Avoiding a pensions disaster at UK universities

After two years of pandemic-induced disruption, students at UK universities were hoping this term that things were slowly returning to normal.

But life may soon get much worse again and this time it has nothing to do with Covid-19.

Ballots on strike action by lecturers have been called at UK universities. The issue is pensions; more precisely, whether the Universities Superannuation Scheme (USS) — the largest pension scheme in the UK with 470,000 members and £85bn in assets — has sufficient funds to pay the pensions promised to lecturers.

Both the USS trustees and the Pensions Regulator think not, and have proposed that the pension contributions increase and that future pension benefits become less generous to bring the scheme back into balance.

The lecturers’ union — the UCU — believes this is unnecessary and that the scheme has more than enough assets to make good on pension promises without either an increase in contributions or a cut to benefits.

The sides in this debate seem to be talking about two completely different realities — one in which the scheme is comfortably in surplus and one in which the deficit (the gap between assets and what is needed to make good on past pension promises) is huge. Both sides seem unable to talk in a common language. This makes strike action — which would be a disaster for students — likely.

The reason this disagreement shows no signs of resolution is that a discussion which is really all about risk — the risk that assets might not be sufficient to pay pension promises because asset returns turn out to be disappointing — is couched in terms that ignore risk. The question has become one about how big is “the deficit” (or “the surplus”) — a question which compares current assets with some single estimate of the value of future pensions to be paid.

But that is not a question that says anything about risk and reasonable people can disagree about how to measure the cost of those future pensions.

Should one use an average return on assets to value future pensions due — which would give an optimistic assessment on how much is needed to fund pensions? Or should one use a much lower return so as to be more certain of having enough money — which would suggest there is a big deficit in the pension fund?

The only way to have a sensible discussion about how risky is the status quo is to recognise the likely degree of uncertainty about asset returns and then to assess the chances that assets would run out at some point in the future before current pension promises are fulfilled. That involves thinking about many possible future scenarios — some in which returns on risky assets like equities are good, some in which they are average and some in which they are below average. This is what James Sefton, a colleague of mine at Imperial College, and I have done in a recent piece of analysis.

Our results do not show that the USS has a huge deficit any more than they show that it has a comfortable surplus. What they do show is that the likeliest outcome is that current assets are more than enough to make good on existing pension promises. But they demonstrate that there is also a significant probability (as high as 40 per cent in some of our simulations) that the funds could be exhausted leaving the universities with a sizeable liability to cover — well in excess of £20bn should assets run out before 2055.

The real issue with university pensions is about what level of risks are acceptable. It is not a question of whether there is certainly a surplus or certainly a deficit — that way of posing the question is misleading and it encourages the parties to take strident positions that they dig ditches to defend.

Today, the risk of assets being insufficient to pay existing pension promises is almost certainly substantially larger than the chances of losing a game of Russian roulette. That risk is too high for the pension regulator.

One of two roads must be followed. The first road is to reduce the chances that assets run out. This means assets need to be supplemented by some combination of higher contributions, from scheme members and from universities, or by less generous pensions.

The second road — where the long-term solution really lies — is to agree in advance how risk of asset underperformance will be shared between scheme members and universities. That might sound unappealing to members of the scheme who have expected pensions that are guaranteed.

But the risk that scheme members would take on is not all on the downside. Our results show that in fact there is greater chance of a scheme surplus than a deficit, and so a fair sharing of these surpluses or possible deficits is more likely to bring higher pensions than smaller ones.

Exploring how risk can be shared is a far better way forward than going on strike.

David Miles and James Sefton are professors of economics at Imperial College.


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