Standalone university pension schemes for non-academic support staff had a combined deficit of £1.1billion at 31 July 2011 according to data released by Mercer. Mercer has also found that university pension scheme life expectancy assumptions vary by up to seven years.
Mercer’s FRS 17 survey looked at the assumptions used by 36 universities with their own pension schemes for support staff (sometime called “self-administered trusts” or “SATs”) to assess the size of their pension deficits at 31 July 2011 and the pension costs that have to be put though their accounts each year. The smallest scheme in the survey has assets of just £6m and a deficit less than £1m: the largest scheme has assets of £360m with a deficit over £200m. The data also showed that the assumption for further life expectancy for a man aged 65 ranged from 17 years to 24 years.
While deficits are calculated at a particular point in time and can vary from one month to the next, the figures do highlight the significance of these schemes on university finances and the importance of pension scheme risk management. The life expectancy findings are interesting as, unlike many private companies, the demographic profile of SATS scheme members is broadly similar so unless some form of university-specific mortality analysis has been carried to justify the differences some universities may eventually have to revise their assumptions. This could lead to a direct increase in pension liabilities for some (while others may find their measurement has been relatively conservative).
Mike Harrison, a Principal in Mercer’s Higher Education Pensions Group, commented: "Some of our university clients have done full mortality experience analysis which means that they can have more comfort that their assumptions are appropriate. However, others haven’t. You would expect to see some variety in the assumptions as life expectancy varies across the country. However, a lot of that difference is due to different mixes of socio-economic groups, so a seven year gap between the shortest and longest life expectancy for employees working in similar roles in the same sector is a bit higher than we’d expect. We’d advise Finance Directors to conduct a benchmarking exercise.”
The pension figures in the universities’ accounts are created under the UK accounting standard FRS 17. In theory, application of this standard should give a good level of consistency and comparability across the sector. In practice there is a wide range of different assumptions that can be used for reporting purposes which can have a material impact on universities' balance sheets and expense disclosures.
Assumptions
In addition to the differences in life expectancy assumptions, Mercer’s analysis showed that across the sector the assumption used for the “discount rate” – a critical measure as it is used to convert all future cashflows into a current value or “liability” - ranged from 5.2% per annum through to 5.65% per annum. Some of the difference could be due to schemes having different maturities, but, for a typical pension scheme, the difference between a 5.2% discount rate and a 5.65% rate would be an extra 10% on a pension scheme’s liabilities or £14million for an average university scheme with liabilities of £140 million.
Other assumptions are also diverse. The gap assumed between future RPI increases (the old measure that used to be used to determine pension increases in much of the Higher Education sector) and CPI increases (the new measure which is typically - but not always - lower) varied between 0.5% per annum and 1.0% per annum.
Mr Harrison added, “All else being equal this difference alone could mean that for exactly the same benefit promise one university is holding reserves 10% higher than another.”
Mercer’s report also showed that real salary growth assumptions are very varied despite the prevalence of national bargaining in the sector. Future salary increase assumptions vary from 0% per annum to 1.5% per annum in excess of RPI.
Of course one assumption being more conservative than the average might be cancelled out by another assumption being less conservative. To allow for this, Mercer created a "relative level of prudence" scale that takes into account all the key assumptions. According to Mercer’s survey the university adopting the most conservative set of assumptions overall is putting a value on its pension liabilities 36% higher than the university with the least conservative set of assumptions.
“This is around £50 million on a typical scheme with liabilities of £140 million,” said Mr Harrison. “While there might be good reasons for assumptions to be at these levels, the financial impact of the assumptions that are set are significant.”
Investment Strategy
A few universities - or more specifically the Trustee Boards of their pension schemes - clearly remain bullish about the outlook for returns from stocks, shares and other growth assets. Some schemes are 100% invested in these asset classes while others hold less than 50% with the balance being in government gilts and corporate bonds.
Mr Harrison commented: "Pension funding is a long-term game and it’s likely that equity and other growth assets will outperform gilts and corporate bonds over any reasonable time period. This is an indication that trustees in the sector are confident that their employer is able and willing to stand behind the scheme and will be there to top up the difference if these investments underperform.”
“Nevertheless, schemes invested heavily in growth assets will have been on a bit of a roller-coaster ride over the last few years. We are seeing some clients rigorously looking at derisking their schemes, as well as considering more innovative non-cash funding options.”
Funding levels
FRS17 funding levels varied across the sector at 31 July 2011 from 61% to 98%. The median funding level across the 36 schemes surveyed was 81%. A high funding level might indicate a less cautious set of assumptions than average instead of (or as well as) a genuinely strong funding level.
“Finance Directors should be concerned if this variety in assumptions is reflected in the assumptions used for determining cash contributions to their schemes without any supporting evidence,” said Mr Harrison. “Different schemes use different assumptions for a variety of good reasons. There is nothing wrong at all with being either at the most cautious or the least cautious edge of the spectrum. However, you should at least know where you are and why you’re there when there’s a multi-million pound issue at stake."
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