Pensions in higher education: what was once a dry subject is becoming bloody. Academics with generous pensions are lining up to defend what has long been considered compensation for a career that is lower paid compared with those in the private sector. There are warnings that the employers will stir up higher education's most acrimonious industrial action ever if they push through unnecessarily radical change. And unions for support staff say that some universities are discriminating against lower-paid female staff by forcing them into cheaper schemes. However, institutions poring over their balance sheets argue that continuing to meet the current costs of the sector's pensions will cause financial crisis. Some employers claim that higher education risks inviting the government to impose downgraded pensions if it cannot reform itself.

A crucial date looms on 7 July when the Joint Negotiating Committee (JNC) of the Universities Superannuation Scheme meets. That meeting could decide the value of the pensions that hundreds of thousands of future academics and senior administrators will receive during retirement.

Despite protracted talks, employers' and members' representatives on the JNC have so far failed to agree on the changes needed to meet cost pressures, such as pensioners living longer. The employers want to close final-salary pensions to new entrants, who would be offered a different type of defined-benefit package, the career-average scheme (see below). The University and College Union, which represents all members of the USS, wants to keep the final-salary scheme going but would ask members to make larger personal contributions.

The independent chair of the JNC, Sir Andrew Cubie, could use his casting vote to push through one side's proposals unless a last-minute compromise is agreed.

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The choice facing Cubie comes with a heavy burden of responsibility. The USS has assets worth nearly ?30 billion and counts 130,000 active members, mainly academics and senior administrators in pre-1992 universities. It is the second-biggest private pension fund in the UK, outranked only by BT's fund.

The gulf separating the employers' and the members' representatives is vast. To one side of Cubie is the Russell Group of large research-intensive universities, which says in the employers' proposals: "Continuing with an unreformed pension scheme could jeopardise the future financial health of the sector." The employers argue that the coalition government will not let any extra funding released in the wake of Lord Browne's review of tuition fees go towards supporting a pension scheme that is seen as "unaffordable".

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To the other side of Cubie, UCU members warn that they will unleash their "most vicious" industrial action ever if changes to the scheme - sometimes described as the "jewel in the crown" for higher education professionals - are forced through on the casting vote without their consent.

Beyond USS, changes are already under way. Several universities have closed to new entrants the final-salary schemes they run for support staff who are not eligible for the USS. The move means that increasing numbers of lower-paid, mainly female staff are being switched to low-return defined-contribution schemes.

And the government will be seeking to cut costs in the public-sector Teachers' Pension Scheme (TPS) and Local Government Pension Scheme (LGPS), which include among their members tens of thousands of staff from post-1992 universities. The USS could be the first battleground in a conflict over public-service pensions as the coalition embarks on drastic cuts in government spending.

So how did universities get to the stage where cherished benefits are under threat? What, if anything, might an angry government do to the sector's pensions if reform is not agreed? Could universities and the unions reach a solution that keeps alive decent pensions?

The USS is generating the most heat in the pensions debate. The employers are smarting after being forced to raise their contribution rate from 14 per cent to 16 per cent last year, to meet the costs associated with the increased longevity of scheme members. That 2 percentage point rise will cost the sector ?110 million every year, they say, on top of the ?750 million they were already paying into the USS annually.

Government funding cuts mean the sector "does not have capacity to absorb increasing pensions costs without reducing staff numbers", the employers say in their proposal to the JNC. Alan Gilbert, vice-chancellor of the University of Manchester, told his board of governors that pension costs were compounding cuts in government funding for higher education and science and research that total around ?1.2 billion so far.

"The regrettable reality was that escalating pension costs could turn out to be just as serious as public spending cuts in their impact on university finances," Professor Gilbert said, according to minutes of a meeting held on 3 March.

Michael MacNeil, the UCU's head of higher education, dismisses such talk of pensions-induced financial meltdown as "nonsense".

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"The reality is that staff salaries and pension costs - as a proportion of university spending - have been declining over the past 20 years; it is not an inability (on the part of employers) to pay more that is the issue, but rather an unwillingness to do so," he says.

The UCU calculates that the employers' proposals to place new entrants on a career-average scheme will mean that a typical new starter lecturer would lose ?1,000 from their pension, compared with the current package of benefits. This would create a "two-tier" system divided between new members on inferior benefits and current members on final salary, the union argues.

Terry McKnight, the UCU's lead negotiator on the USS, cautions that such a move could eventually affect current members, too. "It won't be long before it's brought in for existing members as well," he told the union's higher education conference in May. "That is what we have to guard against."

At the conference, union members approved a motion to start an industrial dispute with the employers "should attempts be made to change the scheme without UCU agreement".

Alan Carr, another UCU negotiator, told a conference fringe meeting that the union must put the pressure on Cubie. "We need to make him aware that if the casting vote were used against us, it would be met by the most vicious campaign of industrial action this union has ever waged," he said.

The union has also said it wants to return to talks with the employers before the crucial meeting.

Paul Marshall, executive director of the 1994 Group of smaller research-intensive universities, argues that if the sector fails to implement reforms, the government will impose a defined-contribution scheme that is sure to be "far, far worse than the offer on the table from the employers".

Discussions with the Browne review panel and with government advisers have pushed home a clear message on pensions, Marshall says.

"They made it absolutely clear to us that any additional resource that is raised through the Browne review is to go directly back into the student experience.

"They will not accept if there is any shadow of a doubt that any additional income will go to what is seen as an unaffordable pension scheme. The government will not allow us to go down that route."

In a recent speech at Oxford Brookes University, David Willetts, the universities and science minister, discussed the need to reform higher education pensions. He said the Labour government failed to press universities to hold down their costs following the injection of extra income from variable top-up fees. "For example, it's very hard asking students to pay higher fees in order to prop up final-salary pension schemes for universities when their own parents have lost theirs," Willetts added.

Marshall, asked about the prospect of industrial action, outlines the gravity of the situation in the USS. "These are issues that are important to the future funding and financing of higher education. This isn't a set of issues where the employers can possibly walk away and think three years of negotiations can come to nothing.

"If it comes to industrial action - and we really hope it doesn't - we must be prepared to ride that out and get a settlement in the long-term interests of the sector."

MacNeil is not swayed by talk of threats of government intervention, saying there is no evidence to suggest that the coalition will force a defined-contribution scheme on the sector. "Given the status of USS as a private, not public, scheme, it would be difficult for the government to impose any such change."

So what exactly is the nature and scale of the problem facing the USS? Mercer, the independent actuary at the scheme's last valuation, delivered a report to the employers and the UCU in March 2009 outlining several "funding pressures".

One of these is the increase in salaries in recent years, which "exceeded expectations" and drove up the cost of pensions. When an individual receives a large pay rise near retirement, the value of that person's final-salary pension is pushed up beyond the value of the contributions he or she has made over a career.

A second pressure on pension schemes is the longer life expectancy of retirees. Mercer says the increase in longevity "may well continue into the future", which would mean benefits are paid out for longer.

The USS also has to comply with the new statutory requirement to be fully funded at its three-yearly valuations. This means it needs to "de-risk" its investments, with the result that it must either seek higher contributions from members or reduce the benefits it pays out to make up the gap left by less volatile but lower-yield investments.

Mercer says the review group, made up of the UCU and the employers, should "discuss changes for the long term that will set the scheme on a secure footing for decades".

There are substantial differences between what was put forward by the Employers Pensions Forum, a group of senior managers that made the formal proposal for their side, and the UCU.

The two sides have differing views on the health of the scheme, which explains their conflicting proposals.

The USS had assets of ?29.7 billion at 31 March, according to internal figures that are the most recent available. Once benefits already promised to members were deducted, the scheme had a deficit of ?3 billion. That calculation is known as the "technical provisions" basis. The scheme's deficit has been shrinking over the past year as the stock market has been rising.

A key test will come on 31 March 2011, when an independent actuary conducts the next external valuation of the scheme. If the valuation finds that the USS is in deficit on technical provisions, the fund will be required to start a recovery plan, which would likely involve higher contributions. But the UCU says the employers admit that there is a chance that the scheme could be in surplus.

In its submission to the JNC, the UCU highlights the scheme's positive cash flow - it is receiving more money from members than it is paying out to pensioners. And higher pay driving up the cost of pensions is no longer an issue, the UCU notes.

The EPF agrees that the scheme is cash-positive, but it argues that the USS will soon "mature" and find itself with more pensioners and the need to shift to lower-risk investments so as to provide greater certainty - bringing a further burden on contributions. On pay, the employers' forum says that although increases on the national pay spine may be flattening out, pensions are still being pushed up by incremental increases.

The UCU says it has the full backing of those it represents. The union recently conducted an online ballot of those of its members who are eligible for the USS. It contacted 35,078 staff, and 21,214 (60.5 per cent) responded. Of those, 96 per cent rejected the employers' proposals and 97 per cent supported the UCU's proposals.

The UCU cited the results as proof that it truly represents scheme members, contrary to the argument of the employers. The EPF said the ballot was flawed.

Was there ever a point in the talks when the two sides could have agreed a deal?

The career-average scheme being proposed by the EPF for new entrants is based on a 1/80th accrual rate, meaning pensioners would receive that portion of their average salary for each year they had worked. That is far less generous than the benefits that existing final-salary members receive, which work out at about a 1/65th basis with a lump sum taken into account.

But at one stage, the EPF offered a 1/60th career-average scheme for all members. Current members would have kept the final-salary benefits accumulated before the change, but benefits after the change would have been calculated on career average. This was rejected by the UCU.

Although MacNeil admits that a career-average basis could reduce the risk from salary volatility, he says: "The UCU made it very clear that it would consider the introduction of career-average only on a cost- and benefit-neutral basis. The employers were not prepared to accept this basis, but rather viewed the introduction of career average as the means by which they could introduce significant benefit cuts."

Reducing costs is certainly an aim of the employers, says Jon Gorringe, a member of both the British Universities Finance Directors Group (BUFDG) and the EPF. He criticises the UCU proposals for their failure to address the possibility that rising pay could lead to future cost increases for the USS.

Damian Docherty, an adviser to the EPF, says the union's plan would leave members exposed to rises in their contribution rate. Rising costs to individual members could mean new academics and administrators are put off joining the scheme. "That is bad for them, it is bad for the pension scheme and it is bad for the sector," he contends.

Asked why he thinks the UCU turned down the better career-average scheme, Docherty says: "It would, I presume, be difficult for them to persuade some members within their executive and community ... They would be the first trade union to accept this kind of modification to a public-services pension."

Ben Thomas, national education officer at Unison, says his union would be much closer to the UCU's proposals than those of the employers.

But he adds: "The main thing is, we would like to see an agreed way forward, rather than two conflicting proposals. We think there was probably an ability to have a compromise between the two."

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Many pensions experts argue that career-average schemes can be fairer than final-salary schemes. The latter bring big benefits for those who gain promotions - such as vice-chancellors - but less for those whose earnings do not vary greatly over their careers. However, the key to any career-average scheme is the accrual rate offered by the employers.

The UCU says in its proposal that it is "leaving open the possibility that there might be circumstances in the future ... where career-average provision might be considered".

During the talks, the employers began to ask how legitimate it was for the UCU to represent all members of the scheme. The USS was opened to non-academic staff in 1999. Not all USS members are UCU members.

Would the UCU consider letting other unions represent members in the scheme? MacNeil points out that the USS was established through an agreement between the Association of University Teachers (now the UCU) and the employers. It is only now, he says, "when the employers want to force through draconian changes that they have discovered a newfound interest in diluting our members' influence in what is, after all, their pension scheme".

As big as it is, the USS is not the only show in town. Outside it, there are other fierce debates raging as universities begin to close their final-salary schemes for support staff.

To grasp what is happening in those schemes requires an understanding of the complex make-up of the sector's pensions system.

"Because there are so many schemes in operation, there is no clear national voice on pensions," Marshall says. "We have ended up in the little bit of a mess we are in at the moment because there hasn't been any leadership from the sector - or from the union side - on having an overall understanding of how pension schemes in higher education work."

At pre-1992 institutions, staff above grades five or six on the national pay spine - mostly academics and senior administrators - may join the USS. Staff below grades five or six are generally eligible for universities' individual self-administered trusts (SATs).

In post-1992 institutions, academics may join the TPS. Non-academic staff are eligible for the LGPS.

The USS was established in 1974 by the AUT, which represented academics in pre-1992 institutions. Post-1992 institutions often grew out of local authority colleges, so had a natural link to public-sector pension funds. In Scotland, academics at post-1992 institutions are generally members of the Scottish Teachers' Superannuation Scheme.

The government has announced a review of all public-sector pension schemes, which will include the final-salary TPS and LGPS. Whereas the USS is funded from its own pot of assets built through contributions, the TPS is an unfunded scheme covered by the taxpayer. About 10 per cent of members of both the TPS and the LGPS come from higher education.

Vice-chancellors are unhappy about the management of some schemes in the LGPS, with some employer contribution rates running as high as 20 per cent. There is "some concern about the limited influence that the sector has on these schemes (LGPS and TPS)", pensions expert Peter Thompson said in a 2008 report.

Within the sector, there is particular concern about the SATs, of which there are about 40. Marshall says many believe the volatility of the SATs is "completely unacceptable", warning that deficits are "rising very dramatically".

The universities of Cambridge and Edinburgh reported deficits of ?182.7 million and ?101.6 million on their respective funds at July 2009. Cambridge's employer contribution rate rose to 23.7 per cent and Edinburgh's climbed to 20.3 per cent.

The sector had a combined deficit of ?3.5 billion in the SATs and the LGPS at July 2009, up from ?2.4 billion the previous year, according to the ³ÉÈËVRÊÓƵ Funding Council for England.

Warwick, Sussex and Birmingham are among the universities to have closed final-salary schemes in their SATs, with new entrants put on cheaper defined-contribution schemes. Edinburgh is consulting on plans to switch from final-salary to career-average.

The unions Unison and Unite have led opposition to defined-contribution schemes. Thomas says institutions seem "unwilling to work as a sector to resolve the issue around the SATs schemes". Somewhere between 65 and 70 per cent of the staff eligible for SATs are female, he says, meaning women are disproportionately affected by the switch to defined-contribution. "This divide in pension provision (between academic and support staff) is only going to widen the gender pay gap in higher education," he adds.

Barbara Limon, head of public-sector duties at the Equality and Human Rights Commission, wrote to the University of Warwick's vice-chancellor, Nigel Thrift, about the institution's plans for support staff.

"In this instance," she writes, "there does not appear to have been any consideration of the fact that making amendments to a pension scheme offered to one group of staff (predominantly female) might widen the disparity with another group of staff, ie, the academic staff who might be predominantly male and who might enjoy more generous pension provision."

In response, Warwick said that it had complied with equality rules. The correspondence continues.

Thomas argues that universities could preserve defined-benefit schemes for support staff by merging their SATs into the larger Superannuation Arrangements of the University of London (SAUL) or into the USS. He believes this would reduce the cost of the SATs, each of which must currently employ its own fund manager, actuary and accountant.

What do academics who study pensions make of the current debates in higher education?

Hugh Pemberton, co-editor of Britain's Pensions Crisis: History and Policy (2006), believes the USS is the victim of "four different pressures (that) are coming together to create a major problem". Those pressures are: increasing longevity, falling returns from the stock market, a rise in salaries in recent years, and universities' use of early retirement as a means of cutting jobs.

Pemberton, a senior lecturer in modern British history at the University of Bristol, points to the UCU's success in negotiating recent pay rises and the impact this has had on pension costs. The union and employers were "probably complicit" in creating this problem, he argues. "Nobody chose to confront the problem that rising salaries would create a burden for the pension fund."

But other mistakes are down to the employers, Pemberton says. "How is the sector responding to the financial pressures on it? It is easing people out at the top end of the age range, into early retirement. For each university, that makes sense. But for the pension fund, it makes no sense. People who might have been expected to go on to retirement age are taking their pension early."

Can final-salary survive in the USS? "Unless compromises are made, it probably will have to go," Pemberton says. "If compromises are on the table - like raising the pension age, like changing to average-salary rather than final-salary - that is a way of saving the USS as a defined-benefit scheme."

Charles Sutcliffe, professor of finance at the ICMA Centre business school, is a former UCU-nominated USS director and the author of a paper titled "Should defined-benefit schemes be career-average or final-salary?".

He says that the challenges, of longevity in particular, make change necessary. But he describes the 1/80th career-average scheme proposed by the employers as "appalling".

"New entrants pay the same as existing final-salary members, but get out of it 30 to 35 per cent less in benefits."

Career-average is "much fairer" than final-salary if introduced on a cost-neutral basis, Sutcliffe says.

He argues that the employers' previous offer of a 1/60th career-average scheme for new and current members would be "much closer to cost neutral", adding: "It would be much more worth considering, whereas the 1/80th scheme is not worth considering for any length of time."

And what might Cubie decide on the future of USS? Will he use his casting vote to back the employers or the UCU, or not use it and leave the status quo in place? The feeling at the UCU conference was that Cubie, the author of the report that brought about the abolition of tuition fees in Scotland, would not want to spark a bitter industrial dispute that might stain his reputation for "fixing things".

The question is whether his desire to avoid conflict with the UCU will be outweighed by the employers' warnings on government pressure.

The new universities minister happens to be something of an expert in pensions. Willetts is the author of a pamphlet titled Old Europe? Demographic change and pensions reform, and he discussed the subject in his recent book on intergenerational inequality, The Pinch: How the Baby Boomers Took their Children's Future and Why They Should Give it Back.

In The Pinch, Willetts says final-salary "now looks an extraordinary set of responsibilities" for employers. But he also describes defined-contribution schemes - the sort being offered to many support staff and which some employers warn the government could impose on the whole sector - as being "worth a pittance".

For the USS, it looks like coming down to how Cubie picks his way through the conflicting arguments. The government will be watching closely - along with everyone in higher education whose retirement depends on the fund.

THE PROPOSALS COMPARED

The Universities Superannuation Scheme is, under current rules, a final-salary scheme.

Members can retire at 60 without a reduction in benefits. Employers must fund all contribution rate increases required. Depending on whether the employers' or the union's plans win approval, some or all of these key elements could change.

The Employers Pensions Forum proposed:

• Career-average scheme for new entrants on a 1/80th accrual rate, with existing members retaining the final-salary scheme
• A normal pension age of 65 for all members, rising to 68 in stages between 2024 and 2046 in line with increases to the state pension age
• Immediately raising member contributions from 6.35 per cent to 7.5 per cent
• Sharing future increases in contributions 50:50 with members
• Capping pension increases linked to the retail prices index inflation at 5 per cent

The UCU proposed:

• Retaining a final-salary scheme
• Normal pension age of 65 for new entrants only
• Immediately raising member contributions from 6.35 per cent to 7.35 per cent. Those earning ?25,000 a year or less keep current rate
• Sharing future contribution rate increases 65:35 between employers and members
• Tiered contribution system with higher rates for higher-earning members.

THE GOLD VS THE BRONZE STANDARD

Pension schemes fall into two broad categories: defined-benefit (which covers final-salary and career-average schemes) and defined-contribution.

In a defined-benefit scheme, the value of a pension is decided in advance based on salary and length of service.

With final-salary, the value of employees' pensions are calculated by awarding a certain portion of their salary close to retirement for each year worked.

With career-average, a portion of employees' average salary over the course of their career is awarded for each year worked.

Employees receive the agreed sum for the rest of their lives, regardless how long that is.

Below the category of defined-benefit are inferior defined-contribution schemes, also known as "money-purchase", in which the value of the pension is not decided in advance.

Both employees and employers still pay into the scheme, but its value is determined by the condition of the stock market when an employee retires. The employee is given an annuity on retirement, deciding how many years to spread this sum over, according to how long he or she expects to live.

In a defined-benefit scheme, the employer bears most of the risk and must ensure the fund has sufficient assets to meet pensions of an agreed value over the course of pensioners' lives.

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In a defined-contribution scheme, the employee bears the investment and longevity risks.