The USS Trustee announced last week that it will undertake a new valuation of the scheme’s funding position as at 31 March 2018.
This decision has not been made lightly. It was prompted by Universities UK’s request for the trustee to consider the recommendations made by a joint expert panel, commissioned by themselves and the University and College Union to review the 2017 valuation.
The panel’s proposals would involve employers being willing to take on a greater amount of risk in the scheme’s investment and funding arrangements than previously expressed to us, in order to reduce the payroll contributions required under the 2017 valuation.
The trustee’s consideration of these issues will require another formal consultation with UUK (to take place during December and January), to fully understand how and if the proposals made by the panel could be put into effect. With a commitment on all sides to progress these discussions quickly, this process could result in a new funding arrangement by mid-2019.
Understanding the rationale
Members may well wonder why this is necessary, and how such a process might change previous conclusions. This is understandable: the debate on the USS funding arrangements has generated a commentary from both extremes. On the one side, the trustee has been accused of being “recklessly prudent” in its funding assumptions, requiring contributions that are unnecessarily high. On the other, the trustee has been alleged to be taking on such high risks that it has endangered the security of the pensions that have been promised.
The reality of the situation is far more complex, however. As an illustration, at 31 March 2017, the cost of buying sufficient low risk investments to secure a greater than 95% chance of being able to pay pensions earned to date would have been circa £22bn more than our assets. The cost of buying equivalent pensions from an insurance company would be more than twice our assets.
The clear, if uncomfortable, fact is that insuring the future has become more expensive and the cost of wrongly assuming that pension promises could be met more cheaply is potentially enormous. Without a strong commitment from the scheme’s sponsoring employers to underwrite this risk, the cost of providing pensions – the contributions required of members and employers – must increase.
Messages that pensions have become more expensive are not popular, of course. This is why the independent judgement of the trustee on these issues is such a critical part of the checks and balances of running a mutual pension arrangement. The trustee has no other agenda than to ensure that the pensions already promised are secure, and the scheme is sustainable into the future. In doing that, difficult and hugely consequential decisions are required and the USS Trustee takes these responsibilities very seriously.
Given that prices for all assets (house prices, shares, bonds etc) have been buoyed by lower interest rates over recent years, it would be surprising if the price of actual pensions had not also increased. After all, these assets are what we purchase in order to produce the future cash to pay future pensions. However, because the USS pension is a mutual promise, and the institutions of the higher education sector are long-established, it is possible for us to own a balanced portfolio of assets and to take account of likely future investment returns in setting today’s contribution rates. This can only be achieved, however, when there is agreement with sponsors.
Understanding the risks
So the USS scheme does and will depend on future returns from riskier assets to pay pension promises. That dependency is limited by the need to manage the future calls that might ultimately be made on the sector if return-seeking investments turn out to underperform relative to our expectations. Critically, this judgement must be supported by the scheme’s employers. It is the employers that are the stewards of the balance sheets of their institutions and must decide to what risks they are comfortable exposing their successors.
The trustee’s view is that the gap between the current interest rate-driven view, and expected-returns view is too wide for comfort and should be reduced the next twenty years. It is also the trustee’s view that interest rates are more likely to increase rather than decrease in the medium term, which will help. The intention is that the scheme’s relative reliance on riskier investments will also decrease gradually, over a twenty-year period.
After consultation with UUK in 2017, the shared risk appetite for the scheme in twenty years time was set. This is one of the issues on which the panel recommended reconsideration, and on which we will consult again. Other things being equal, a greater tolerance for future risk in the scheme would reduce current contributions.
However, the trustee must also manage potential scenarios that could make reaching that longer term destination more difficult, including significant further falls in interest rates or in asset values from their current levels. The resilience of the scheme in such circumstances requires an understanding of the willingness of employers to increase contributions in response to short-term market shocks or to provide other forms of security.
Possible changes in employers’ assessment of their capacity and appetite to support (and if necessary, mitigate) any risk of contributions being inadequate in both the short and longer term is a key factor behind the trustee’s decision to conduct an additional valuation. This will use similar methodology to the 2017 valuation, but it will also take into account more recent changes in other factors such as market returns and life expectancy.
The trustee must act within the law and will complete the current 2017 valuation, with the staged increases in cost-sharing contributions that this entails. However, with a shared commitment from all sides, this additional 2018 valuation could be completed before the higher phases of cost-sharing come into effect from next October.
We recognise the strongly-held opinions held by all parties in this situation; the trustee has listened carefully to all sides. Throughout, the trustee’s objective has been to ensure that the defined pension benefits USS members earn can be paid as they fall due, without excessive current and potential burdens on the sector. This will continue to be our primary focus.