaging allows people individual preference but by using social solidarity smooths out the vagaries of the stock market, life expectancy, annuity etc. (Fairness) If you retire on black Monday, you don't get wiped out, equally if you retire on Flashy Friday you don't scoop the pot. It's not a guaranteed benefit but nothing is; the larger the employer contribution the better your pension (Generous).
I had no idea employers had reduced their contributions in 1996 as well, so employees have been shafted at least four times now. This poorly managed scheme which is run by a large number of people on bloated salaries now wants employees to stump 100% of the shortfall (which is based on a dubious snapshot and unrealistic scenario of all our universities collapsing at once). Universities UK clearly only want to cut costs and deflect all the attention away from spiralling vice chancellor salaries and huge white elephant buildings popping up on campuses everywhere. Eventually universities will realise the huge importance of their staff, not buildings or marketing departments, but it will probably be too late.
My recollection from 1996 was that the 18 % had been a temporary level intended to ensure no deficit, the scheme was doing well so they could go back to previous 14% level . Also at that stage the scheme was doing so OK there was talk of also increasing pension benefits . So it wss about general scheme management. Also then all the VCs and all the senior management were in the same USS pension scheme as everyone else and that was the best guarantee of its security... And the scheme wasnt then seen as poorly managed, indeed for many years it was the gold standard, among the largest and most secure private pension schemes in the country. Halcyon days. But various government actions ( starting with Gordon Brown's raid on pension schemes and carrying on to more recent government's Lifetime allowance restrictions which means better paid staff leave the scheme) have really contributed to the steady demise of the scheme . But this article makes a very good point, the biggest objection to an employer switching to defined contribution is the tendency to happily define their own contributions downwards.. All very well to witter on about need to share the investment risk between employed and employer but then reducing contributions in these circumstances is just about cost cutting and is effectively a cut in salary . A better sign of good faith would be to say make the shared risk argument but increase the employer contribution as part of that. ....
We thank the editors for streamlining the text of our original article, but should point out that the sentence "An additional 4.75 per cent of salary will go towards servicing the existing debt" was not in our original, and a more accurate statement would be that an additional 4.75 per cent of salary will go towards other costs and, in the short term, servicing the deficit. Jon, Graham and James
Following publication of our note above we came across the excellent article by Susan Cooper (https://users.physics.ox.ac.uk/~scooper/USS/2014-11%20Pensions.pdf) written in 2014 at the time of the previous changes to USS, which makes many of the same points that we do above. Jon, Graham and James

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