The overwhelming case for retaining current USS pension benefits until April 2023
The modest and affordable rise in contributions for 12 months is a small price to pay to avoid large cuts to pensions
In this post, I show how impressive the rate of return is on the modest increases in member contributions for 12 months that would be sufficient to retain current benefits until April 2023. I make the case in Section II that, for most members, these higher contributions are well worth the losses they would avert. Section IIa illustrates the benefits to members earning £40,000 or less and Section IIb to members earning £60,000. In Section III, I demonstrate that the increases in employer contributions necessary to retain current benefits are within their budgets. I turn first, in Section I, to some background.
I. Background
Member contributions are currently 9.8% and employer contributions 21.4%. If UUK’s cuts are imposed from April 2022, contributions will remain at these levels. It is, however, possible to avoid these cuts and retain current benefits for another year (i.e., until April 2023), at the following increased rates:
- 11% member and 23.7% employer contributions for the first six months of 2022–23 (1 April to 30 September 2022)
- 11.8% member and 25.2% employer contributions for the second six months of 2022–23 (1 October 2022 to 31 March 2023)
These latter rates from 1 October — rather than the higher “fall-back” rates of 12.9% for members and 27.1% for employers listed in the consultation material — can be secured so long as employers agree to provide the same level of covenant support for current benefits as they have agreed to provide for their own cuts. Prime among such support is the making good on their “longer-term commitments” not to abandon the scheme, which USS “assumed, in good faith, would follow” the close of the 2018 valuation, where such commitment was deemed necessary to undo the damage to the covenant caused by the departure of one of their own members: Trinity College Cambridge.
To date, UUK has endorsed adequate covenant support only for their own proposals. The upshot has been a ramping up of the cost of alternatives to their cuts, including both UCU’s proposals that were formally tabled for JNC discussion in August and the retention of current benefits as the default “fall-back” in the absence of any changes to benefits.
UCU has received specialist legal advice that such selective covenant support may be in unlawful breach of the scheme’s rules. Moreover, one prominent employer has already called on UUK to seek the same high level of covenant support for proposals that originate from UCU as for their own proposals.
II. The cuts to benefits are much worse than the increases in member contributions
IIa. The case of 40-year-old members earning £40,000 (or less)
Figure 1 illustrates the favourable return on the increases in contributions for 40-year-old members now earning £40,000. To retain current benefits — which are represented by the horizontal blue line — each member would need to provide an additional £640 in contributions over 12 months, which would translate into a net reduction in pay of only £427 after savings in income tax and national insurance are taken into account. This averages out to a modest decrease in net take-home pay of £36 per month for 12 months. These deductions would spare members the imposition of UUK’s large cut in pension accrual throughout the 2022–23 tax year. This cut is modelled by the lower and downwardly sloping orange line.
It is important to stress that this modelling of both current benefits and UUK’s cuts is based entirely on assumptions that UUK has approved, and USS has deemed reasonable, for the formal statutory consultation of members.
The blue dots represent the guaranteed pension income 40-year-old members earning £40,000 would receive during each year of their retirement, for as long as they live, in exchange for the decrease in net pay of £36 per month in 2022–23. The value of the pension purchased by these contributions is simply £40,000 multiplied by the current accrual rate of 1/75, or £533 per annum.
All points on the graph are in today’s pounds — i.e., ‘real’ inflation-adjusted terms. Given the high degree of inflation protection members currently enjoy, the modelling assumes that these members’ pensions will be revalued upwards in nominal terms for each year of their lives, to fully keep up with CPI increases in inflation. That is why the blue line is perfectly horizontal.
The extra contributions spare these members an immediate 12% cut in the value of their pension on account of UUK’s reduction in the accrual rate from 1/75th of the value of each year’s salary to 1/85th. The lower accrual rate reduces the annual pension from £533 to £471 (i.e., £40k/85).
The extra contributions also spare members decades of further erosion in the value of their pensions by inflation, on account of UUK’s 2.5% cap on CPI revaluation. This erosion is represented by the downward slope of the orange line. On the default assumptions of the USS consultation modeller which UUK approved, the initial 12% cut is expected to grow into a 22% cut down to £414 in the first year these members draw pensions at retirement age 66, and into a 30% cut down to £376 by age 86. (See red circles.)
The graph also indicates the following: the extra £640 in contributions would avert a total loss, in today’s pounds, of £3,270, consisting of a £2,910 loss in pension income from ages 66 to 86 plus a £360 loss in the 3x lump sum of tax-free cash at retirement. The rate of return on this £640 is CPI+4.86% per annum, which is excellent in comparison with alternative possible investments of this sum of money.
These monetary values will be of the same proportions for anyone of the same age who is paid less than £40,000. For a 40 year old who is paid £30,000, for example, all the above values indicated in pounds should be reduced by 25%. The rate of return on the extra contributions, as well as the 22% and 30% reduction in pension value at ages 66 and 86, remain unchanged for lower salaries.
As can be inferred from the downward slope of the orange line in Figure 1, the erosion by inflation in the value of member pensions at ages 66 and 86 will be greater, the younger one is. For those paid £40,000 or less who are 30 years old, for example, the reduction in the value of their pension at ages 66 and 86 will be 26% and 33% respectively. Hence, the younger one is, the greater the losses in pension income one averts by paying a modest extra sum to retain current benefits.
The downward slope of the orange line models the default assumption that CPI inflation runs at 2.5% per annum on average over the long term. This is USS’s assumed long term rate as at 31 March 2021.
In December, the annual rate of CPI inflation hit a 30-year high of 5.4%. Although long-term market inflation expectations are lower than this, they have been higher than 3% in recent months. If one slightly adjusts the CPI slider on the consultation modeller upward to 3.0% to capture these higher inflation expectations, the loss in the value of pensions for those now age 40 rises from 22% to 32% at age 66 and from 30% to 44% by age 86. (See Figure 2 below.) In this scenario, the expected rate of return on the £640 increase in contributions required to maintain the current level of inflation protection is a phenomenal CPI+6% per annum.
IIb. The case of 40-year-old members earning £60,000
So far we have been modelling the effects of only two of the three elements of UUK’s cuts: (1) the reduction in the accrual rate from 1/75 to 1/85 and (2) the 2.5% cap on inflation revaluation. UUK’s proposals also involve (3) the lowering of the salary threshold between defined benefit (DB) and defined contribution (DC) from £60,000 to £40,000. As I shall demonstrate in this section, the detrimental impact of UUK’s cuts is greater on earnings between £40k and £60k than it is on earnings below £40k. Consider Figure 3 below, which models the effect of UUK’s cuts on 40-year-old members now earning £60,000.
For these members, UUK’s cuts immediately reduce the value of their DB pension accrual by 41%: from £800 per annum (£60k/75) down to the same £471 p.a. that members earning £40k receive (£40k/85). This reduction is owing to the double whammy of UUK’s worsening of the accrual rate and their lowering of the salary threshold. These members subsequently experience further erosion in the value of their pension by inflation, at the same downwardly sloping rate of the orange line as the erosion that members earning £40k suffer.
The reduction in the DB/DC salary threshold is partially compensated by contributions into a DC pension pot equal to 20% of earnings between £40k and £60k. But this compensation is only partial. When the contributions are converted at retirement into an annuity that replicates the current DB pension (as represented by the grey line with triangles), these members experience a 30% reduction in the overall value of their pension at age 66 and a 34% reduction at age 86. These losses are greater than the analogous losses of 22% and 30% respectively for members earning £40k (see Figure 1 above).
The rate of return on the extra £960 in contributions for members earning £60k to retain current benefits (as represented by the horizontal purple line) is an excellent CPI+5.6% per annum.
Moreover, the actual deduction in the net pay of these members would be only £545 rather than £960 over the year, once savings in income tax and NI are taken into account. This averages out to a net deduction in take-home pay of only £45 a month.
Figure 3 is based on the default inflation assumption of 2.5%. Figure 4 below illustrates the loss to 40-year-old members earning £60k when we move the slider up to a CPI rate of 3%.
Here the overall reductions of 36% and 44% in the value of their pensions at ages 66 and 86 are somewhat worse than the analogous reductions (see Figure 2) for a member earning £40k. The rate of return on the extra £960 in contributions is a staggering CPI+6.3% per annum in this scenario.
III. The increases in employer contributions to retain current benefits are within their budgets
For the 2021–22 fiscal year, employers budgeted for a 2.6 percentage point increase in their contributions from 21.1% to 23.7% in October 2021, as this is the rate at which contributions were then scheduled to rise under the last valuation. Therefore the 23.7% level of employer contributions required to retain current benefits from 1 April to 30 September 2022 is no greater than what employers have already budgeted. Moreover, this 23.7% level is only slightly higher than the 23.68% employer contribution that the generally less financially well off post-92 universities pay into the Teachers Pension Scheme.
By means of their resolution to cut member pensions, employers have managed to limit the scheduled and already budgeted 2.6 point rise to a minuscule 0.3 (i.e., to 21.4%), thereby reaping a windfall surplus. The further 2.3 point rise in contributions employers have avoided over the six months of 1 October 2021 to 31 March 2022 is greater than the 1.5 point rise from 23.7% to 25.2% that would be needed for the six months of 1 October 2022 to 31 March 2023 to retain current benefits throughout that period. Employers would therefore be quids in, relative to what they have already budgeted for, if they pay that which is necessary to retain current benefits until April 2023.
Conclusion
In this post, I have demonstrated the excellent ‘value for money’ for members, and the affordability for employers, of retaining current benefits until April 2023, as an alternative to UUK’s cuts whose severity is vividly illustrated by the four graphs above. Such an arrangement will also provide time to reach a negotiated settlement on a reasonably valued package of benefits and contributions beyond April 2023. In the light of the modest and affordable increases in contributions required to retain current benefits for a further year, the cuts that UUK is attempting to impose from this April are gratuitously harsh. If employers nevertheless persists in trying to push these large cuts through, because they refuse to pay a penny more than their current contribution rate of 21.4%, it will become clear that employers, rather than the union, are the ones who are in the fanatical grip of an ideology of ‘no detriment’.
A spreadsheet with the data and calculations for Section IIa (members earning £40k) is linked here and for Section IIb (members earning £60k) is linked here. Thanks to Jackie Grant of the University of Sussex for designing the graphs in this post, which greatly improve on, and add to, the rudimentary graphs I posted in this thread.
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