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REPORTS

Report of the Council on the financial position and budget of the University, recommending allocations from the Chest for 2009-10

The COUNCIL begs leave to report to the University as follows:

1. This Budget Report reviews the financial position of the University and recommends allocations from the Chest for the financial year 2009-10. Information on trends in staff and student numbers, research, and expenditure is provided in Appendices 1, 2, and 3.

Overview

2. The past decade has seen healthy growth in the University's operating budget and an improvement in the overall financial position. Income from all sources has increased at rates well above inflation and this has allowed the University to support additional expenditure, including substantial increases in pay costs arising from pay awards, increased numbers of promotions, implementation of the new pay and grading policy, and rising pension costs. The operating budget during this period has been in balance or has recorded small surpluses. At the same time, external funding streams from the Funding Council and from benefactors have supported a major programme of capital development, providing improved accommodation, expanded capacity, and enabled the introduction of modern business information systems.

3. The unprecedented events in the global financial conditions during the past twelve months, and the consequent economic downturn, have changed the landscape and introduced great uncertainty into budget setting and forecasting. The depth and length of the recession are unknown but most of the University's income sources will be affected: funds from the public purse to the Funding Council and Research Councils will be under great pressure from 2010; charities, a major source of research funds, are already reducing funding in response to decreased returns from investments and legacies; industry and commerce are likely to reduce investment in R&D; the level of donations and benefactions is expected to decrease. At the same time, pension fund assets have fallen and pension costs will rise.

4. Nevertheless, income during 2008-09 is forecast to exceed estimates, virtually all parts of the University are within budget and a Chest surplus is forecast. Most of the University's income for 2009-10 is known and is relatively secure, subject to the remarks made in paragraph 28 below - the HEFCE Block Grant; student fees; existing and awarded research grants and contracts. The position beyond 2010 is, however, much less secure.

5. Experience of past recessions suggests that higher education is more resilient than most aspects of the economy. The Government will not want school-leavers to join a difficult employment market; parents will make every effort to send their children to university; postgraduate education will be attractive in the face of reduced employment opportunities; research grants will become harder to win but existing grants and contracts, most of which are for three or five years, are expected to be honoured. These are not grounds for complacency; the University will suffer from the recession but the impact is difficult to gauge and is unlikely to be sudden.

6. In this Report, the Council seeks to strike an appropriate balance, responding to the uncertain outlook by proposing action to contain or reduce spending that is not damaging to the University, while recognizing that more decisive action may prove necessary in the medium term.

The current year

7. The Council reported in May 2008 (Reporter, 2007-08, p. 792) that it estimated that the total income for the year 2008-09 would be £678.5m, of which £332.0m would be Chest income and £346.5m would be non-Chest income. The overall position on the Chest was expected to be a surplus of £4.9m. On the same basis, the latest forecast is for the Chest to have a surplus of £11.3m. This arises from a number of changes summarized in Table 1. The most significant are

8. The non-Chest component of the University (excluding Cambridge University Press, Cambridge Assessment, and the Trusts) was forecast to have a surplus of £1.9m in 2008-09. This component of the budget is difficult to predict at this point in the year, but most Schools and institutions appear to be operating within budget and, in aggregate the 'teaching and research' University is still expected to show a surplus for the year on a current income and expenditure basis.

Planning Round

9. The Planning Round builds up estimates of income and expenditure in both the Chest and non-Chest positions from detailed projections provided by Schools and other institutions, and from information on other income and expenditure. Development of the budget for 2009-10 has been challenging in the face of changing economic conditions, uncertainty concerning pay costs (including pension costs), volatility in energy prices, and uncertainty about the impact of the outcome of the Research Assessment Exercise (RAE) on distribution of HEFCE funds for research. It is also apparent that the RAE alters the attribution of HEFCE R funds within the University and will therefore change the relative financial position of Schools in the RAM. It was agreed, however, that any such changes would be ignored for the purpose of setting School budgets for 2009-10. As usual, the submission of plans and forecasts was followed by analysis, consolidation, and in-depth review in individual meetings with Schools and institutions. A significant issue has been how to adjust to the lower rates of inflation that now seem prudent to assume for both income and expenditure. Further analysis and discussions will take place this term about projections for the subsequent years to review the academic and financial aspects of the plans beyond 2009-10. This is particularly difficult at a time when the Retail Price Index (RPI), the index usually linked to pay awards, is very much lower than the Consumer Price Index (CPI), the figure now used by the Government to describe inflation, and when both indices are changing rapidly. The Council and the General Board have agreed that adjustments should be made to all components of the forecasts to reflect the impact on both income and expenditure of lower inflation rates, and the presentation in this Report includes those adjustments based on latest information. For each year in prospect it is now assumed for planning purposes that pay inflation will be 2% - except in 2009-10, where the budget assumption is that pay inflation will be no greater than 1.5%, but a balancing 0.5% has been used to establish a contingency reserve. It is assumed that non-pay inflation will be 1.5% in all years.

Estimates for the forthcoming year

10. Chest income for 2009-10 is predicted to be lower than projected at this point last year, while non-Chest income is predicted to be higher, largely as a result of continued growth in research activity.

11. The HEFCE Block Grant for 2009-10 is increased by 2% by comparison with 2008-09, slightly below the level (-£2m) assumed in past projections. An analysis of the Grant is provided in Appendix 4.

12. The reduction in the Chest income projection is due primarily to the most recent estimate of recovery of the indirect costs of research. This element of research grants forms an increasingly important component of Chest income (see Tables 1, 2, and 3, pp. 764-766) and, as in the current year, the recovery of indirect costs under the full Economic Costing (fEC) regime is predicted to be below the level originally forecast. A significant factor in this is the technical change to the indirect cost and estates rates that Research Councils will accept in grant applications; this affected grants applied for in 2007 and 2008. Indirect cost rates were reassessed during 2008 and higher rates have been applied to grants submitted from February 2009, with an expected improvement in cost recovery phasing in from 2009-10. Small reductions in projected Chest income result from reduced returns from the endowment and revised estimates of composition fee income.

13. On the Chest expenditure side, the main changes are the large increases in utilities costs (£3.3m), increased pension contributions (£3.4m), and the impact of the unexpectedly large pay award in October 2008, reflecting the high RPI figure (of 5.0%) as at September 2008.

14. Steps have been taken to try to control utilities expenditure by setting targets for reductions in electricity usage at building level, accompanied by financial incentives.

15. On the basis of regular condition reviews, and on the recommendation of the Buildings Committee, the Council considers that the current level of the maintenance budget, adjusted for inflation, is broadly appropriate. In the current financial climate a £1m saving will be applied in 2009-10, and it is not expected that this will give rise to serious difficulties. The Buildings, Finance, and Planning and Resources Committees have all given consideration to the implications of making more serious reductions in maintenance expenditure should that prove necessary, but recognize that this could largely be an exercise in deferring expenditure between years, rather than an absolute saving.

16. Capital expenditure will continue at a relatively high level in 2009-10, largely on projects already in progress and funded almost entirely from benefactions and from an earmarked HEFCE funding stream (Capital Investment Framework - CIF). The table below shows projects in progress, together with the main sources of secured funding, and includes projects where formal proposals will be the subject of Reports to the University in due course. Some of these are necessary precursors to potential redevelopment of the Mill Lane and New Museums Sites which were referred to in last year's Budget Report (Reporter, 2007-08, p. 795).

 Approx. Cost (£m) Source of Funds Predicted Construction Dates
Laboratory for Molecular Biology 10.0 HEFCE CIF
Wolfson Foundation
Jun 09 - Jun12
Sainsbury Laboratory 89.9 Gatsby Trust
HEFCE CIF
Sep 08 - Dec 10
7 West Road 16.0 HEFCE CIF Feb 10 - Jul 11
University Library West Bookstacks Phase 6 7.0 HEFCE CIF
University
Oct 08 - Aug 10
Kavli Institute of Cosmology 4.1 HEFCE CIF
University
Jun 08 - Jun 09
Hauser Forum 12.1 Hauser-Raspe Foundation
University
Sep 08 - Nov 09
Dept of Materials Science - New Building 46.4 HEFCE CIF Mar 10 - Nov 11

17. The plans for capital expenditure are mainly dependent on a HEFCE CIF award of £115m notified to the University in 2008 for expenditure in the period April 2008 to March 2011. The tranche of these funds for 2010-11 is not guaranteed because it is contingent on the funds made available to HEFCE in the 2010-11 budget. There is therefore an element of risk in proceeding with current plans but this must be balanced against the risk of losing these funds if projects are not initiated in time for expenditure to be incurred within the tight deadline set by HEFCE. It is therefore prudent to continue making modest provision (£6.5m) for potential capital expenditure and strategic initiatives which, together with the funds allocated in 2008-09, will provide a cushion against any loss of external funds for this purpose. These allocations are additional to the elements for minor works, maintenance, equipment, and utilities included in 'estates related expenditure'. 'Other administered funds' includes undergraduate bursaries and support for the Cambridge Trusts. The allocation to the Trusts has been increased by £0.5m to compensate partially for the loss of income following the unwelcome decision of HEFCE to wind up the ORS (Overseas Research Students) award scheme.

18. The combination of predicted income and expenditure outlined results in a projected Chest deficit for 2009-10 of approximately £7m (Table 2); this should be viewed in the context of about £150m in unrestricted central reserves available to absorb deficits. While recognizing that this is not a sustainable position, the Council considers that the proposed allocations for Schools and other institutions and for investment in Estate condition and business support systems have been scrutinized in detail and that further reductions for 2009-10 would damage the position of the University.

Looking forward

Financial projections

19. Projections beyond 2009-10 have been built up from detailed plans at School and institution level submitted in December 2008, but, as noted earlier, the assumptions made in preparation for the 2008 Planning Round have changed significantly during the course of the year. As is now customary, the assumptions will be subjected to further examination to inform future planning rounds, but it is unlikely that predictions can be made with real confidence during the next twelve months.

20. The projections shown in Table 2 assume that pay inflation will be 2%, non-pay inflation 1.5%, and that increases in HEFCE funding will not exceed inflation.

21. Despite consistent year-on-year growth in research during the past decade, it is prudent to assume for the purpose of this forecast that research activity (as measured by direct expenditure) will not grow significantly during the next five years. Total research income is, however, expected to show modest growth above inflation due to the continued 'roll in' of grants on an fEC costed basis.

22. Endowment and investment income from the Cambridge University Endowment Fund (CUEF) has been projected by applying the formula set out in the regulations for the distributions from the Amalgamated Fund (Statutes and Ordinances, p. 963) with the assumption of modest recovery of the investment markets over the plan period. The formula balances the competing objectives of a stable flow of income to support operations while protecting the value of the endowment in real terms over time. This 'smoothing' approach allows consistency for planning and expenditure whilst adjusting gradually to changes in market values. Investment markets have performed very well until recently and the CUEF has been distributing less than its long-term rate, hence the projected distributions do not show substantial reductions that might be expected in current circumstances. Nevertheless, current economic conditions are exceptional and the Finance Committee, with the advice of the Investment Board, will keep the distribution policy under review.

23. Tuition fee income beyond 2009-10 is predicted to show a modest increase above previous forecasts, based on projections of student mix and the latest fee structures, including fee levels for 2010-11 and beyond that remain to be approved by Grace. This includes recognition of market levels of fee for particular graduate taught programmes, and adjustment of the level of overseas fee to reflect the increased costs described in paragraph 13 above. Increased fee levels imply an increased need for student support and the Council notes that about £14m has been raised for graduate student scholarships by the University during the 800th Campaign (at July 2008).

24. Cambridge Assessment has a robust business plan covering the next five years and the business is expected to be largely unaffected by the recession. The contributions to the Chest shown in Table 3 are derived from the formula agreed with Cambridge Assessment and applied to the operating surpluses shown by its business plan.

25. During the planning period, reviews will fall due of the funding basis of various activities, particularly those involving the M.B.A. and executive education. Those institutions responsible for these activities currently retain all their fee income in order to finance agreed investment plans. However, they are expected to show increasing levels of income by the end of the plan period and the Council and the General Board expect that reviews of current arrangements will result in contributions to the Chest from these activities. The Chest projections shown in Table 3 do not include estimates of this income.

26. Table 3 shows income streams that are almost entirely non-Chest: 'other services rendered' and 'other operating income', covering a variety of trading and other activities, mainly carried out at departmental level. These have grown as a proportion of the overall budget in recent years and represent activities that make use of and demands on the core infrastructure of the University, yet the contribution of these activities to Chest income is small. This matter was considered by the working party set up by the Planning and Resources Committee in May 2002 which concluded that an 'overhead' charge should be made when salaries are met from such funds. The charge is currently set at 30% but this remains well below the real indirect costs associated with employment of staff and the policy will need to be reviewed. The projections take account of anticipated donations and their planned expenditure, and those in the museums explain some of the apparent unusual year-on-year movements in relation to academic institutions and services.

27. Projected allocations to Schools and institutions beyond 2009-10 assume that pay awards will not be higher than inflation but a further 1% annual increase has been included to cover incremental pay increases that are built into the pay spine or result from regrading. If the income assumptions are incorrect this may prove unaffordable. The employer's contribution to the Universities Superannuation Scheme (USS) will increase from 14% to 16% of salary in October 2009 and is assumed to rise by a further 2% in 2011. Contributions to the Cambridge University Assistants Contributory Pension Scheme (CPS) will increase by 4% to a total of 23.7% from August 2009. These increases in pension contributions are included as a specific element in 'other administered funds' and they will be identifiable in future years. Projections beyond 2009 include no provision for further increases. Pensions are discussed further in paragraphs 34 and 35.

28. Some of the assumptions described above may be optimistic. In particular, the HEFCE Block Grant may not keep pace with inflation, maintaining research activity at current levels may prove too great a challenge, and pension costs may increase more than predicted. Attempts by the Government to drive the economy out of recession may increase inflation while simultaneously forcing reductions in public expenditure. The Budget speech on 22 April announced savings from improved procurement and better estates management in Higher Education and through a renewed 'efficiency drive' but also a real increase in the Department for Innovation, Universities and Skills (DIUS) Science Budget. The impact on the University is difficult to assess but the indications are not encouraging. Despite the relatively optimistic assumptions underlying the figures in Table 3, the projections show continuing Chest deficits. This is not a sustainable position, particularly since funds set aside for capital investment will be inadequate unless there is a continued stream of external funding for this purpose.

29. Further work will be needed to improve cost effectiveness, generate additional income, and identify savings to return the Chest position to balance. In the meantime the Council, in consultation with the General Board, has agreed the following actions to restrict the growth in pay costs:

30. Taken together these measures are expected to yield savings of about £2.5m a year. The Council recognizes that these proposals will not be popular, and may not be sufficient, but in the current economic climate 'business as usual' is not a prudent option.

The capital programme

31. During the past decade the condition of the Estate has been improved by a programme of large-scale refurbishments and through construction of new buildings on the West Cambridge, Sidgwick, Addenbrooke's, and Tennis Court Road sites. These capital projects have been funded almost entirely from external earmarked funds (from HEFCE and benefactors) sometimes supplemented by departmental reserves. In order to minimise risk to central funds the University has authorized capital projects only when funds to cover the full costs are identified and secure. As a result individual buildings have been constructed when appropriate funds become available. This approach has proved satisfactory for sites such as West Cambridge where vacant plots can be developed in the overall context of the Estate Plan as funds are secured.

32. The University has been reviewing options for the renewal of the central sites, notably the Old Press Site and the New Museums Site during the past year as part of the development of the Estate Implementation Plan (Reporter, 2008-09, p. 387). Redevelopment of these sites cannot take place on a piecemeal basis; a co-ordinated programme is required which will involve making commitments in advance of securing additional funding. In the current economic climate it would be intuitive to defer these plans, but the counter argument is that construction costs are falling and interest rates are low. Detailed analyses will be undertaken of the risks and benefits, both financial and academic, of proceeding with development plans and these will be considered by the Finance Committee during the course of the year.

Uncertainties

33. This Report has noted the many uncertainties in future budget estimates. Pensions are worthy of further note. The pay bill represents more than 50% of the University's costs and increases in pension contributions impact directly because under current arrangements the employer is liable for the full cost of the increase.

34. The triennial actuarial valuation as at 31 March 2008 of the Universities Superannuation Scheme (USS) showed that as at that date the scheme was sufficiently funded on the technical provisions basis (i.e. that it has sufficient and appropriate assets to cover its liabilities). However, the Scheme is facing growing pressure from factors such as uncertainty over future investment returns, improving life expectancy, and salary levels. As noted earlier, the employer's contribution rate to the USS will increase from 14% to 16% of salary from 1 October 2009, and this is included in the Budget. Recent promotional salary increases in the sector may also lead to a need for the USS to increase employer's contribution rate further, and projections allow for a further increase of 2% in 2011. It is equally probable that a further increase will be required at the next valuation in 2011 because of increased life expectancy and without substantial improvement in the investment markets greater contributions will be required to deal with the consequent deficits in the asset base. The University has little, if any, control over this situation. The USS is a very large multi-employer scheme. The USS note that the participating employers and the members, the latter represented by the University and College Union, are currently discussing ways in which the scheme can remain attractive and affordable.

35. The Cambridge University Assistants Contributory Pension Scheme is similarly affected by investment performance, actuarial assumptions, and salary increases. The employer's contribution will be increased by 4% to a total of 23.7% from August 2009, following an interim review in 2008. A full triennial review will be carried out as at 31 July 2009 and further increases in funding may then be necessary. The scale of the increase will depend in part on the state of the investment markets and the length of the recovery period allowed by the Pensions Regulator, as well as the actuarial assumptions agreed by the Trustees. The Finance Committee is exploring ways of ensuring that this scheme remains sustainable.

Sensitivity

36. Given the uncertainties, particularly of certain income streams, it is worth examining the sensitivity of the budget forecasts to reductions in major income sources.

37. With reference to 2010-11 in Table 3, the significant uncertain sources of Chest income are the HEFCE Block Grant and research grants. Taking a pessimistic view, if the former is reduced by 5% and the latter by 10% the combined loss of income to the Chest is of the order of £15m, a serious loss but one that would not be disastrous in the short term.

38. The Non-Chest budget is less predictable. A 10% reduction in research funding would result in a decrease in activity and force research staff redundancies at a time of high unemployment. Endowment income is almost entirely restricted; it often contributes to the cost of academic staff and loss of income would have to be met from departmental or central reserves. Two further elements, 'other operating income' and 'other services rendered' represent income from a variety of sources and activities at departmental level including donations, gifts for current use, and trading income. This income has been growing rapidly in recent years and is projected to approach £100m in 2010-11. It is very unevenly distributed in different Schools and institutions and its sensitivity to the economic downturn is uncertain. Nor is it clear to what extent this income is being used to cover fixed costs as opposed to discretionary activity. These issues will be investigated during the next planning round.

39. On the basis that work is under way to address the longer term issues described in this Report, the Council is content to recommend allocations for 2009-10.

Recommendations

40. The Council recommends:

I. That allocations from the Chest for the year 2009-10 be as follows:

(a) to the Council for all purposes other than the University Education Fund: £155.4m.

(b) to the General Board for the University Education Fund: £188.7m.

II. That any supplementary HEFCE grants which may be received for special purposes during 2009-10 be allocated by the Council, wholly or in part, either to the General Board for the University Education Fund or to any other purpose consistent with any specification made by the HEFCE, and that the amounts contained in Recommendation I above be adjusted accordingly.

18 May 2009 ALISON RICHARD, Vice-Chancellor WILLIAM BROWN CHRISTOPHER HUM
 DAVID ABULAFIA M. R. CLARK F. P. KELLY
 ROSS ANDERSON S. J. COWLEY VANESSA LAWRENCE
 A. P. BAGSHAW M. J. DAUNTON DEBBIE LOWTHER
 NICK BAMPOS A. M. DONALD MAVIS MCDONALD
 R. J. BARNES R. J. DOWLING RACHAEL PADMAN
 NIGEL BROWN DAVID GOOD DAVID SIMON

The appendices and tables for this Report are available as a PDF file:


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Cambridge University Reporter 20 May 2009
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