USS changes — don’t be fooled

This post is meant for anybody who will be affected by proposed changes to the Universities Superannuation Scheme, the body to which I and many other UK academics have paid our pension contributions and that now proposes to change the rules to deal with the fact that it has a large deficit as a result of the financial crisis. (Or rather, it says it has a large deficit, but there are arguments that the amount by which it is in deficit or surplus is highly volatile, so major changes are not necessarily justified.)

Of course, any change will have to be in the direction of making the deal less generous for those with pensions. Indeed, changes have already been made. Until a few years ago, the amount you got at the end was based on your final salary. More precisely, you got one 80th of your final salary per year after retirement for each year that you contributed to the scheme, up to a maximum of 40 years of contributions (and thus a maximum of half your final salary when you retire). But a few years ago they closed this final-salary scheme to new entrants, because (they said) it had become too expensive. This was partly because now a much larger proportion of academics end up as professors, so their final salaries are higher, and also of course because people live for longer.

They now propose to close the final-salary scheme even for existing participants. That of course raises the question of what happens to the contributions we have already made to the scheme. If the USS really can’t afford to keep going with the present arrangements, it is perhaps reasonable to say that we cannot continue to make contributions under those arrangements, but our past contributions were made under the very clear understanding that each year of contributions would add one 80th of our final salary to our eventual annual pension payments. Will that still be the case?

I received a letter from the USS yesterday that included the following reassuring paragraph.

As an active member of the Final Salary section of the scheme, you would be affected by the proposed changes. Under the proposals, the pension benefits provided to you in the future would be different to those that are currently provided through the scheme. It is important to note that the pension rights you have already earned are protected by law and in the scheme rules; the proposed changes will only affect the pension benefits that you will be able to build up in the future if the changes are implemented as proposed.

Does this mean, then, that the pension I have already built up is safe? No, it decidedly doesn’t. If you received a similar letter and were reassured by the above paragraph, then please unreassure yourself, since it is hiding the fact that you stand to lose a lot of money (the precise amount depending on your circumstances — I will discuss this later in the post).

The key to how this can be lies in a paragraph from a leaflet that I received with the letter. It says the following.

If you are a member of the current final salary section, the benefits you have built up — your accrued benefits — will be calculated using your pensionable salary and pensionable service immediately prior to the implementation date. Going forward, those accrued benefits will be revalued in line with increases in official pensions (currently the Consumer Prices Index — CPI) each April, up to the point of retirement or leaving the scheme.

In plain language, they are saying that for each year of contributions that you have made to the scheme, you will now earn one 80th of your salary at the time that the changes to the scheme are implemented and not at the time that you retire. So if, say, you are in mid career and your final salary ends up 25% higher than your current salary, then what you will get for your contributions so far will be reduced by 20%. (The difference between those two percentages is because if you increase a number by 25%, then to get back to the original number you have to decrease the new number by 20%.)

Let’s illustrate this USS-style with a few hypothetical examples. I will ignore inflation, but it is straightforward to adjust for it.

1. Alice is a historian. She was appointed 19 years ago, when she was in her late 20s. Since then, she has had two children, which caused a temporary drop in her academic productivity, but she has made up for it since, and her career is going well. She has just become a reader, and is told that she is very likely to become a professor in the next two or three years. Her current salary is £56,482 per year and will be £58,172 next year.

Looking into the future, she does indeed become a professor, in 2018, and starts two notches up from the bottom of the professorial salary scale, at £71,506. Looking further into the future, she ends up at the top of Band 1 of the professorial scale, with a salary of £85,354 (plus inflationary increases).

Unfortunately for her, the changes to the scheme are implemented before she is promoted, so the 20 years of contributions that she has by then amassed earn her 20/80, or a quarter, of her reader’s salary of £58,172, per year. That is, it earns her £14,543 per year. (This is not her total pension — just the part of her pension that results from the contributions she has made so far.) Had the scheme not been changed, those contributions would have instead earned her a quarter of her final salary of £85,354, which would work out as £21,438.50 per year. So she has lost nearly £7,000 per year from her pension as a result of the changes. She is destined to live for 25 years after she retires, so her loss works out as £175,000.

2. Bob is also a historian and a good friend of Alice. He was appointed at the same time, is the same age, and has had a very similar career, but he has progressed slightly earlier because he did not have a period of low academic productivity. He became a reader three years ago and will become a professor later this year, starting two notches above the bottom salary level, at £71,506. He too is destined to end his career at the top of professorial Band 1 with a salary of £85,354.

Under the new scheme, his pension contributions up to the time of the change will earn him a quarter of £71,506 per year, or £17,876.50. Under the current scheme, they would have earned him £21,438.50 per year, just as Alice’s would, since their final salaries are destined to be the same. So Bob too has lost out.

However, Bob was luckier than Alice because he was promoted just before the change to the system, as a result of which his salary at the time of the change will be substantially higher than that of Alice. Even though Alice will be promoted soon afterwards, she will end up much worse off than Bob, to the tune of £3,333.50 per year.

3. Carl is a mathematician. He proved some very good results in his early 30s and was promoted to professor at the age of 38. He too has put in 20 years of contributions by the time of the changes, by which time he is at the top of Band 1 with a salary of £85,354. Unfortunately, soon after he became a professor, he burnt out somewhat, never quite matching the achievements of his youth, so his salary is not going to increase any further. So for him the changes to the system make no difference: his current salary is is final salary. As with both Alice and Bob, under the current system his contributions would earn him £21,438.50. But for Carl they will earn him £21,438.50 under the new system as well.

There are two general points I want to make with these examples. The first is that the changes amount to the breaking of an agreement. We were not obliged to take out a pension with USS, but were told that it was crazy not to do so because the payout was based on our final salary. I started my pension late (out of sheer stupidity, but that’s another story) and decided that at considerable expense (because there was not an accompanying employers’ contribution) I would make additional voluntary contributions. When I was deciding to do this, it was explained to me that each year I bought would add one 80th of my final salary to my pension. I am on a salary scale and have not reached the top of it, so if the USS make the proposed changes then they will be reneging on that agreement.

Is this legal? Here again is what they said.

It is important to note that the pension rights you have already earned are protected by law and in the scheme rules; the proposed changes will only affect the pension benefits that you will be able to build up in the future if the changes are implemented as proposed.

A lot depends on what is meant by “the pension rights you have already earned”. I would understand that to mean my final salary multiplied by the number of years I have contributed to the scheme divided by 80, since that is what I was told I would be getting for the money I have paid in so far. However, I think it may be that in law what I have already earned is what I could take away if I left the scheme now, which would be based on my current salary, and that part of “building up in the future” is sticking around in Cambridge while my salary increases. If anybody knows the answer to this legal question, I would be very interested. I have tried to find out by looking at the Pension Schemes Act 1993, and in particular Chapter 4, but it is pretty impenetrable. (Lawyers often claim that this impenetrability is necessary in order to avoid ambiguity, but in this instance it seems to have the opposite effect.)

But even if it turns out that it is not illegal for USS to interpret “the pension rights you have already earned” in this way, it is quite clearly immoral: it is a straightforward breaking of the terms of the agreement I had with them when I decided to take out a USS pension and make additional voluntary contributions. And of course I am far from alone in this respect. I personally don’t expect my final salary to be all that much higher than my current salary, so I probably won’t lose too much, but people whose final salaries are likely to be a lot higher than their current salaries will lose hugely.

The second point is that the way the USS has decided to share out the pain hugely exacerbates unfairnesses that are already present in the system. It is not fair that scientists are typically promoted much earlier than those in the humanities. In many cases it is not fair when men are promoted earlier than women. But at least those who were promoted more slowly could console themselves with the thought that they would probably catch up eventually, and that their pensions would therefore be comparable. If the changes come into effect, then as the examples above illustrate, if two people are in mid career at the time of the changes and are destined to reach the same final salary, but one has been promoted more than the other at the time of the changes, then the first person will end up not just with all that extra salary as at present but also with a substantially higher pension.

There is a mathematical point to make here that applies to many different policies. It is very wrong if the effect of the policy does not depend roughly continuously on somebody’s circumstances. But if you belong to the final-salary section and are up for promotion soon, you had better hope that you get promoted just before the change rather than just after it, since the accumulated difference it will make to your pension will be very large, even though the difference to your career progression will be small.

If all this bothers you, please do two things. First, alert your colleagues to what is going on and to what is wrong with it. Secondly, consider signing a petition that has been set up to oppose the changes.

Update. There are two further points that have come to my attention that mean that the situation is worse than I described it. The first is that I forgot to mention the lump sum that one receives on retirement. This is worth three times one’s annual pension, so for each of Alice, Bob and Carl, what they stand to lose from the lump sum under the new system is three quarters of the difference between their current salary and their final salary. Thus, Alice loses around £21,000 from her lump sum, while Carl loses nothing from his.

However, it turns out that Carl is not quite as fortunate as I claimed above, owing to a further consideration that I did not know about, which is that academic salaries tend to rise faster than inflation. I don’t mean that the salary of any one individual rises faster as a result of salary increments. I mean that if you take the salary at a fixed place in the salary scale, then that tends to rise faster than inflation. So although Carl will remain on the same point at the top of Band 1 for the rest of his career, his salary is likely to be significantly higher in real terms when he retires than it is now. I am told that it is quite usual for salaries to go up by at least 1% more than inflation, so in 20 years’ time this could make a big difference. This second consideration makes the situation worse for Alice and Bob by the same amount that it does for Carl.

23 Responses to “USS changes — don’t be fooled”

  1. Chris Says:

    This would suggest that, for anyone in the first half of their careers (earning less than their anticipated career-average salary), the final salary scheme provides a lesser pension, at a greater cost (7.5% vs 6.5%) than the career revalued scheme.

  2. Keith Horner Says:

    Totally agree. You make good points.
    I took out an “added years” contract some years ago. The word was “contract”, which seems legal to me. Under the proposed changes, they will be offering “one off” opportunity to carry this on, but it will be based on the salary at April 2016 ( upgraded for CPI), not my actual final pensionable salary. The cost, however, of the added years contract seems as though it will continue to be based on current salary. Seems to me that the contract is being broken by them. Worth a challenge, I think.

  3. Bobby Says:

    You arre right that USS is breaking at least a moral contract.

    Your examples however also show other things.

    1) A final salary scheme benefits some people hugely (and that necessarily has to come at the expense of others). A career average scheme seems much fairer. Of course instead of “one 80th of your final salary” it shouldn’t become “one 80th of your average salary”. It is possible to do a calculation to determine which number gives an equivalent rate to “one 80th of your final salary” for the “average person”. Apparently the number which USS proposes is worse than that and this is another way in which the new scheme will be worse.

    2) Carl should be demoted.

  4. ABC fan Says:

    It appears quite likely that these contracts should never have been agreed to in the first place – the fact that “we were told that it was crazy not to [take out the USS pension]” suggests that the terms were unrealistically generous. If it sounds too good to be true, it probably is.

    Now in a mathematically continuous universe, the remedy would be to make the terms somewhat less generous for everyone, including those already receiving a pension which is unsustainably high.

    But in a world dominated by lawyers, even contracts based on flawed arithmetic have to be honoured. With the likely consequence that USS would become insolvent. If insolvency can already be anticipated, it would not be fair (nor, in my extremely limited understanding of the law, legal) to continue paying everyone at 100% until there is no money left. Thus, USS should be closed now and negotiate with all its creditors, including current pensioners, and might even reach a “continuous” solution.

    However, that is also unlikely to happen. Instead, USS would like to continue accepting new money under far less favourable terms and use excess returns (relative to those less favourable promises) to avoid insolvency. Both the USS proposal and modifications along the lines you have sketched will effectively compel younger contributors to subsidize unsustainably generous promises made in the past.

    I agree about the desirability of a final-salary pension scheme, though, particularly with a view to the unfairness of salary progression (which in itself is unfair – why didn’t Carl earn most money in his early 30s, but had to wait to become anointed professor and then promoted by virtue of the passage of time?).

    If one wanted to retain a final-salary scheme, perhaps it would be easiest to adjust the multiplier: perhaps it would work at 1/100 rather than 1/80?

  5. Ivan Says:

    To understand the exact impact of the proposed changes on your benefits, you would likely need to speak to an actuarial consultant. Accrued pension over the course of a career is generally composed of multiple time segments, each with their own legal environment, guarantees and restrictions. Hence, there is probably no simple answer to the question of what your protected pension rights are and what exactly the Scheme can or cannot pull from underneath you.

    The actuaries advising USS appear to be Mercer, perhaps you can get in touch with them directly (Ali Tayyebi, Four Brindleyplace, Birmingham, B1 2JQ, +44 121 631 3343), or go through the Trustees of the Scheme, who will likely redirect you to the actuaries for any questions regarding benefit calculations.

    Click to access Actuarial%20Report%20as%20at%20March%202013.pdf

    For something more vexing, note the absurdly large volatility in the Scheme’s funding from page 10 – the deficit of 11.5bn (which these proposed changes are supposed to address) shrinks by itself to 7.9bn over the course of the next 3 months. The fixed interest gilt yields used to calculate the net present value of future liabilities are currently even lower than 2013, so the deficit number must be pretty enormous right now. It would seem short-sighted that this number be used as a basis for long-term policy setting, and yet here we are. It clearly does not represent any realistic financial future – only if no new members joined ever again and all old members immediately stopped paying contributions forever would these assets need to be matched against all future liabilities. Also noticably absent are any examples of a pension scheme going the other way and offering to improve future benefits when the market conditions turn in their favour and the fund creates a surplus.

  6. Alex Davies Says:

    On “the pension rights you have already earned” – there’s a section in the Pensions Act 2004 which looks like it deals with this.

    67A (7) – “At any time when the pensionable service of a member of an occupational pension scheme is continuing, his subsisting rights [i.e. his rights today] are to be determined as if he had opted, immediately before that time, to terminate that service.”

    This suggests that the changes are legally correct… which is unsurprising given the expense that will have gone into drafting them. Being morally fair is a different matter.

  7. Matthew Shaw Says:

    What about those earning over £55000 paying into a pension scheme for their entire salary, but only accruing pension rights up to £55000. How is that right or legal? Or have I missed something?

  8. Richard Baron Says:

    I like the continuity criterion of fairness, but wonder how widely it really applies. There may be an argument that it should only be viewed as a very strong constraint in a world in which everything is continuous – for example, a world in which no-one’s salary suddenly jumps because they get promoted. If one could argue that, then the people about to be promoted might not be able to argue that the mere discontinuity in pension treatment was, simply by virtue of its discontinuity, grossly unfair.

    If one did pursue the continuity criterion (in areas in which there might be no discontinuity in the life of the affected person), I suppose that mere continuity would not be enough. A very steeply increasing or decreasing function can be almost as unpleasant as a discontinuous one. Perhaps we would want some rule that no current or prospective cash inflow should, at any one time, change at more than (say) twice the rate of any other one affecting the same person in relation to the same employment.

    (Declaration of non-interest: I have never been, and never expect to be, a member of a defined benefit pension scheme.)

  9. John Says:

    Thanks Tim. Good job. A similar, but more detailed, analysis has already been carefully done by UCU. They even have a rough pension calculator on their website so that you can work out how you will lose out. See:

    We should all join UCU and support their campaign too.

    My wife is a professor enrolled in USS. I work in a University, am also a professor, and earn about the same as my wife, but I am employed by the Medical Research Council and enrolled in the MRC pension scheme. The MRC scheme is essentially identical to the USS scheme in terms of benefits and costs. The MRC scheme is much smaller than the USS one, and so might be expected to have similar problems, if not worse. Is this the case? No.

    Although the MRC scheme took a hit around 2007-9, and despite a cautious investment profile, it bounced back well as the stockmarket rose (after all, fluctuation is precisely what stockmarkets are supposed to do and pension funds normally plan for these events). Moreover, I get a clear and concise annual report on the MRC scheme, which shows that the last full actuarial valuation showed it is fully funded and in a strong financial position (assets at 31/12/13 were 118% of liabilities, up from 110% at 31/12/10). There have been no hints of plans to alter the final salary scheme arrangements. My wife does not receive a similar annual report from USS.

    One can ask:
    1) is the USS scheme really so under-funded as is claimed, or are there vested interests that are eager to use the excuse of the Crash to close out the scheme unnecessarily?
    2) if so, what might those interests be?
    3) if the USS scheme is indeed underfunded, who made the bad investment decisions that led to the problems?
    4) should members have confidence in the USS management/Trustees going forward? If not, how can they act to improve things?
    5) why does USS not report its financial position clearly, succinctly and annually to its members?

    I have also heard that several top Universities, as institutions, have publicly expressed their opposition to the USS changes, but that several other top Universities have not. Can anyone shed light on why all the employers are not taking the same line?

  10. Patrick Says:

    An academic under the old scheme is unlikely to have contributed anything like the cost of purchasing a comparable annuity to the USS scheme. This is unsustainable, and a change is necessary.

    The inequalities discussed above pale into comparison when you consider those who will bear the costs if this petition is upheld: young academics currently struggling to find employment. Salaries and job security have been eroded since the financial collapse. Our generation will work longer and retire on less than those the current changes effect – whether the petition is successful or not. If we ever manage to secure permanent, pensionable jobs at all.

  11. Eric Says:

    The USS “benefits” modeller is up and running now ( to compare your existing versus proposed pension scheme.

    Shockingly, for me (mid-career person), there is a 20% reduction in the annual pension at retirement and I will have to pay 10% more towards my pension per month as well !!

    What a joke, a very poor one ,grrrr !!!!

  12. William Says:

    I agree with your opinions. I don’t think that there are any benefits from the USS changes.

  13. Dennis Leech Says:

    The UCU commissioned its own report on USS from a top firm of actuaries who actually still believe in defined benefit pensions. Their report makes interesting reading: .

    It is important to understand that the issue is as much to do with the methodology being used to value the fund as it is to do with increased life expectancy or salaries. It is not poor investment decisions but the absurd method used to value liabilities. It uses gilt rates to discount pensions and when they are as low as they are today (due to the BoE Quantitative Easing policy) the liabilities balloon – a lot like what happens when you divide by a number very close to zero. This is the source of the large deficit and its volatility threat to pensions. And it is getting worse – don’t expect the JNC proposals to be the last – there is another valuation in three years time.

    Also there are many actuaries and trustees (including we are told most of the current USS trustees, especially the independent ones who have been co-opted to the board as pension experts) who see defined benefit pensions as out-dated relics from the past and expect them all to be closed. And they do not question the flawed methodology.

    The trustees have been making assumptions as unfavourable as possible to the survival of the scheme. Also they are assuming it will not survive after 17 years because the support of universities after then cannot be relied on (radical uncertainty). So the scheme has to be got ready to close by then – hence the absurd de-risking policy which involves deliberately not seeking to make the best return on investments in case that exposes the scheme to risk.

  14. A mathematician analyzes the bad news about pensions | Mathematics without Apologies, by Michael Harris Says:

    […] blog to check on the last two posts about the Elsevier boycott, and discovered that his most recent post is about how the university pension scheme in Britain has announced a unilateral change in the way […]

  15. Luke Says:

    I’m in what I assume is a fairly unusual position for readers of this blog: I was once a combinatorialist but these days I’m a chartered accountant and audit the accounts of a number of large companies with pension schemes.

    The thought I would like to contribute is that the deficit is almost certainly massively worse than the valuation has stated. There are two ways you can work out what position a pension scheme is in. The approach they’ve taken (and are required to take in law) is to calculate the pension scheme’s position under a set of accounting rules called FRS 17. The other approach is to try and sell the pension. That is, to find an insurance company who’ll take on the obligation to pay all the members’ pensions when they retire. What you’d like if the accounting rules work well is that these give similar answers. At present however you’ll universally find that the second approach will give you a much worse position. Unfortunately second approach is the accurate one: using the accounting rules is easy, cheap and predictable but the amount that an investor with money resting on the result will actually pay is a much better guideline.

    The good news is that the pension you’ll receive from your contributions to this scheme will be greater than anything else you could have received from the money you contributed.

    The bad news is you’re unlikely to get what you were promised. In general the final salary pensions promised to people are so much bigger than the savings made by employers and employees to pay for them that something has to give. If the government accidentally promised one person a million pounds then you’d say they’re duty bound to keep their promise. If the government accidentally promised hundreds of thousands of people one million pounds then there’s a problem.

    • Dennis Leech Says:

      You are very wrong. It is NOT true that there is a legal requirement to use the accounting rule FRS17. That in fact is very misleading because it uses a gilts discount rate to value liabilities. Pension schemes (like USS) do not invest exclusively or event mainly in gilts but in return assets such as equities. Equities make a much higher return (in the case of USS in excess of 8 percent). OTOH gilts are currently at the lowest rate ever. Using a gilts discount rate makes liabilities unrealistically high – it massively overestimates them. Better to use the internal rate of return.

      The law relating to pensions gives trustees wide discretion in choice of discount rate. They do NOT have to use FRS17.

      It is highly questionable whether USS is in deficit or if it is by how much. Have a look at this article which questions the whole methodology for valuing pension schemes:

      Also have a look at this article by a firm of actuaries who believe in DB pensions instead of doom mongers like you:

      The point is that pensions are in better shape if valued on an ongoing basis than if valued using short term risk and expectations of closing.

      Mathematicians have a lot to answer for by ignoring the economics that underlies pensions. Sometimes they talk as if the world is going to cease. The economy is going to continue to make profits from which pension funds can benefit and the universities that are members of USS are going to continue in existence on an ongoing basis.

  16. Dennis Leech Says:

    Your argument is lacking in analysis. FRS17: first the economics underlying it is highly dubious; second it does not in itself provide a valuation – that requires the trustees to make many assumptions and there is a wide range of valuations, some of which give a surplus. The most important of these assumptions is how long the university sector will be able to continue to provide pensions. The valuation provided by the trustees assume a short period of less than 20 years – following private sector norms – but this is absurd to apply to the ‘old’ universities which make up the USS employers and are not going to go bankrupt soon. Independent analysis by First Actuarial has shown that there is not necessarily a deficit if reasonable assumptions are made.

  17. David gill Says:

    You don’t mention that for the contribution years 2011-16, the inflation adjustment is capped at 5%. So if inflation ever rises above 5%, we won’t even get our current salaries in real terms.

  18. George Says:

    Colleagues, Do you remember when employers took a pension holiday and not contributed to your pension plan in the late 80’s why are they not happy to mitigate the damage now?? My big question:
    Is the USS going to be around to pay my pension in 10 years time or I am going to be in line for food banks??
    God help us from another financial meltdown…it is coming…

  19. Alan Says:

    Contractual Pension Age/Date is no longer recognised by USS since the 2011 changes and it is now left to the employers to deal with any actuarial reduction that USS may apply if a member retires on their CPA/D and that CPA/D is earlier than the USS Normal Retirement Age. In which contract was CPA defined (employee contract or between employer and USS) and is meeting the actuarial reduction now discretionary on the part of the employer or do they still have a contractual obligation?

  20. Philip K Says:

    It is a great shame that there seems no-one to call upon to advise in detail on individual cases.

  21. Alfred Vella Says:

    The government, and the USS are trying to force people to take risks rather than contributing to pensions with fixed returns everyone is pushed towards gambling on dodgy financial instruments. Unfortunately, politicians are educated to bluff and to bully rather than to apply logic and fairness. Perhaps in 40 or so years, when current newcomers to the pension arrangements are retiring, these new pensioners will take some stronger actions to stop future generations from being robbed.

  22. Spring Roberts Says:

    There are lots of inequalities, and the whole thing stinks.
    I’d like to consider Ernie, Flo and George. Ernie Flo and George each pay £1000pcm to rent their homes and are struggling to get a mortgage because of rising house prices and short-term academic contracts. Their older friends bought when house prices were lower, and started paying mortgages off earlier: even benefiting from low interest rates (while the pension pot withered for the same reason). Having paid off the mortgage over 25 years, they could be 11k better off a year than anyone still paying rent/mortgage from their pensions. (I’m allowing a random 1k a year for repairs.)
    In the meantime, Ernie Flo and George have been over-paying compared with the benefits they are due to receive, supporting the final-salary promises made to longer-standing USS members they themselves will never benefit from them. Woe to Ernie Flo and George.

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