Prudence is the price of the UK’s generous pensions

Asking for higher contributions is painful but unavoidable in such uncertain times, says USS chair Sir David Eastwood

June 18, 2019
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Defined-benefit pensions have long been a valued element of the total reward enjoyed by colleagues in the higher education sector.

For those who hold the promise of a defined-benefits pension, it is likely to be the most valuable asset they will possess, providing certainty of a fixed income for life in retirement, a high level of protection against inflation and dedicated financial support for dependants at critical life events.

But the challenge of fulfilling a legally binding promise at a time of significant uncertainty is precisely why – outside the public sector schemes whose pensions are paid for by taxpayers – defined-benefit schemes are increasingly rare. The objective price of “guaranteed” benefits has been made much more expensive than in the past by a combination of record low interest rates, an outlook of “lower for longer” future investment returns, and the fog surrounding the global economy.

The vast majority of the UK’s private defined-benefit pension schemes are now closed, either to new members or in full: the Universities Superannuation Scheme accounts for nearly a sixth of the people still actively paying into the schemes that remain open.

But the price of certainty in delivering the extremely valuable pension promises being made by USS is now higher than at any point in the scheme’s history. The resources of our sponsoring employers may be considerable but they are not limitless, and they are subject to uncertainty themselves. We need to think only of the potential impacts of the Augar review, Brexit, the next spending review and the competition for student recruitment to understand the challenges faced by universities and their governing bodies.

The fundamental question faced by any trustee carrying out a valuation today is, therefore, how can it secure the certainty of a defined-benefits promise when, economically and politically, these are such uncertain times. The increased legislative and regulatory protections now in place for defined-benefit pensions mean that this is no longer a question of restrained optimism (as it might arguably have been in the past). It is, rather, how wrong can we afford to be?

Apart from the value of the assets we currently hold and the cost of more certain investments, such as government bonds, almost everything else is an estimate and subject to change. We can look to the past and to predictive models for guidance on how interest rates, investments, financial markets and key demographics might evolve, but this can only inform a judgement about an inherently unknowable future.

Uncertainty serves to increase the premium for insuring defined-benefit pensions, and the independent conclusion of the USS trustee is that the contributions required today must increase to respond to this. Here, we are not alone. Even the Teachers’ Pension Scheme, whose pensions are “unfunded” and are, in that sense, a direct call on the taxpayer, is significantly increasing the contributions required to fund its defined-benefits pensions.

We are acutely aware of the value of the USS pensions promise to the attractiveness of the higher education sector as an employer. The trustee is determined to ensure that this continues and that pensions promised by the USS are seen as secure, regardless of the future prospects of individual employers or the sector as a whole. This must be in the long-term interests of members and the sector.

We acknowledge the challenges in levying higher contributions – that is why we have worked very hard to find ways in which these can be escalated gradually, or made contingent on events. The process has been painful and contested. Given the scale of the challenges we face, this is understandable. The trustee, though, is in a unique position where it is required to make objective judgements. It must operate in a regulated environment, it must have regard to its fiduciary responsibilities, and it must be prudent.

Because of the nature of the benefits we underwrite, the trustee must consider the possibility of adverse scenarios as well as positive ones. In short, we must ensure that the promises being made to our members will continue to hold their real value.

Sir David Eastwood is chair of the Universities Superannuation Scheme trustee board and vice-chancellor of the University of Birmingham.

POSTSCRIPT:

Print headline: Caution, danger ahead

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Reader's comments (3)

Lots of fine, soothing words here, but not a word of contrition about the two main reasons the USS scheme is in such trouble, as mentioned in my response to the article about the pension deficit on 9th May. These reasons (repeated here) are: - 1. In the 1980's, universities loaded the scheme with liabilities. Many staff seen as unwanted were given very generous pensions while in their early fifties. The financial cost of this has been horrendous. 2. In the mid-1990's, USS was perceived to be doing so well that the universities reduced their contributions from 18.85% to just 14%. And this reduced level carried on for well over a decade (but no reduction in employee contribution happened). Universities were entitled to do this, but the other side of the deal was that if the scheme reached hard times then the univerisities *only* would have to increase their contributions. In recent years this promise, clearly, has been broken. And think about 4.85% of your salary, and that of every other academic, over 10-15 years - the answer will run into billions in cash alone, even without a return on investment. I know it isn't necessarily helpful to the here and now to relate historical reasons for why the scheme is in trouble. But saying to others to share the pain of terrible decision making is even worse. I suspect nothing will be learnt, though. Just look at how universities have stacked up future liabilities with PFI-style loans for building projects, *all* based on the idea that student numbers will rise. What happens if - when? - that doesn't happen? Not a problem for today's management, but more likely one for future vice-chancellors, who are currently at primary school, to solve.
Either the chair of USS trustee board has not read the USS valuation documents since 2014 or he is not being honest. The "deficit" claimed by USS is a result of actuarial oddity they call Test 1. The question Test 1 answers is, "how much more funding is needed to be absolutely sure that if we follow a low-risk low-return investment strategy USS will be able to CLOSE the USS pension fund in 20 years". Being absolutely sure that USS can be closed in 20 years is not in the interest of universities, and not what USS members want. By pursuing this policy the USS trustee is acting against the interest of its stakeholders. Bill Galvin and David Eastwood's positions are untenable and they should resign.
David Eastwood is being tendentious. His statement "The vast majority of the UK’s private defined-benefit pension schemes are now closed, "is dishonest because the vast majority of schemes are single employer schemes not comparable with USS, a multi employer scheme. Most companies have a finite life span unlike the higher education sector which is of fundamental importance to society and the economy. Why should we consider higher education in the same way as a company like BHS or Woolworths? His comparison is inappropriate and the fact he offers it to us, insulting. He mentions "record low interest rates". In fact interest rates on government bonds, or gilts, are currently so low that the are below inflation. Anybody who invests in government bonds loses money at today's low interest rates. No rational investor would choose to do that. Yet that is what USS under the unthinking leadership of David Eastwood is doing. They are blindly following what in the past would have been a sensible low risk investment strategy. Today it is throwing members savings down the drain. And then asking members to pay for it. That is called 'de-risking'. It sounds like a good idea to reduce or avoid risk. But it is actually increasing the risk that there will be insufficient money to pay pensions by making it more likely the scheme will not make enough return on its investments. It is not prudent. He uses the word 'objective' as a weapon, implying the assumptions made by the trustees about the future are more than opinions. He refers to the trustees as 'independent' when in fact they are anything but, being highly paid to conform. Th job of the trustees is to take a view on how best to protect members' interests not to act as cyphers in the pretence that what they are doing is 'objective'. They need to understand that 'de-risking' investing in gilts in the knowledge that will make a guaranteed loss is not rational or prudent and arguably a breach of their duties as trustees.

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