Gold standard reassessed

During the darkest days of higher education, when morale sank along with sliding budgets, there was, perhaps, one beacon of hope for the disgruntled university employee - a generous pension at the end of his or her career.

It was probably the gilt-edged, safe-as-houses final-salary pension scheme that made higher education, in purely financial terms, a career that merited consideration by society's brightest. The private sector would have paid them much more, but company pensions were less generous and less secure than those in higher education. Without the sweetener of its munificent pensions, academe would have found it much more difficult to recruit the intellectual elite over the past 25 years.

But times have changed. In the past decade, a seemingly inexorable decline in higher education funding that began in the late 1970s has been halted and arguably reversed. The salaries of academics are at last regaining the ground they lost to private-sector equivalents.

Where higher education has yet to follow the private sector's example, however, is in the matter of pensions. Now, depending on one's viewpoint, the final-salary public-sector pension is seen either as a gold-plated millstone around the taxpayer's neck or essential to compensate for salaries that tend still to lag behind the private sector, where most final-salary schemes have been closed.

But other powerful factors are squeezing pensions. People are living longer, a trend that calls into question the long-term affordability of all pension schemes. Final-salary schemes already tend to be more expensive to run than others.

No surprise then that, in recent months, higher education employers have been looking at the final-salary pension (also known as a defined benefit plan) and its sustainability.

The pensions picture in higher education is complicated by the different pensions schemes that cover the sector (see below).

The Universities Superannuation Scheme covers academics largely in the pre-1992 universities. The Teachers' Pension Scheme caters for academics in post-1992 institutions along with lecturers in further education and schoolteachers. The Local Government Pension Scheme covers mainly non-academic staff. There are also local schemes such as the Superannuation Arrangements for the University of London. They are distinct from both the USS and the TPS.

A report into higher education pensions published in October by Universities UK and the Universities and Colleges Employers Association (Ucea) found that a majority of universities wanted their employees to pay a greater share of the cost of their pensions.

Because pensions are a sensitive subject, matters are proceeding slowly, and there are as yet few people in the sector willing to predict the end of the final-salary pension.

Nonetheless, it is clear from the noises coming from employers that the long-term future for the final-salary pension looks bleak and that, in the short term, employees will have to pay higher contributions.

A revaluation of the USS began last month, and the trustees are expected to report their findings to the sector in the autumn. There is a general feeling in the sector that contributions will have to rise, but the question yet to be answered is who will be paying more, the employees or the employers?

Long before that is decided, the sector will be able to consider the results of consultation by the Employers Pensions Forum, which will set the scene for a far wider debate. The inquiry, which has just begun, is led by Bill Wakeham, chairman of Ucea and vice-chancellor of the University of Southampton. It will look at, among other things, the possibility of a single pension scheme for higher education and the sustainability of the current final-salary pension. The results of the Wakeham consultation are due in July.

"There are many different pension schemes in the higher education system at the moment, and they are very much valued by staff and employers. It's just getting rather difficult to be sure that they are all sustainable into the long-term future," Wakeham says.

"People are living nearly as long into retirement as they are working, so we want to make sure we can continue to afford the pensions. We want to continue to ensure that we can offer an attractive pension for all our staff."

The consultation will consider how much desire there is to retain a final-salary scheme, which Wakeham says "rewards particular types of behaviour and is seen as the gold standard". Does that still suit higher education?

The creation of a single, unified higher education pension scheme will also be examined. "Is that possible?" Wakeham asks. "Does it make any sense? The bigger the scheme the better, so in one way that would sound sensible. Bigger schemes are cheaper to run, which is why some of the local schemes in the pre-1992 sector have some greater difficulties than the national schemes."

Asked if the status quo remains an option, Wakeham replies: "I simply don't know. I suspect it's not. We need to get some serious work done. This is a complicated area, especially with many different types of scheme already in existence."

The view that the final-salary pension arrangements cannot continue in their current form appears to be crystallising in the minds of senior management in universities. The consequences of that would mean - certainly for staff in the USS - that individuals will have to pay greater contributions or receive fewer benefits.

Phil Harding, the chairman of the British Universities Finance Directors' Group and finance director of the University of Westminster, says: "There is naturally much reluctance to abandon the final-salary pension scheme. A recent survey showed that the sector wishes to hang on (to the final-salary scheme) for as long as it possibly can because it is seen as such a valuable means of recruiting and retaining staff for the sector.

"I think what we will see are contribution rates going up for employers and employees as well. In the past, the employer contribution rates have been edging upwards, but the employee rates have remained fairly static.

"The other change is that we will inevitably see some tightening up of the benefits on offer within those schemes. The USS is being revalued, and that will provoke a discussion and a debate about where benefits need to be tightened up and reduced," Harding says.

"There will certainly have to be a discussion about retirement age being pushed up, and I think that has to happen given the improvements in longevity of staff. There has to be an acceptance that there has to be a bit of a rebalancing in people's lives about the amount of time they are working and the amount of time they are retired.

"My personal view is that if you are looking over a medium term, I don't think that final-salary schemes are sustainable in higher education any more than they are in any other part of the economy. I think that we'll hang on to them as long as we can, but the economics are all against them and so are the demographics." Harding believes that a pension based on average career earnings will be the way to go.

Declan Leyden, pensions policy adviser to the Employers Pensions Forum and Ucea, echoes fears about the final-salary pension scheme's unsustainability.

"There is concern among employers about whether pensions are sustainable in the future and in what shape or form. In principle, they would like to continue with a defined-benefit scheme - but can they do it? Employers can't give an answer at the moment because they are considering it. They are now moving to the stage of forward thinking about what the options for pension provision in the future would be.

"It's about stabilising costs and making pensions affordable so we can have defined-benefit pensions in the future. When employees ask if they are going to have defined-benefit provision into the future, employers have to ask if they are going to help pay for it.

"We will have to see what the outcome of the USS valuation will be, but employers will want to contain the costs as they are at the moment - 14 per cent is what they pay, and they would struggle to pay more. So, to cope with the inevitable increasing costs, they will have to look at ways of sharing them with the employees or reducing the benefits."

Leyden says that employers would like to bring the benefit of generous pensions into much sharper focus when discussing an individual's overall remuneration package. Employers have mooted this in the past, but the trade unions representing higher education staff are opposed.

"Employees value pensions highly, and employers would like to make much more explicit the financial benefit of a good pension and the high cost of providing it and that it is in addition to pay," Leyden says. "It is a substantial benefit no longer widely available in the private sector. It helps recruit and retain staff and needs to be taken into account when comparing pay in the sector with elsewhere. If you disregard the pension, you are disregarding a substantial benefit."

Many outside the sector view the current pension arrangements as an anomaly and believe it ought to examine better ways of recruiting and retaining staff.

Gemma Tetlow, senior research economist with the Institute for Fiscal Studies, argues that one way forward might be to offer higher initial salaries, with academics contributing to a money-purchase pension scheme, where the amount paid in has some flexibility.

"It might better to think about it in terms of the structure of the remuneration current workers get. They get current pay after pensions contribution, then get deferred remuneration in the form of a pension when they retire. I suppose the question is whether people prefer that form of remuneration."

Tetlow says that pay and pensions must be linked more closely in negotiations over the whole remuneration package. "The spotlight is increasingly turning to pensions as a part of the wage bill, which is very expensive. Is that the best way to reward people whom we want to work in the public sector? They encourage long tenure in jobs. This may be beneficial; but if not there might be scope for a rethink on whether this is the most efficient way of using the money.

"One of the things about the public-sector schemes is that people do not really realise the generosity of the scheme and do not understand how expensive it is.

"The real cost of pensions is not just the 6 per cent of a typical employee contribution. It is worth 25 per cent of an individual's annual salary. So if you had an academic earning £50,000 a year, theoretically we could afford to give them a 12.5 per cent pay rise (in lieu of a pension) because that is what it costs to run the pension scheme."

It is a fascinating debate: would early-career academics and other higher education staff prefer to have better pay at the start of their careers when people often need money to set up home and pay off their student loans? Would they rather start contributing immediately towards a pension that pays out 40 years down the line? And might universities enjoy the flexibility to switch resources between pensions and pay when better salaries may help them recruit the right people?

Phil Harding, from the British Universities Finance Directors' Group, agrees that the role of pensions in the remuneration package could be due for re-examination.

"Bear in mind that for individuals starting their career at a relatively young age, the value of the pension in their eyes isn't as great as it is for those at the end of their working lives. For them, with debts and commitments, a higher salary rather than a more generous pension might be a more attractive.

"I do believe that pension considerations need to be built into the process of negotiation. The benefit comes in considering the pay of staff in higher education compared with staff outside higher education.

"Beyond the public sector, it's pretty rare that staff get a final-salary scheme, and a more mature comparison of remuneration levels would be one that took account of the value of the pension. That would give a different picture as to whether staff in higher education are well paid or not."

Tony Bruce, head of research at the UUK, also subscribes to this view. "We need to raise awareness among employees of the benefits they receive via their pension scheme. It is a valuable benefit not widely available elsewhere in either the public or private sectors."

But Deian Hopkin, the vice-chancellor of London South Bank University, sounds a note of caution when it comes to shifting the balance between pensions and salary. He argues that moving to a different system could present new problems.

"I do think that the big difference between final-salary schemes and money-purchase schemes is that (in final-salary) for most of your career you can semi-relax as long as at the end of the day you can maximise your earnings towards the end of your career.

"With money-purchase, you need to get higher earnings much earlier on, and that creates institutional pressures. If you say to someone, 'don't worry, you'll get promotion next year', that will have a different ring to it because it will have an impact on their money-purchase scheme.

"I don't think anybody knows what the impact of money-purchase schemes will be on public services where earnings have traditionally been low. People have always said that if you go to the private sector you do earn more, but you then have a much dodgier pension scheme.

"If you have a less attractive pension scheme in the public services, what do you say to people?"

The trustees of the USS will begin briefing the sector on the revaluation in September, after which it is likely that negotiations with the University and College Union will begin on the details of who pays what.

At this stage, the union is keeping its powder dry. It will wait to learn the outcome of the USS valuation before substantively weighing in.

Nonetheless, the union does recognise the case for reform, says Geraldine Egan, the UCU's national pensions official.

"There has to be a way forward. At this moment we could put our heads in the sand and say there is no pressure on us to change things at this time - and that would not cause a problem to the scheme. It would frustrate the trustees, but it would not cause a problem to the scheme, necessarily."

She believes it unlikely that pensions would be included as part of negotiations on salaries.

"I know what the employers constantly say, that pensions are part of pay and we need to have it on the table in the salary negotiations. It may well be (the case) in that there's only one pot and pensions will affect salaries, and it may well be that the employers have reached the stage of more consciously framing it that way.

"But I don't expect them to sit down in pay negotiations and negotiate the pensions as well simply because of the diversity of the pension arrangements that they have."

Sally Hunt, the UCU's general secretary, adds in a statement: "Employers in the higher education sector have established a pensions forum and negotiate on the terms and conditions within separate forums on the individual pension schemes.

"The UCU remains happy to discuss any matters of concerns raised on pension issues within the appropriate forums. We see pension as deferred pay, and UCU members see it as an important part of their remunerations."

THE TEACHERS' PENSION SCHEME

The Teachers' Pension Scheme is the second-largest public-sector pension scheme in England and Wales: it claims 1.4 million members, including academics in post-1992 universities, further education lecturers and, of course, schoolteachers.

It is, like the USS and the local government scheme, a final-salary scheme. Depending on when someone joined, his or her pension is based on the highest average amount earned in the period up to retirement. This can be calculated in one of two ways. It is based either on the person's salary in the final year of employment or on an average of the best three consecutive years' salary from the last ten years of service.

For those who joined the TPS before January 2007, the normal pension age (NPA) is 60. Those who entered the scheme later have an NPA of 65. The decision to increase the NPA reflects increasing longevity and concerns over the sustainability of the scheme. The minimum age at which the pension can be paid (except on grounds of ill health) remains 55 years.

A curious aspect of publicly funded systems is that the money deducted from an employee's salary at source is not invested anywhere to produce a return that will one day help pay for that employee's pension.

It helps to imagine a single pot of money that includes salaries for current employees and pensions for former employees. Taking pensions contributions from the salary side of the equation creates a nominal return on the pensions side, from which current benefits are paid.

Because there is no investment, whatever is deducted at any given time from the pay packets of current employees is, in effect, a pay cut. This produces a saving on the state salary bill for lecturers and teachers.

The apparent unfairness is that raising individual contributions reduces further the salaries of current employees for the benefit of those who are already retired or about to retire.

Of course, in reality, any decision to raise contributions is taken after careful long-term projections are done on the future costs of pensions. So even the youngest employee paying more now ought to benefit in terms of a decent pension.

'I WAS LOOKING FOR SECURITY'

For Robin Clark, one of the attractions of academia was the prospect of a generous final-salary pension on retirement.

Dr Clark, a senior lecturer in Aston University's School of Engineering and Applied Science, has experience of both private and public-sector pensions.

He explains that when he used to work for a railway engineering company in the US the value of his pension could fluctuate depending on how the stock market was performing.

"There you get sent regular statements telling you how the (pension) share portfolio is performing, and you can move it around if you like," he says.

But when he decided on a career shift the prospect of a secure, generous pension helped drive his choice.

"A pension is very important to me. One of the reasons I looked at higher education was that I was at a stage in my life when I was looking for security.

"I have young children and I was looking towards the future. I thought that if I were in a small, private firm my pension might not be worth as much."

THE UNIVERSITIES SUPERANNUATION SCHEME

The Universities Superannuation Scheme became operational in 1975, when it replaced the Federated Superannuation System for Universities.

It is one of the largest private-sector pension schemes in the UK.

The USS claimed more than 390 participating institutions and assets of £30.1 billion on 31 March 2007. Employers contribute 14 per cent of an individual's salary and the employee pays 6.35 per cent.

The USS is a balance-of-cost scheme - the members pay a fixed contribution and the employers pay the balance. If, as has been speculated, employers want staff to pay more towards the scheme, a rule change will have to be agreed.

The scheme is administered by a trustee company from its Liverpool office while the assets are managed by a London investment office.

It is controlled by a board of 12 directors - four of them are appointed by Universities UK, three by the University and College Union, one by the funding councils and four are co-opted or independent directors.

The USS is in the midst of a revaluation, which it is legally obliged to undertake every three years. It is generally considered to be a robust and well-managed scheme, albeit one that faces the same pressures - an ageing population and volatile stock market - as other pension funds.

If the fund cannot meet its liabilities because of a deadlock over who pays extra contributions, the trustees have the power to make the employers pay more but not the members.