The UK’s embattled university sector is facing a probe by MPs who are concerned about a large and growing funding hole in the main pension scheme for academics.
Frank Field, chair-elect of the Commons work and pensions select committee, on Wednesday revealed that he would be seeking answers about why the finances of the giant Universities Superannuation Scheme have deteriorated.
What triggered Mr Field’s concerns?
Mr Field’s intervention follows the publication last month of the USS annual report which showed on a so-called technical-provisions basis that the pension scheme’s deficit — the amount by which its liabilities exceed its assets — had more than doubled, from £5.3bn in 2014 to £12.6bn at March 31. In 2011, the deficit was £2.9bn.
The rise in the deficit was even more dramatic when measured using accounting rules.
On this basis, the funding shortfall for the USS scheme — which has 390,000 members — soared £9bn over the past year to £17.5bn, making it the largest on record at any British retirement fund.
Mr Field is concerned that students and young academics will end up paying for the pension blow out through increased tuition fees and higher retirement contributions.
Why has the funding hole grown?
The USS fund is a defined benefit pension scheme where members are promised an indexed retirement income based on salary and length of service — for themselves and their spouses and other dependants.
The cost of delivering this type of pension has become more expensive as life expectancy has increased.
But the USS said last month that the main reason for the widening deficit was a large drop in long-term interest rates which had the effect of inflating the pension scheme’s liabilities.
This is a trend which has also affected thousands of defined benefit schemes in the private sector, where employers are under pressure to contribute more.
In the year to March, the value of USS’s assets increased 20 per cent to £60bn when measured on the technical provisions basis, but this did not outpace the growth in liabilities, which rose from £59.8bn to £72.6bn.
John Ralfe, an independent pensions expert, believes the root cause of the fund’s rocky finances is an “aggressive bet” by the scheme’s trustees that equities would outperform bonds. “The bet has not paid off,” he says, as the deficit has got worse.
Over the past five years, the USS scheme’s assets have outperformed their benchmark by 0.5 per cent per annum. The net added value from the outperformance has contributed a total of £1.1bn to the value of the scheme’s assets.
But the USS said the asset liability mismatch it deliberately runs to create value had not performed as highly as expected over the five-year period.
Is the USS scheme worse than others?
A key indicator of a pension scheme’s financial health is its funding ratio — what the assets represent as a percentage of the fund’s liabilities.
Between 2011 and 2017, the USS funding ratio fell from 92 per cent to 83 per cent, reflecting a broader deteriorating trend for defined benefit schemes.
According to the Pension Protection Fund, the lifeboat fund for failed private sector pension funds, the average funding ratio for private sector defined benefit schemes with more than 10,000 members was 84 per cent in 2016 — in line with the 83 per cent recorded by USS.
But the USS fund fares less well when its assets and liabilities are measured under accounting rules.
On this basis, the USS reported a funding level of 77 per cent, compared with an average of 90 per cent for the wider universe of defined benefit schemes, according to JLT Employee Benefits, the pension consultants.
What does Mr Field want to know?
He is probing whether deficit repair plans agreed for the USS fund in 2011 and 2014 were adequate.
He has also asked questions about the role of Bill Galvin, current chief executive of the USS and former head of the Pensions Regulator between 2010 and 2013. Mr Field also wants to know what arrangements are in place to prevent tuition fee income being used to plug the USS scheme’s deficit.
What is the outlook for the scheme?
The USS insists that the scheme is well governed and funded, but the prospect of pain for academics and students looms.
The trustees of the scheme are undertaking its triennial actuarial valuation. The USS said last month that it expected lower returns on assets, which would increase the cost of future pensions.
Steps have been taken in previous years to control the USS pension costs, including shifting staff still building their benefits from a final salary pension arrangement to a less generous career-average.
But experts say much deeper cuts may be needed to deal with the growing USS shortfall, including closing the defined benefit scheme or linking access to retirements benefits with the state pension age.