The challenges we face in meeting the cost of funding defined benefits are the same for every pension scheme. In 2019, SAUL reported that “the real cost” of its pensions was about 30.4% of salary, and that its ongoing “contribution strain” had risen from 7% in 2018 to 8.4%. The Teachers’ Pension Scheme, which is ‘unfunded’ and a direct call on taxpayers, has raised employer contributions to 23.68% – two percent more than our sponsors currently contribute and the same as is currently scheduled from next October (23.7%) unless the 2020 valuation results in any changes. It’s a tiered scheme – more details here – but the average salary among USS members is £41k, which falls into the 9.6% member contribution bracket for TPS (what all USS members currently contribute).
In practice, comparisons of the costs and performance of different defined benefit pension funds are far from straightforward. The profile of a scheme’s membership, the relative maturity of a scheme, and the range and type of benefits provided all influence the cost of a £1 of pension. Similarly, investment policies may be set in different contexts and their relative performance will therefore differ across different periods.
The cost of benefits is influenced by a number of underlying factors that might not be immediately apparent at face value.
There can be differences in the make-up of the membership – analysis of scheme-specific experience shows that USS members live significantly longer than an average member of the UK population.
There will be differences in benefits provided, such as the level of death in service and incapacity benefits, and inflation protection. Small differences here can add up to big differences overall to the contribution rate required to fund a scheme’s benefits.
There can also be notable differences in the investments and investment strategies that fund defined benefit pension schemes that can give rise to differences in past and expected future investment performance. For example, a scheme that hedged to a greater extent than USS, and/or elected to de-risk its investment strategy, in recent years will have seen its investments performing relatively better – but this would also lead to an increase in the expected cost of funding benefits in future. Analysis we carried out last year found that if we had not done any interest rate or inflation hedging since 2013, the funding level as at 31 August 2019 would have been about 8% lower.
While we have gradually increased our liability-hedging assets, it would not have been realistic – given market capacity issues – for a scheme of our size to have approached full hedging of our liabilities, even if our sponsoring employers said they wanted us to pursue such an approach. Employers have been clear in the past, when we consulted on our statement of investment principles, that they supported a gradual shift in portfolio risk, rather than a short-term hedging strategy.
USS has been consistent with the investment strategies consulted upon with employers – and has performed well: the DB fund (the Retirement Income Builder) grew by £17 billion to £66.5bn over the five years to 31 March 2020. Investment returns averaged 6.19% pa (worth £17.4bn) - 0.91% pa ahead of benchmark (worth £2.74bn). Our in-house investment team and their strategy significantly reduced asset value volatility compared to their benchmark during this period which means the asset value reduction was more modest (some £2.7bn ‘better’) than the ‘passive’ benchmark at 31 March – in the middle of the market turmoil. The team has also delivered strong investment returns for less than it costs other schemes: the most recent independent analysis found that our investment management costs were equivalent to £49m a year lower than our peers (funds of a similar size and complexity).