The three-yearly actuarial valuation of the Universities Superannuation Scheme (USS) is under way. Once again, there will soon be very difficult discussions taking place between employers, staff and trustees to try to find an outcome that everyone is happy with. Perhaps the best that can be hoped for this time is an answer that everyone is equally unhappy with.
The valuation requires a value to be placed on the cost of pension benefits provided by the USS to determine two things – whether there is enough money already invested to provide the benefits already built up and how much the benefits being earned in future years will cost. If everything had gone as planned, the money already paid in would be sufficient to pay for the benefits already built up (the “past service”), but asset values fluctuate and views on the cost of pensions change, so deficits can build up over time.
As life expectancy increases and long-term expectations of interest rates fall, the value placed on pension benefits increases, and so over recent years this has caused the benefits provided by the USS to look increasingly difficult to afford.
This is not a new issue – it’s been the case for the past few actuarial valuations. With the benefit of hindsight, it is easy to argue that some difficult decisions should have been taken earlier (either reducing benefits or increasing contributions) rather than hoping market conditions would improve making the USS benefits more affordable.
One of the key reasons that this has been so hard is that there is no objective measure of how much pension promises from a “defined benefit” scheme such as the USS will cost. There is such a wide range of uncertainty over what will happen over the next 80 or so years (the time frame of the promises to current USS members), which means that any attempt to place a value on that now involves an awful lot of judgement.
The Pensions Regulator (TPR) has a role here in setting the standards for how actuarial valuations are done, but its focus has increasingly been on the vast majority of UK defined benefit pension schemes that are closed, with no future benefits building up. This means that TPR’s focus has effectively been on protecting members’ past service benefits and ensuring there is a sufficient level of prudence when valuing benefits.
The downsides of overpricing pensions (by focusing on prudence) in a closed defined benefit scheme are low – the main outcome is more money in the scheme and more security for the members. In an open scheme like the USS, where understanding the affordability of benefits is very important, this approach of focusing on prudence could lead to misguided judgements about what is affordable and what is not.
That said, what we are left with is the huge level of uncertainty; whether you believe current benefits are affordable or you believe they are not affordable, there is a big risk if you turn out to be wrong. This brings us back to the very difficult discussions between groups with very different viewpoints (current benefits are affordable v “no, they are not”), plausible explanations for their own position (given the very wide range of possible future outcomes) and no real way to know now who is right.
As if that weren’t enough of a challenge, there are some features of the way the USS works that don’t seem to be talked about openly. Without acknowledging these issues, it makes all the conversations about how much benefits cost that much harder. The most striking example is that employers pay a single contribution rate to the USS covering both the cost of future benefits and the cost of paying off any shortfall for past service.
This can really muddy the waters in the discussion because, for example, not all employers within the USS are equal when it comes to how the deficit in respect of the past has built up. Some universities have a much longer history within the USS (and so a greater share of the past service) compared to others. The current approach means that the deficit is shared between employers based on their current members, not their share of the past service. In effect, a new employer joining the USS now would not have caused any deficit but would still have to pay towards it.
The USS also has a default position that if contribution rates increase, then the increase is shared (broadly two-thirds/one-third) between the employers and the members. Again, is it right that the deficit is included when doing that sharing? Maybe this is OK when the deficit makes up a small part of the contributions, but it looks less sensible if the deficit makes up a large part of the increased cost (which would be the case under the results being discussed for the 2020 valuation)?
The approach to the USS valuation needs to be rethought, taking a step back to revisit some fundamental principles. The employers (largely universities) need to agree how the past service position – in particular, the deficit – is going to be paid off.
Only when that has been separated out can we start to make sensible decisions about the affordability or otherwise of future years’ benefits.
Even then it is not going to be easy, particularly at a time when the sector is facing unprecedented challenges and uncertainties, but waiting and hoping for the best is not going to work.
Paul Hamilton is partner and head of higher education at Barnett Waddingham, a professional services company with expertise in pensions.
