Conflicting interests in the grey market

June 9, 2000

The Universities Superannuation Scheme has a surplus of 8 per cent - Pounds 1.44 billion. Of this, Pounds 201 million will go to improve member benefits and Pounds 561.3 million has gone to lower the employers' contribution rate to 14 per cent. When Andrew Oswald suggested in The THES on April 14 that more of this surplus should be going to members, academics took note. So who runs the USS? What is happening to the surplus? And should the scheme be restructured so members could benefit more from buoyant markets? Claire Sanders reports.

The Universities Superannuation Scheme is administered by a trustee company, USS Ltd. There are 12 directors, four appointed by the Committee of Vice-Chancellors and Principals, three by the Association of University Teachers, one by the higher education funding councils and four co-opted, or independent, members.

The directors of the trustee company are advised by the officers of USS Ltd and external advisers, including an independent solicitor and actuary. The trustee company has a fundamental duty to act in the interests of all beneficiaries - which can include the employers - and complaints can be taken ultimately to the pensions ombudsman.

Under the 1995 Pension Act, schemes are required to have member-nominated trustees. But, as David Chynoweth, chief executive of USS Ltd, explained:

"USS Ltd, like certain other industry-wide schemes, was able to meet stringent conditions and as a result was exempt from the requirement to have one-third of its directors nominated by the membership."

Peter Knight, vice-chancellor of the University of Central England and former member of the working party on pension schemes, compared the USS arrangements with those of the Teachers' Pension Scheme, which covers lecturers in new universities.

"It is infinitely better to have a body of trustees representing members than the government. What you want is knowledgeable people who can represent the views of members running a scheme - and that is what the USS has got. At the TPS we've just got a post box in Sanctuary Buildings," he said.

No significant surplus Mr Chynoweth made clear in his response to Professor Oswald in The THES on April 28 that the USS has a surplus of 8.3 per cent of assets over liabilities. This was a snap-shot taken at the end of March last year and could, given stock market fluctuations, disappear over a short period of time.

It is not, as surpluses go, particularly high. A 1999 Inland Revenue Statistics table puts the average surplus for large self-administered schemes with surpluses over 5 per cent at 14 per cent.

Mike Reid, of the consultants William M. Mercer Ltd, is the USS's actuary. He described a surplus of 8 per cent as "not hugely significant".

It nevertheless amounts to almost Pounds 1.5 billion. What has the trustee company decided to do with it?

For members, they decided to: pay a 1 per cent permanent pension increase to all non-active members (cost Pounds 74 million); increase the lump-sum death-in-service benefit from 2.5 to 3 times pensionable salary (cost Pounds 24 million); and remove reductions to younger spouses' pensions if they are more than ten or 15 years younger than the deceased (cost Pounds 103 million).

The trustee company has also decided to set up a working party to see if the fund should change its arrangements to a 60ths pensions accrual rate in place of the existing 80ths accrual rate and a 3/80ths lump-sum accrual rate. The main point of this is that the increasing cost of annuities has reduced the value of the lump sum. As a result, members are in effect retiring on the basis of a 1/64ths scheme.

Christine Cheeseman is assistant general secretary of the Association of University Teachers and the joint negotiating committee of the USS. This committee does not have final say on decisions, but is a forum for airing views and agreeing policy to go to the trustees.

She said: "Moving to a 60ths pensions accrual rate is something the AUT has been calling for for a number of years. However, it is going to cost a fair amount of money - especially if it goes to past service. It is vital that the working group, which contains members from the CVCP as well as the AUT, considers this."

But Sir Martin Harris, vice-chancellor of Manchester University and a USS Ltd director, said: "Going to a 1/60th accrual rate would wipe out the surplus."

Mr Chynoweth said: "We have had one report from a working party on this explaining the cost of changing the scheme. This does vary depending on the rate of commutation used, but the cost could be in excess of Pounds 1 billion for past service and would require an addition to the contribution rate for future services of around 3 per cent. However, we are looking at it again." The working party, led by Colin Donald, one of the co-opted directors, is due to report in 2001.

Benefiting employers While employees have benefited, and may benefit further, from the surplus, the employers have certainly done so. Trustees have kept the employers' contribution at 14 per cent - this is 2.3 per cent lower than the actuary's estimate of what is necessary for maintaining future service benefits. It is costing the scheme Pounds 561.3 million. Three years ago the employers' contribution was reduced from 18.5 per cent. Mr Reid estimated that if the employers' contribution had still been 18.5 per cent in 1999, the fund would have been Pounds 105 million better off that year.

Has the USS been too generous to employers? Compared to other schemes the answer would appear to be no. The employers' contribution to the TPS is 7.4 per cent, the industry average is 10 per cent.

But why decrease the employers' contribution at all?

Part of the answer lies in the nature of the scheme. Before 1975, the forerunner of the USS was a defined-contribution scheme called the Federated Superannuation Scheme for Universities. Under this type of scheme, members' pensions depend on how much they put into the scheme - and on how well the investment markets do.

The downturn in the markets in the 1970s meant that many academics faced shortfalls in their pensions and because members' pension levels were insured, or defined in their contracts, individual universities were making up the difference. The scheme was consequently wound down, and the USS was introduced in 1975 as a defined-benefit scheme.

Under this type of scheme, members are guaranteed a pension dependent on their final salary, and the employer, through the USS, ensures that in bad times the fund can meet its commitments. The pre-1975 liability was not extinguished until 1996 - for 21 years employers paid contribution rates over and above the cost of the scheme in order to pay it off. In good times the employer is not expected to pay over and above what is required to meet future commitments.

But why use part of the surplus to bring the employers' contribution to 2.3 per cent below the cost of the future service contribution rate?

Angela Crum Ewing, former president of the AUT, is the pensioner representative. She said a high contribution from employers affects members in more ways than one. "It may mean more money in the fund, but it also stops employers improving salaries, which would in turn improve pensions. It also stops employers from taking on more staff."

She pointed out that because the employer contribution to the USS is so much higher than that to the TPS, employment costs in old universities are considerably higher than in new universities.

"This works against a level playing field, creating great difficulties for old universities in the USS when they bid for schools of nursing, for example, against new universities."

But Dr Knight said that universities in the USS scheme in England and Wales receive extra money to help cover the cost of the extra contribution.

A spokesman for the Higher Education Funding Council for England said: "It is true that we consider pension costs as part of the funding formula. One of the institutional premiums covers this and is calculated as a percentage of full-time equivalent students. But there is not an exact correlation between what universities pay in pension contributions and what the Hefce gives them, because of the way Hefce allocates grant."

Hefce calculates a standard resource - a notional figure of what the university would get if its grant was calculated afresh each year - and an actual resource. The final grant is somewhere between these two figures.

This arrangement does not mean Hefce snatches back any money saved by universities as their contribution rate is lowered.

Sir Graeme Davies, principal of Glasgow University and a USS director, said: "When the employer contribution comes down for English and Welsh universities, the money saved is put into a general pot and distributed through the funding councils."

It is, however, of great concern to Scottish universities in the USS that they receive no such compensation. Sir Graeme said: "The eight Scottish pre-1992 institutions have had to carry this differential as an unreimbursed cost." When the employer contribution rate falls these universities do, however, receive the saving directly.

There is no support for a contributions holiday for employers. Mr Chynoweth said the idea has not even been debated by the trustee company.

Mrs Crum Ewing said: "What employers want is stability, and a contributions holiday for employers one year would mean higher contributions in later years, especially as the USS is a 'young fund' - with only a quarter of members currently drawing pensions."

Sir Graeme said: "Several local authority funds did give contributions holidays - and employers now face far higher contributions to make up for this."

Mrs Crum Ewing said that employers would also have no guarantee that the money would not be clawed back through a reduction in funding council grant. The funding council spokesman said the situation was "highly hypothetical" and a matter for the USS, not Hefce.

A question of definition.

Should the USS become a defined-contribution scheme?

In his THES article, Professor Oswald raised the issue of whether the USS should be a defined-benefit or a defined-contribution scheme. He pointed to the Teachers' Insurance and Annuity Association and College Retirement Equities Fund, the main academic pension fund in the United States, a defined-contribution scheme that enables members to take full advantage of the buoyant stock markets. It also allows members to have a say in which funds their money is invested. But it would not protect members should the markets fall.

According to the National Association of Pension Funds annual survey of occupational pension funds, there are 57 defined-benefit schemes in the public sector and three defined-contribution schemes. In the private sector the comparative figures are 462 and 67. But there is a move away from defined-benefit schemes. Why?

Nick Edmans, a spokesman for the Occupational Pensions Regulatory Authority, said that for employees, defined-benefit schemes are "far, far superior" to defined-contribution schemes. He said that employers that can are moving away from defined-benefit schemes because they are "like writing blank cheques".

Mr Edmans said: "As an employee you cannot put too high a value on certainty, and with defined-benefit you get that. There is no knowing what the low interest rates will do to the performance of funds in the long-run. Under a defined-benefit scheme such worries become irrelevant."

Des Hamilton, technical director at the Pension Advisory Service, agreed that there is an "employer-led" move away from defined-benefit schemes because of their "open-ended liability".

Should the USS join this trend? The AUT does not have a formal policy on this, but Christine Cheeseman said: "Defined benefits are definitely safer and provide a package of benefits for the scheme member, with the employer bearing the risk."

Professor Oswald said that the USS could become a hybrid, enabling members to switch between different types of scheme.

Bill Trythall, one of the AUT directors, said: "It is extremely expensive to run a hybrid scheme. Some private-sector companies do it, allowing members to opt in to a defined-contributions system when they are earning more. But you have to be extremely confident of your ability to pick a winner."

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