Live long and prosper: we must work together to reform our pensions

Change to the USS scheme is urgently needed to address greater life expectancy and a £17 billion shortfall, says Nicola Dandridge

May 27, 2010

As the world economy emerges from recession and governments tackle their financial deficits, the pace of pensions reform has quickened. Greece and Spain, for example, have made significant changes to their public-sector pensions provision as an essential part of their recently announced austerity measures. In the UK, the coalition government has agreed that it will establish an independent pensions commission to examine the long-term affordability of public-sector pensions. The commission is expected to complete its work within a year or so and is likely to lead to further changes to the main public-sector schemes, including the Teachers' Pensions Scheme (TPS) and the Local Government Pensions Scheme (LGPS), which have a significant presence in the higher education sector. There is some political pressure to replace final-salary schemes with defined contribution provision in the public sector in order to reduce future liabilities for the taxpayer and erode the increasing gulf between public and private pensions.

Unlike these schemes, the Universities Superannuation Scheme (USS), which is now the largest private-sector scheme in the UK, has remained virtually unchanged since its formation in 1974. Like other final-salary schemes, the USS has been facing growing cost pressures in recent years and, as of March 2010, had a deficit of £17 billion in historic funding levels. The need for change was first raised by the pension fund itself more than four years ago but negotiations between the employers and the University and College Union have not produced an agreement. Proposals from both sides are now being considered within the USS structure.

Why is change to the USS needed? These pressures arise to a large extent from increasing life expectancy. When it was set up in 1974, a typical USS pensioner retired at the age of 65 and drew a pension for 6-10 years; the average retirement age of USS pensioners is now 62 and they may receive a pension for up to 20 years. Further improvements in life expectancy - and increasing financial pressures on the USS - are expected, with future retirees' life expectancy reaching 100 years within the lifetime of current USS members.

A second important factor has been the rapid growth in salary costs. Significant pay rises were agreed for higher education staff from 2001 to 2008, including the increases under the framework agreement and the three-year pay deal (2006/09). These were well in excess of the funding assumptions made by USS actuaries and have a significant financial impact on a final-salary scheme. Third, the USS, which has most of its assets in equities, has faced uncertain investment returns. Stock market performance has been poor over the past decade and there has been considerable volatility in USS asset values, which will continue as the eurozone crisis unfolds.

The employers' plan is to address all of these risks, including the establishment of a retirement age of 65 for existing and future USS members (with a safety net for members nearing retirement). The result will be an increase in the average retirement age of USS members (currently age 62), which will help to contain future costs. It also addresses a political imperative by aligning the USS with other public and private pension schemes.

Under the employers' proposals, all existing USS members will continue to enjoy a final pension scheme based on the current terms. However, in order to contain future risks to the scheme, the employers' proposals would offer new members of the USS a CARE scheme - career-average revalued earnings rather than a final-salary scheme. This change safeguards the USS from higher than expected salary increases in the future while protecting the defined benefits of new entrants (who will receive a pension for a longer period as a result of further improvements in longevity). Finally, the employers will be supporting moves to change the USS' heavy dependence on equity investments by diversifying its investment portfolio over time so that there is greater stability in the value of its assets.

The UCU's proposals for change - which focus on increasing employee contributions - are welcome but fall short of what is needed to address these severe cost pressures and secure the future of the scheme. They also fail to acknowledge the difficult financial and political climate in which the sector now operates.

With the outcome of Lord Browne's review and the spending review due late in the year, the sector can no longer justify spending increasing amounts of public money on an open-ended final-salary pension scheme that has not been reformed for more than 35 years. Our objective is to make the changes necessary so that the USS' future sustainability as a defined benefit scheme will be assured while remaining affordable for universities and their employees. Ultimately, this surely has to be the best outcome for staff.

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