This is the third in a series of three blogs that HEPI is running this week on the state of university pensions and particularly the Universities Superannuation Scheme (USS). The previous two blogs are available here and here.
However tough the predicament faced by any pension scheme, as the title of this trilogy of blogs asserts, ‘If something cannot go on forever, it will stop.’ This is named Stein’s Law after the economist Herbert Stein.
It is clear the current USS arrangements with a large and increasing deficit cannot go on forever. So something will have to give. My guess is that, in the end, more will need to come from the benefits side of the equation than has so far been widely accepted, even though (as yesterday’s blog showed, this could be very difficult to achieve).
The decline of defined benefit pensions
This is what has happened elsewhere in society. Pension schemes with guaranteed benefits are now rare beyond the public sector.
When I worked on pensions almost a generation ago, we used to roll our eyes at the number of press releases from the pensions sector that claimed some specific change or another was ‘the final nail in the coffin of defined benefit pension schemes’.
The argument was typically overdone when applied to any individual tweak, but cumulatively lots of individual costly changes (some wise, some less so) gradually served to kill off defined benefit pension provision.
In 1994, every FTSE-100 company ran a defined benefit pension scheme and it is thought ‘all of these were open to new employees’. In 2012, the Financial Times reported that ‘Shell is to close the FTSE 100’s last remaining final salary pension scheme’ (a generous form of defined benefit scheme that was once common).
By 2015, there were only five FTSE-100 companies with any form of defined benefit scheme open to new members of staff. Many companies are now looking to offload their defined benefit schemes altogether, with one pre-COVID headline reading: ‘Half of FTSE 100 DB pension schemes could buyout by 2028’.
A few years ago, it was proposed that the USS should close its defined benefits section too, which could have stemmed the mounting problems, though it prompted ‘the longest ever strike in UK higher-education history.’
The Pensions Regulator and the deficit
The second reason why the benefits side of the equation is likely to be affected is that the deficit remains large whatever happens. This is because you can only alter pension benefits for future service; you cannot alter the pension entitlement accrued to date by the 200,000+ existing members, nor the accrued entitlements of the 180,000 deferred members and the 75,000 retired members.
It is just not possible for institutional leaders and governors to turn their heads and ignore the problem the way that some of the organisations in Lowenstein’s book While America Aged (which prompted these blogs) were able to as the Pensions Regulator will keep twisting their heads back to focus on the problems.
Many years ago, my job included lobbying the powers that be on behalf of the insurance industry over the extraordinary number of decimal places they expected to be used when calculating elements of people’s personal pension funds (which was greater than the functionality of insurance companies’ IT systems at the time). The idea that such an intrusive regulatory regime could now be relaxed about a deficit of perhaps as much as £23,900,000,000 in just one pension scheme is for the birds. (To those shouting at me on social media in response to this series of blogs, including those who have claimed the USS deficit is entirely illusory, I would point out that it is the Regulator you need to convince of your case.)
Could the Government absorb the problem?
Some opponents of change might draw parallels with student funding and its reliance on loan-based finance. If it is okay to fund today’s education of students by appearing to mortgage their futures, why can’t pensions be funded the same way?
Some people have even argued that the best way to resolve the USS challenge is for the Government to underwrite the Scheme, just as it takes on the burden of unpaid student loans.
But student loans fund education that helps people become more productive (as well as better citizens). So the benefits hugely outweigh the costs on average. The extra taxes graduates will pay as a result of being more highly educated, combined with their student loan repayments, more than cover the costs of their extra education.
In contrast, putting the USS on the public books could prove a significant burden on taxpayers, most of whom can only dream of benefits like those on offer from the USS. No responsible government is likely to do it.
Moreover, if the Treasury ever really did have considerable amounts of spare cash to spend on future pensioners, then more disadvantaged people than retired university staff members may have a better claim – and also look a surer electoral bet.
Expecting taxpayers to absorb the cost of past pension errors in our sector would also bring huge moral hazard to the fore: why should any private sector scheme ever act responsibly if it believed the Treasury will pick up the bills if things don’t work out?
These three blogs flag problems more than provide solutions and they therefore risk breaching HEPI’s own rules, which state ‘a publication that criticises without proposing better alternatives is unlikely to be published by HEPI’.
This is intentional, given the point the debate over the USS is currently at: the primary purpose of these blogs is to try and ensure discussion about the USS is not lost in the all-encompassing COVID-created fog that is leaving less room than usual for other issues.
However, as implied above, it seems clear further change needs to happen that goes beyond ideas like changing modelling assumptions on the real state of the USS, hoping the Government will step in or trying to ignore pressure from the Pensions Regulator.
Personally, I would keep a shift to a wholly defined contribution scheme on the table, as that is what has already happened throughout the private and charitable sectors. It could be attractive to the material proportion of younger staff who refuse to join the USS – and may make it easier for institutions to offer more permanent employment, rather than insecure contracts, to early career staff. But it would be a major shift and likely cause further industrial action. Moreover, if the current defined benefit part of the USS were closed, many people think it would need to be further derisked, prompting even bigger contributions. So this is not a perfect solution. (Notably, there are many types of DC schemes and one long-time critic of the USS, John Ralfe, is delivering a free lecture on so-called Collective Defined Contribution schemes at Imperial College Business School later this month.)
Another less radical idea would be to retain the current defined benefit arrangement but to lower the salary cap below its current level of almost £60,000. Salaries above this threshold are still pensionable, just on a defined contribution basis.
I explained in a history of the USS that HEPI published in 2019 that the original motivation for a defined benefit scheme for university staff came from the top. It is clear that many senior managers are keen to maintain some defined benefit provision. But it needs to be affordable at a time when university incomes are being squeezed.
HEPI’s previous output on the challenges faced by the Universities Superannuation Scheme includes a history of the Scheme from its foundation in the mid-1970s, a piece on why the COVID pandemic is likely to lead to pension reforms and a response to some of our commentary on the USS by Matt Waddup of the UCU.