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19 June 2019

Rarity value

This article was originally published by Times Higher Education on Tuesday 18 June 2019.

Defined benefit pensions have long been a valued element of the total reward enjoyed by colleagues in the higher education sector.

For those who hold the promise of a defined benefits pension, it is likely to be the most valuable asset they will possess, providing certainty of a fixed income for life in retirement, a high level of protection against inflation and dedicated financial support for dependants at critical life events.

But the challenge of fulfilling a legally binding promise at a time of significant uncertainty is precisely why – outside the public sector schemes whose pensions are paid for by taxpayers – defined benefit schemes are increasingly rare. The objective price of “guaranteed” benefits have been made much more expensive than in the past by a combination of record low interest rates, an outlook of “lower for longer” future investment returns, and the fog surrounding the global economy.

The vast majority of the UK’s private defined benefit pension schemes are now closed, either to new members or in full: USS accounts for nearly a sixth of the people still actively paying into the schemes that remain open.

But the price of certainty in delivering the extremely valuable pension promises being made by USS is now higher than at any point in the scheme’s history. The resources of our sponsoring employers may be considerable but they are not limitless, and they are subject to uncertainty themselves. We need to think only of the potential impacts of the Augar Review, Brexit, the next spending review and the competition for student recruitment to understand the challenges faced by universities and their governing bodies.

The fundamental question faced by any trustee carrying out a valuation today is, therefore, how can it secure the certainty of a defined benefits promise when, economically and politically, these are such uncertain times. The increased legislative and regulatory protections now in place for defined benefit pensions mean that this is no longer a question of restrained optimism (as it might arguably have been in the past). It is, rather, how wrong can we afford to be?

Apart from the value of the assets we currently hold and the cost of more certain investments, such as government bonds, almost everything else is an estimate and subject to change. We can look to the past and to predictive models for guidance on how interest rates, investments, financial markets and key demographics might evolve, but this can only inform a judgement about an inherently unknowable future.

Uncertainty serves to increase the premium for insuring defined benefit pensions, and the independent conclusion of the USS trustee is that the contributions required today must increase to respond to this. Here, we are not alone. Even the Teachers’ Pension Scheme, whose pensions are “unfunded” and are, in that sense, a direct call on the taxpayer, is significantly increasing the contributions required to fund its defined benefits pensions.

We are acutely aware of the value of the USS pensions promise to the attractiveness of the higher education sector as an employer. The trustee is determined to ensure that this continues and that pensions promised by the USS are seen as secure, regardless of the future prospects of individual employers or the sector as a whole. This must be in the long-term interests of members and the sector.

We acknowledge the challenges in levying higher contributions – that is why we have worked very hard to find ways in which these can be escalated gradually, or made contingent on events. The process has been painful and contested. Given the scale of the challenges we face, this is understandable. The trustee, though, is in a unique position where it is required to make objective judgements. It must operate in a regulated environment, it must have regard to its fiduciary responsibilities, and it must be prudent.

Because of the nature of the benefits we underwrite, the trustee must consider the possibility of adverse scenarios as well as positive. In short, we must ensure that the promises being made to our members will continue to hold their real value.

Professor Sir David Eastwood is chair of the Universities Superannuation Scheme trustee board and vice-chancellor of the University of Birmingham.