USS 2020 valuation promises another difficult year

The USS 2020 valuation technical provisions consultation contains some startling numbers. Debbie McVitty has a go at explaining what’s going on.

In case anyone was in the market for more bleak tidings, the Universities Superannuation Scheme 2020 technical provisions consultation, published yesterday, has some jaw-dropping numbers in it.

Thanks primarily to the Covid economic downturn, the USS trustee, under new chair Kate Barker, estimates that the scheme’s technical deficit, set at £3.6bn at the 2018 valuation, has increased to somewhere between £9.8bn to £17.9bn.

Currently, USS pension contributions are set at 30.7 per cent of USS payroll (the salaries of employees enrolled in the scheme), with scheme members contributing 9.6 per cent of their pay and employers the remaining 21.1 per cent.

USS is now predicting that the total cost of maintaining benefits at their current level and reducing the scheme’s deficit could run to somewhere between 40.8 per cent of payroll to as high as 67.9 per cent.

USS is keen to clarify that these are not its final numbers – these won’t be confirmed until December, once the current consultation is complete and there’s been further work on assessing financial conditions and the strength of USS’s covenant (more on that shortly). But if by including these projections USS hoped to focus minds, it’s done that in spades.

How did we get here?

This particular consultation is part of the formal process of the 2020 USS valuation, which started with an economic assessment on 31 March 2020. The valuation must, by law, be completed on 30 June 2021. “Completed” essentially means that employer and scheme member representatives – Universities UK and UCU, via a joint negotiating committee – have agreed on how to meet the costs of funding the pension scheme, as determined by the USS trustee.

USS has, of course, been in difficult financial territory for a long time. Attempts by employers to control spiralling costs and address the scheme’s technical deficit by reducing the defined benefit element of the scheme to zero at the 2017 valuation were not well received by UCU, acting on behalf of the scheme’s members.

The 2017 valuation ended in stalemate, with widespread industrial action in the winter of 2018 and no consensus reached by the supposed date of completion. That led to a further valuation in 2018, in parallel with the creation of a Joint Expert Panel made up of nominees from Universities UK and UCU with a remit to look into USS’s valuation methodology.

In the end, USS to all intents and purposes imposed increased contributions on employers and scheme members, but deferred the worst of these to October 2021, in hopes that before the 2020 valuation something would turn up – in the form of a new methodology, new assurances from employers or, just possibly, better economic circumstances.

So, employers and scheme members are staring down the barrel of further contribution increases from October 2021, to a combined total of 34.7 per cent of USS payroll. In the meantime, economic circumstances just got a whole lot worse.

There has been a methodological change though. One of the recommendations of the Joint Expert Panel was that USS should consider dual discount rates – meaning that the calculation of what is owed in pensions liabilities in today’s money could be estimated at different levels depending on whether it is liabilities relating to people who are already retired, or those who are still in work.

The JEP suggested that USS should be very prudent indeed in securing liabilities for those currently drawing from the scheme in retirement, but could be a bit more relaxed with future liabilities, as there would be time to recoup any losses before people started drawing on their pension pot. More risk and less prudence means lower contributions right now, which in principle everyone can get behind.

In normal times, this change, combined with an economic uptick, might have released some pressure on the scheme. And USS has changed its approach from previous valuations, consulting informally on its planned methodology ahead of this formal consultation including through constituting a valuation methodology discussion forum. But if anyone was hoping for a methodological change that would vanish the USS deficit or restrain projected costs, they’ll be disappointed.

Feet to the fire

Since the 2018 valuation, USS has also been leaning on employers to take action to strengthen USS’s covenant, in hopes of creating more wiggle room for riskier investments.

More risk can lead to bigger reward – and less upfront contribution from employers and members. But no pension scheme is free to take big risks willy-nilly – The Pensions Regulator has firm views on the amount of risk that any scheme should carry. And the USS trustee has a legal responsibility to make sure the scheme is financed for the long term and is able to meet its obligations.

One of the factors that influences the trustee’s views of risk is the strength of the covenant – which USS defines as “the legal and financial ability of employers to support the scheme now and in the future.” The Pensions Regulator has a four-point scale for describing covenant strength: weak; tending-to-weak; tending-to-strong; and strong.

In light of current conditions, and with external advice, USS has taken the decision to assume that the covenant is likely to be downgraded from strong to tending-to-strong unless employers commit to a range of measures to strengthen the covenant by signalling their long term commitment to the scheme.

These measures include:

  • Introducing a change to USS rules that would mean no employer could buy themselves out of the pension scheme without written permission from the USS trustee – currently following the 2018 valuation there is a moratorium on employers leaving USS until the end of the 2020 valuation
  • What’s known as parri passu arrangements in which employers would take on more secured debt on their balance sheets, giving USS the equivalent financial security
  • A debt monitoring framework that would give USS the power to collect data on debt from employers and where the trustee believes there is a risk of weakening the covenant, agree mitigation measures

USS floated these ideas earlier this year, but reports that employers have not yet agreed on a course of action that could underpin a covenant assessment of “strong”.

So, should employers get it in the neck for dragging their heels? Not necessarily. USS is essentially asking for an open-ended commitment from employers to the scheme, whatever their financial circumstances, for additional powers as a “creditor” of employers, and for a direct line into employers’ balance sheets – hardly small asks.

Universities UK’s response to the publication of the consultation document refers to employers requiring “further information on some issues before they can respond” which basically means USS hasn’t – yet – put the case convincingly enough to give the majority of employers reason to support it.

And according to the consultation, those measures would only secure the strength of the covenant to the extent that USS could set future contributions at the (illustrative) best-case scenario of 40.8 per cent of payroll. Employers will legitimately be asking whether what would be gained will be worth the trade-off and whether there are less irrevocable measures that could be put in place, such as a time-bound extension to the current moratorium.

What happens next?

Employers are the audience for this particular consultation, and they have – individually and collectively, via Universities UK – eight weeks to respond, when they’ll have to take a view on what measures they might be prepared to adopt, whether they agree with the methodology described, and what changes they might seek.

After that, there’ll be a further assessment of the strength of the covenant, taking into account employers’ position, and implementation of the valuation methodology which will conclude with USS announcing a number for future contributions in December.

Then the joint negotiating committee will have until March to agree how to fund the scheme – whether to increase contributions or restructure benefits. Obviously, neither is palatable – and the cost of participating in the scheme and the risk of early career academics opting out are high on everyone’s minds.

UCU has already fired a warning shot, suggesting that the USS approach is “needlessly cautious” and that the scheme has a “strong long-term outlook”. And, though employers have emphasised historic and ongoing work with UCU on USS reform, and USS has expressed a desire to work through the valuation in partnership with the HE sector, there’s still every likelihood that the pension scheme will be the occasion for significant tension in the year ahead.

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