Final-salary pensions could be wound up by the Universities Superannuation Scheme (USS), according to the head of a review group looking at the fund's future.

Sir Andrew Cubie, chairman of USS' Joint Review Group (JRG), said that changes such as a career-average structure, later retirement and higher member contributions are being considered to meet "formidable funding challenges".

He told a recent USS institutions' meeting in London: "I would not want anyone to think that a career-average outcome is inevitable, but it is under active consideration."

Lord Mandelson, the First Secretary, said in his grant letter to the Higher Education Funding Council for England last month that "moving towards a sustainable position on pensions within the sector will be a key challenge".

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This week, the Association of Consulting Actuaries warned that, across all sectors, final-salary schemes are "all but extinct", with nine out of ten now closed to new entrants.

USS, the second-largest private-pension scheme in the UK, said the value of its fund was ?26.8 billion at 30 September 2009, the most recent figures available.

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With ?31.8 billion of benefits promised to members, this left it with a ?5 billion deficit on the "technical provisions" basis. The scheme's most recent annual report says the year to 31 December 2008 was one of "very poor returns for USS and pension funds generally".

But the September 2009 value was up from ?21.4 billion at 31 March, driven by improving conditions in the stock market.

USS is open to academic and professional and managerial staff in all pre-1992 universities.

Any changes to contributions or benefits must be decided by its Joint Negotiating Committee (JNC), of which the JRG is a working group.

The JNC is made up of five member representatives nominated by the University and College Union and five employer representatives nominated by Universities UK. Sir Andrew, chairman of both the JRG and JNC, holds the casting vote.

A UCU spokesman said the union "would like to see USS continue as a final-salary scheme and we would need convincing that any proposed changes were not detrimental to members, pensioners and the fund itself before making any recommendation to members".

He added that while 2008 was a bad year for all pension funds, pensions are "about the long term" and USS is in "robust health".

'Radical changes' needed

But Phil Harding, chairman of the British Universities Finance Directors Group, said that view "involved a bit of spin". He added that the switch from final salary to career average is among the "fairly radical changes" needed to help the fund avoid higher contribution rates for employers and employees.

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"I think career average is absolutely the way to go because it helps to mitigate the risk to the pension scheme of increasing salary costs," Mr Harding said.

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"In recent years we've seen salary costs in higher education going up very substantially, putting immense funding pressure on USS."

Employer contributions to USS went up from 14 per cent to 16 per cent on 1 October 2009.

Mr Harding said that at City University London, where he is chief finance officer, this increased annual pension costs by ?1.5 million.

Sir Andrew told the meeting that the detail of any changes would be agreed by April 2010, with an October target for implementation.

In the event of a switch to a career-average system, existing members would have their benefits calculated in two parts, USS said.

Up to the date of the change, benefits would be based on final salary, with any future benefits based on career averages. "No member would receive less than the value of their existing benefits, which would be protected, plus the value of any future benefits," a USS spokesman said. Existing pensioners' benefits would not be affected.

Sir Andrew said five key areas were being considered by the review: increased longevity (longer lives have increased costs for USS); salary increase risk (in a final-salary scheme, pay increases raise the value of all of a member's past service); flexible retirement (employees could "step" their way into retirement with reduced hours and draw a proportion of their benefits later); cost-sharing (ensuring that members are "not denied the opportunity of paying more if that might mean they could retain high-quality pension arrangements"); and the level of risk in the investment strategy.

On addressing the costs of increased longevity, Sir Andrew said: "Various mechanisms are available, such as later retirement ages for payment of benefits and higher contributions for members."

The scheme's current retirement age is 65, but members can draw an unreduced pension at 60 under existing rules, the USS spokesman said.

Sir Andrew's speech included a warning on the review group's work.

"If we fail in our task, the consequences will be significant for individuals, institutions and the standing of the sector," he said. "If we fail, government of whichever colour in 2010 is highly likely to intrude into our discussions."

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john.morgan@tsleducation.com.