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.