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March 30, 2011

The pensions timebomb

UK universities started nationwide strike action last week. Why? David Rowley explains why the dispute is far from a typical disagreement about public-sector pensions.

The University Superannuation Scheme (USS) is at the heart of the first in a series of battles between unions and government over proposed cuts to public-sector final-salary pension schemes.

Ten years ago an employer closing their final salary scheme to new entrants could expect a muted response from employees. Since then a steady drip of closures has made those still lucky enough to have a final-salary pension aware of what is at stake. For employers the dawning realisation has been of the open-ended costs they are liable for.

The biggest of these is longevity. World Bank figures show that a child born in 1974, when the USS opened, usually lived until 72.5 years old, while a child born in 2008 was predicted to live on average until 79.9. If both retired at 65, one would draw their pension for seven and a half years, the other would for almost 15—the younger employee costs the fund about twice as much. The USS claims its pensioners are living an extra 13 years over this period—thanks to healthier lifestyles and new medicines.

Actuaries use these longevity figures to estimate a fund’s ability to pay future pensions. For the last 10 years most final-salary schemes have been 60 per cent to 110 per cent funded; that is, the majority are in a deficit which the employer has to make good.

The USS was estimated to be 91 per cent funded in March 2010. Its value stood at £25bn in 2001, but slumped to £15bn in 2003 after the dotcom bubble. It rose to a high in 2007, but fell in 2008 and has now clawed its way up to £30bn.

Following accounting changes in 2003, this volatility appeared on balance sheets. Most private-sector companies opted to close their schemes. Instead they opened defined-contribution schemes linking pensions to how well investments performed. BT, the UK’s biggest private sector employer of full-time staff, took this step in 2001. Most have taken the same path, though a few have sought to gain a recruitment and retention edge by moving from a  final-salary scheme to a career average for new employees, as Sainsbury’s did in 2002.

John Hutton has proposed a career average for public-sector pension schemes too. These schemes effectively offer a  final-salary scheme for those never promoted in their career—predominantly low paid employees, though a back-bench MP would fall into this bracket too—but a reduced pension for anyone else. Hutton also proposes higher employee contributions, a state pension age that rises to age 66 in 2020 and a move to link rises in pensions to the historically lower consumer-price index rather than retail-price inflation. This should clear the funding deficits—though for unfunded schemes such as the teachers' scheme this is only a notional deficit. However, if the deficits do not disappear, then Lord Hutton proposes a cost-sharing measure which forces employees to make extra contributions from pay.

The universities paying into the USS are quick to point out that their proposed cuts do not go this far. They instead propose (see table below) a career-average scheme for new employees only: Hutton wants existing final-salary scheme members to be shifted into career-average schemes.

The University and Colleges Union accepts some of the arguments about longevity and the need for employees to bear extra costs, but wants a  final-salary scheme retained for new employees.

Unlike most other UK pension schemes, the USS has a rule which ensures any changes must be approved by both employer and employee representatives. Such a panel debated changes to the scheme last year and hit deadlock. An independent chairman was appointed to give a deciding vote and came down on the side of the employers.

A schedule was drawn up for cuts to pensions to take place this April but, crucially, the UCU has boycotted any final sign-off of these changes, forcing a postponement of the new career-average scheme.

The UCU argues that the consultation period was flawed and wants ACAS to help resolve the dispute. The employers counter that all normal procedures have been followed, and that recent government funding cuts have strengthen their arguments. Something has got to give.

Rowley_table

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