The pensions timebomb

A dispute over adacemics' retirement benefits will be the first of many such clashes in the public sector

By John O'Leary

The first shots were fired this month in what seems certain to be a bloody war over public sector pensions. Although it is technically a private scheme, all eyes are on the Universities Superannuation Scheme (USS), whose trustees have voted for cuts in benefits in the teeth of union opposition.

With George Osborne, the Chancellor, describing public sector pensions as “unsustainable” and Mark Serwotka, general secretary of the Public and Commercial Services Union, threatening industrial action on a scale “not seen for decades” if pay and pensions are attacked, the machinations over USS may soon be small beer. But they illustrate the near inevitability of a series of standoffs and the difficulty of reaching agreements.

Consultation on the USS proposals will begin in September, shortly after John Hutton, the former Labour Work and Pensions Secretary, presents his interim report on the sustainability of public sector pensions. Hutton’s final report is due with next year’s Budget and promises a watering down of final salary schemes as well as the postponement of normal pension ages.

The proposals for academics and university administrators covered by USS – mainly those in the older universities – are less dramatic than some of those canvassed for the larger, unfunded schemes for public servants. But they are still bitterly opposed by the University and College Union, which insists that the changes are unnecessary and has threatened industrial action.

The ten proposals include changing the normal pension age from 60 to 65 for all members now below the age of 55, increasing the employee contribution rate, and switching from final salary to average career earnings as the basis of entitlements for new entrants. The scheme would also follow other public sector schemes in switching from the retail prices index to the consumer prices index in calculating inflation.

Universities have already increased their contributions from 14 per cent to 16 per cent of earnings to meet the costs of increased longevity among USS members, adding £110 million a year to their £750 million annual bill. Professor Alan Gilbert, vice-chancellor of Manchester University, has predicted that escalating pension costs could have as serious an impact on university finances as Government cuts.

Several universities have closed their separate final-salary pension schemes for new staff – mainly lower-paid clerical workers - who are not eligible for USS. And the former polytechnics and newer universities will face the fall-out from any changes to the teachers’ and local government workers’ schemes, both of which draw about 10 per cent of their members from higher education.

However, USS is exceptional in the public sector not only because it is a funded scheme, but also because half of its trustees are employee representatives - all of them UCU nominees, despite the fact that a minority of the scheme’s members are current UCU members. This month’s changes went through only on the casting vote of Sir Andrew Cubie, the USS chairman. The UCU has since demanded a ballot of members on the changes, but this has been refused on the grounds that each university will be consulting, as the scheme's rules require them to do.

The need for reform in response to greater longevity and fluctuations in the stock market – 90 per cent of USS funds are invested in equities – has been obvious for some time. The union blocked an attempt to move the normal pension age to 65 in 2006 and the current proposals have been under discussion for more than two years.

The scheme has assets of nearly £30 billion but will be £3 billion in deficit when current liabilities are met, with worse to come in future years. A revaluation next April would require action to plug the hole if those figures are confirmed.

The union acknowledges that some changes are necessary in the long term, but its more modest proposals would not make savings on this scale. Its case is based on the fact that the scheme currently receives more money than it pays out to pensioners, although the employers say that this will not last, as the number of pensioners continues to increase and a less risky investment strategy is adopted.

A poll of UCU members found 96 per cent opposed to the employers’ proposals. Sally Hunt, the union’s general secretary, said: “The employers seem determined to create a two-tier pension system with their draconian proposals, which would damage recruitment and retention of university staff and lead, inevitably, to further attempts to reduce benefits for existing staff to the lowest common denominator.”

With the union already threatening industrial action over pay, the spectre of further disruption over pensions looms large. The universities are in no mood for compromise, their backbone stiffened by David Willetts, the Universities Minister, who linked the dispute ominously to the case for raising tuition fees. “It’s very hard asking students to pay higher fees in order to prop up final-salary pension schemes in universities when their own parents have lost theirs,” he said in a recent speech.

Where USS has gone, the main public sector schemes will surely follow – and probably go further. Only 11 per cent of workers in the private sector still have final-salary schemes, compared with 94 per cent in the public sector. The independent Pensions Commission has calculated that public sector pensions are worth 40 per cent of salary, double the last Government estimate. Ros Altmann, a member of the commission, said: “Taxpayers are giving public sector workers a first-class air ticket to retirement and charging them just for an economy fare, while the taxpayers themselves have to wait for the bus.”

There are few clues yet on how far Hutton’s recommendations will go, but the commission laid down a marker with recommendations for a switch to career-average schemes, higher contribution rates and a normal pension age of 65, rising to at least 68 for the state pension. Others, such as Charles Cowling, managing director of Pension Capital Strategies, writing in a new Politeia pamphlet, propose taxing defined benefit accruals as benefits in kind.

Whatever mechanism the Government chooses, public sector pension schemes, with their £1,000 billion liabilities, are bound to be high on its list of targets. Brendan Barber, the Trade Union Congress general secretary, has vowed to resist cuts in benefits, arguing that ministers are presenting the figures selectively, ignoring the impact of the public sector pay freeze.

Peter Thompson, the independent consultant to the employers on USS, believes that too much attention is being focused on the final-salary mechanism. “What really matters is how much money is put into a scheme,” he says. Expect that amount to drop considerably after Hutton reports.

28 July 2010

John O'Leary. Editor, Policy Review Magazine