Your questions answered on the 2020 valuation

At the moment, the combined contribution rate is 30.7% – you pay 9.6% of your salary, and on top of the salary they pay you, employers pay 21.1% to the scheme.

In October, the combined rate is due to rise to 34.7%, agreed as part of the 2018 valuation. Your contribution will go up to 11%, and employers will pay 23.7%.

The Scheme Actuary has set out the cost of the contributions that would be needed to maintain the same level of benefits in future in the ‘Rule 76.1 report’. This report shows that the combined rate will need to rise to at least 42.1% to provide the same level of benefits in the future as members are building up now.

However, even this rate depends on employers committing to measures to ‘strengthen the covenant’, which means committing to support the ongoing funding needs of the scheme for the long-term, based on a range of possible future circumstances.

The 76.1 report sets out higher rates that would apply if employers don’t feel they’re able to agree with the long-term commitments required to secure a rate of 42.1%.

The level of commitment that employers are prepared to give, has not yet been agreed. In addition, the JNC has not yet decided how the increase in contributions will be shared between members and employers, so at this stage, we can’t say what your contribution rate will be.

As trustee of the scheme, we determine the cost of continuing to offer the current level of benefits. We don’t set contribution rates – the Joint Negotiating Committee is responsible for deciding how to meet any increase in contributions that are needed.

The cost of funding benefits already earned has also increased, creating a bigger funding gap, or ‘deficit’, and we’re legally bound to make sure the benefits earned so far can be paid out in full as they fall due.

The deficit, or funding gap, is based on the difference between the assets and liabilities of the scheme. When we carry out a valuation, we take into account the cost of future pension payments and the income we expect our investments to make in the future. A deficit is not a result of losing money, but because the scheme’s liabilities are greater than its assets, which is caused by factors such as a worsening outlook for investment returns.

Your USS membership gives you a set, inflation-protected income for life in retirement. This is promised by employers regardless of what happens to the economy in the future. Fulfilling this type of promise has become increasingly expensive, with the pensions that need to be paid outstripping the investment growth. This increasing cost is down to a number of things, from members living longer and needing those pension payments for longer, to a poorer long-term outlook for investment growth driven by economic uncertainty and historically low interest rates.

The valuation is based on a snapshot of the scheme’s funding at the valuation date 31 March 2020. That date was agreed long in advance, without of course knowing that the pandemic would cause funding conditions at that date to be so volatile. When the situation became clear, we decided that continuing with the 2020 valuation was the most measured response to addressing the scheme’s deteriorating funding position. It avoided more immediate and impactful measures, such as increasing contributions, and it’s likely we would have decided to hold a valuation if preparations for one weren’t already under way.

A year later, we still believe that continuing with the 31 March 2020 date is the most measured response. This is because we now expect investments to produce less income than we assumed in the past, which means our members’ pensions are at risk of being under-funded. So, we have to investigate and act upon that.

By law, a valuation would have been required by 31 March 2021 in any event.

The pandemic has had a severe effect on the global economy, and so has affected growth forecasts. But even before the pandemic, the scheme was facing very challenging conditions.

It’s difficult to predict future returns because in general, historical returns are a very poor forecast of future returns. However, when we compare our projections with those of others across pensions and investments, we’re not an outlier.

Our expected investment returns feed into the valuation as one potential version of the future. Under legislation, we have to choose prudent assumptions when we complete a valuation.

Looking at asset values and investment returns alone is only one part of the equation for a valuation. We also need to consider the liabilities: that is, if and how the amount of money we need to pay members’ benefits has changed.

So, prudent expectations for investment returns are, by definition, not a ‘best estimate’. They reflect a wide range of factors – not just one potential version of the future in isolation. Our Head of Investment Strategy and Advice recently wrote a blog on this subject.

Prudence is a way of managing the scheme’s risk. Under legislation, we need to incorporate prudence into the valuation.

We need to take into account factors such as the deteriorating and increasingly uncertain outlook for future investment returns, and the employers’ attitude to risk. This is not to ‘overfund’ the scheme, it reflects our obligations under pensions legislation to adopt a prudent approach to the valuation. We’ve looked at prudence in a number of different ways, and you can find out more in a separate briefing.

UUK has suggested that we may be able to reduce the level of prudence. However, The Pensions Regulator (TPR) has said that of the three options (scenarios) that have been set out in the Scheme Actuary’s Rule 76.1 report for funding the scheme, the two with the lowest contribution rates (known as Scenarios 2 and 3) are already at the limit of what TPR considers to be compliant with legislation.

TPR is the public body that protects workplace pensions in the UK. They make sure schemes are run properly and can take enforcement action if schemes don’t comply with the law.

We’ve held extensive discussions with TPR throughout the valuation process, discussing areas of our proposals that TPR felt would not be prudent enough to comply with Part 3 of the Pensions Act 2004.

We’ve considered TPR’s position in our conclusions, and we’ve carefully considered the advice of the Scheme Actuary and our covenant advisors Ernst & Young, as well as UUK’s formal response to our consultation, representations from UCU and other representations. The proposals in the Scheme Actuary’s 76.1 report known as Scenarios 2 and 3 represent the limit of what TPR would regard as compliant.

Employers are responsible for making sure that there’s enough money in the scheme to pay the benefits that they’ve promised to members. The covenant is the employers’ financial ability and commitment to support the scheme. When the scheme takes risk, it is relying on the covenant for support if, for example, investment returns are lower than we expected.

The covenant has a major impact on what contribution rates will be needed. Its strength affects how we invest: if it’s strong, we can follow a higher risk strategy and use higher potential investment growth to help fund the scheme. This means, all things being equal, we’d need less contributions than if we had to adopt a lower risk approach.

So, to know what contributions will be, we need to know what support we can rely on from employers. This isn’t just about their ability to support the scheme but their commitment to prioritising funding for the scheme in future. We’ve been in discussions with UUK for some time on this issue, and we understand UUK will be consulting employers in the coming weeks on covenant support measures.

For the 2020 valuation, we’ve used a ‘dual discount rate’, which just means we use a different calculation to work out the current cost of future pension obligations for members paying into their pension and members that have retired. Moving to a dual discount rate approach was one of the Joint Expert Panel’s (JEP) main recommendations.

We express discount rates relative to gilts, which are fixed interest loans issued by the UK Government. In line with advice from the Scheme Actuary, we’ve expressed the discount rates relative to gilts, whereas the 2017 and 2018 valuation discount rates were expressed relative to the CPI measure of inflation. However, the discount rates are informed by our analysis of all asset classes which are derived relative to CPI.

You can read more about ‘gilts plus’ in this briefing.

The JEP was set up under an agreement between UUK and UCU to assess the 2017 valuation and make recommendations for future valuations.

The JEP developed a number of key recommendations on how we value the scheme. We’ve adopted many of these for the 2020 valuation. Some of the recommendations are for UUK and UCU to consider rather than us, and some are for all three of us to consider together. We set out the recommendations we have and have not adopted, and why, in a briefing note.

As the trustee, our role is to determine the combined contributions needed to provide the same level of benefits in the future as members are building up now. The Joint Negotiating Committee is responsible for deciding how to meet any overall increase to the required contribution rate, through the design of the scheme’s benefits and its contribution structure. We stand ready to support the JNC’s discussions as appropriate.

Benefits you’ve already earned are protected by law and the Scheme Rules, so will not be affected. The valuation is about making sure the scheme can meet the commitments employers have already made.

USS is unique in some ways, which makes it difficult to directly compare with other schemes. For example, schemes that seem similar may have different benefit structures such as tiered contribution rates.

In 2006, there were almost 3,500 DB schemes in the private sector open to new joiners. Now, there are less than 800 still accepting new members, and of those, even fewer are ‘funded’.

If a scheme’s funded, it means it has to have enough assets to pay the pensions promised to members. USS is a funded scheme.

Members often compare USS to the Teachers’ Pension Scheme, but it’s very different. One of the big differences is that the Teachers’ Pension Scheme is ‘unfunded’, which means it’s supported by the government, and it doesn’t have to do valuations regularly.

Even in the Teachers’ Pension Scheme, employer contributions have risen to two percent more than our employers currently contribute. So, while we can’t directly compare schemes, other defined benefit schemes are experiencing the same issue of costs increasing to provide the benefits promised, resulting in increasing contributions.

We’ve given the Scheme Actuary’s Rule 76.1 report and the trustee’s contribution determination to the JNC. At UUK’s request, we have also provided illustrative examples of how the current contribution rate (30.7% of payroll) could stay as it is by changing the benefit structure. Benefit design however is a matter primarily for the JNC to consider.

The JNC now has until early June (or such other longer period as the trustee may allow), to decide how the cost of the increase should be met, through the design of the scheme’s benefits and its contribution structure.

UUK plans to consult employers on covenant support measures, contributions and benefit options in the coming weeks.

The trustee will review the funding assumptions if different covenant support measures and/or benefit structures are proposed by the stakeholders as a result of this consultation.