In preparing for the future, we’re taking a bet. At least one, that is. We’re betting that the course of action we take will have, broadly, an outcome that we expect. We might also think about what happens if our bet doesn’t come off. I often need to travel from my house in south London to King’s Cross. Google reckons that this will take 40 minutes. I could allow 40 minutes, but I also know that the journey could take at least an hour, and sometimes as little as 30 minutes. If I planned as Google suggested, I might miss my connecting train at King’s Cross 25% of the time. Does it matter? Well, it depends on why I’m catching the train in the first place.
There’s a big challenge facing the Universities Superannuation Scheme (USS). It’s in deficit, and there needs to be some reassurance – for member institutions, pensioners and pensioners-to-be – that the scheme is both sustainable and suitable. There are some competing views about the imagined future for USS and the University and College Union – representing employees – has commissioned a report to consider an alternative way of financing the scheme versus the USS approach (about which more here).
Given that the debate can be pretty complicated and dry, it should be useful to look at different ways of conceiving of the problem. One is to consider the bet which is being placed. USS’s projections are that long-term interest rates will increase by 1.5 percentage points above what the market expects. Now it’s not necessary to assume that the market will definitely be correct, and therefore that USS is wrong, but it flags that there are divergent views on what is most likely to happen.
Put simply there could be three scenarios: one that the markets are correct; one that USS is correct. Another is that we end up with Japan-style low rates for a very long time. Given that these three perspectives produce very different outcomes – because they relate to the returns USS might get on its investment, and therefore the money it has to pay out pensions – we might reasonably ask whether one or other of these bets is the right one to take. But we should also try to find out what might happen in any of these cases: how bad would it be? And who is going to pay for it? If I miss my connecting train, what are the likely consequences?
There’s a second set of questions that the USS valuation poses, and that’s around whether the scheme is fit for purpose. A cross-university scheme seems something of an anachronism in the age of increasing competition between providers and differentiation of universities. It has been a received truth that a pension is a default element of the package of benefits, but might employees want other savings options? Or choose – if they were presented with a choice – for more cash up front in place of benefits which might be deferred for decades?
What makes a sustainable scheme?
On the questions of sustainability for the scheme, David Spreckley, a KPMG higher education pension expert, outlined for me four tests that he has for evaluating a scheme:
- Adaptable design (to reflect both the reward philosophy and risk appetite of the employer and retirement needs of the members).
- Flexibility of funding that reflects underlying covenant and ability to absorb risk.
- Self-sufficiency within the covenant of the sponsor without relying on third parties to underwrite risks or funding.
- Be delivered efficiently.
In relation to these criteria, Spreckley commented:
“The USS is an incredibly efficient delivery vehicle for each pound of liability accumulated. People will argue their case either way around self-sufficiency and regulatory scrutiny should help the USS get on the right side of this. However, there is a big question around whether its rigidity, in terms of allowing flexibility of funding and adaptability of design, is harming its long-term sustainability. If a pension system is not sustainable, then it is unlikely to be suitable.”
Given the significance of the sums involved, the current valuation process might prompt some institutions to think more creatively about what they want to offer their staff. Just because it’s what’s always been available in the past doesn’t mean that the scheme is right for the future. And given the scale of the problem, a misplaced bet could have serious consequences. Spreckley cautioned that:
“Having a position on something is fine, but you should never create more exposure than you can afford. If markets are right about the direction of rates, the impact on the education sector could be very difficult to absorb. The proposed change in actuarial method is effectively a bet made on behalf of future generations.”
Taking a bet on a train connection might not be that serious in the scheme of things. But when it comes to thousands of pensioners, the stakes are high.
The consultation process for USS continues with a deadline of 29 September 2017 for institutional responses.