Barnett Waddingham: Pension costs universities to soar

16 April 2015

Universities may find their pension liabilities soar in the coming months, warns Barnett Waddingham in a  new report. According to the business advisors, the recent fall in corporate bond yield may push up liabilities by between 20% and 25%.

The survey, titled ‘Accounting for pension costs’, is based on data in the published accounts of universities with financial years that ended on 31 July 2014. The figures in this survey are based on a sample of 35 universities whose accounts showed they operate Self Administered Trusts (SATs).

The analysis reveals that the changes in SAT pension deficit as a proportion of university of net assets hasn’t changed between 2013 and 2014 – with the average at 8%.

SAT pension deficit as a proportion of university net assets

In terms of contribution by universities to the pension schemes, 2014 continued to show relative stability compared to 2013. 2014 contributions for SATs amounted to 3.6% of total staff costs, whereas in 2013 the average was 3.3% of total staff costs. While for Universities Superannuation Scheme (USS) contributions as a proportion of total staff costs have increased slightly in 2014 at 10.2%, whereas in 2013 the average was 10.0%. Across the surveyed universities however, the percentage varied considerably.

SAT and USS employer contributions as a proportion of total staff costs

The FRS17 funding level for different universities’ pension schemes has decreased slightly, from 83% in 2013 to 81% in 2014. With the principal reason for the reduction in funding down to decreases in bond yields, however, this was offset according to the report by ‘by strong asset performance and deficit contributions paid by the universities.’

FRS17 funding level as at 31 July 2014

Equity and Bond returns
According to the respondents, the expected return on equities decreased slightly to 6.9% in 2014 compared to 7% in 2013. However, the distribution of returns has stabilised near the average in 2014 compared to 2013. The ‘risk premium’ on equity investments stood at around 3.6% above the average expected return on long-dated gilts of 3.3% per annum – with the average expected bond return was 4.1% per annum, which is, according to the survey, “more reflective of the yield on long-dated corporate bonds rather than long-dated gilts at the year-end.” With the equity weighting of total assets down slightly from 62% in 2013 to 58% in 2014.

Expected return on equities

Soaring costs
While the 2014 survey results show that there is not a great deal of change between the assumptions and the fundamentals affecting the schemes between 2013 and 2014 – and that there is therefore considerable stability in the sector – a recently released press release from Barnett Waddingham warns that due to a significant drop in yields on AA rated corporate bonds since the survey, SAT accounting liabilities could increase by between 20% and 25%.

Nick Griggs, Partner at Barnett Waddingham explains: “Although asset classes have seen positive returns, they are unlikely to have kept up with the growth in liabilities. If yields remain at current levels, Universities can expect to see increases in their accounting liabilities of between 20% and 25% as a result of the fall in bond yields alone. The impact will vary according to the specific circumstances of the SAT, including the duration of the SAT’s liabilities. SATs with large exposures to UK equities and benefits which are not linked to inflation are likely to have fared the worst. We expect that Universities will want to pay closer attention to the assumptions they adopt for pensions accounting at 31 July to mitigate the effect of an increase in deficit.”

Griggs suggests that universities continue to monitor the situation, with uncertainties in economic outlook further complicating the funding positions and investment strategies of the schemes. According to the consultancy, the high average exposure to equities for SATs meaning that market volatility brings with it continued significant risks for the pots.