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29 November 2021

There is no silver bullet in the UK’s pension dispute

The following article was first published by Times Higher Education on 26 November 2021.

Passions are running high in the debate over UK university pensions. This is wholly understandable: pensions are an important influence on the financial security of members and their families and on the financial stability of many academic institutions. We all wish to provide the best possible outcome, but we must deal with the world as it is, not as we wish it would be.

Some opponents of the proposed changes to the Universities Superannuation Scheme (USS) have focused on a particular issue: the valuation date of 31 March 2020. They believe the solution is a 2021 valuation – which would be the scheme’s fourth full actuarial valuation in five years. It is argued that the 2020 valuation was fatally undermined because it was carried out in the early days of the pandemic, when global markets were crashing. Since financial markets have now recovered, a new valuation would yield a much brighter conclusion, resulting in less need for reductions in benefits.

We would, of course, wish to carry out a fresh valuation if this were true. But this argument is based on a misinterpretation of our valuation process and approach. Under existing legislation, we are required to compare the scheme’s assets against its liabilities at a date in time. But the prudent conclusions and outcomes we have reached regarding the contributions required of members and employers do not hinge on the lottery of what happened in the markets on one day in March last year. The ensuing 18 months have been spent making balanced decisions that are informed by subsequent developments. At all times, assets and liabilities need to be looked at together.

The scheme’s deficit had quadrupled from £3.6 billion on 31 March 2018 to more than £14 billion on 31 March 2020. Some of this deterioration occurred pre-pandemic, although the value of USS assets did fall sharply when Covid-19 struck – from £74 billion at the beginning of March 2020 to as low as £64.3 billion by 18 March, before recovering to £66.5 billion by 31 March.

Despite this, the contributions required from employers to close the deficit for the 2020 valuation have been set at 6.3% of payroll – just 0.3% higher than under the 2018 valuation. This is made possible by a long recovery plan, taking 18 years to get to full funding (eight years longer than under the 2018 valuation), and by assuming higher returns over that period as asset values recover.

Two key factors support this outcome. Over two years, we’ve negotiated hard with Universities UK to secure very substantial commitments from employers to the scheme. This gave us the confidence to consider more optimistic assumptions, knowing that the employers would be there to pick up the difference if required. Second, the value of the scheme’s assets has more than recovered, giving confidence in the assumptions in our recovery plan.

However, the stock market turmoil on 31 March 2020 also meant that asset prices were low. If you invest when an asset is relatively cheap, you can expect to make more of a return on it in future. That meant the outlook for future expected investment returns was unusually high on 31 March 2020. Higher expected future investment returns lower the cost of funding new benefits in the scheme. While the deficit is lower today than on 31 March 2020, the price of the assets we can buy with today’s contributions are that much higher. This means we expect to get proportionately lower returns on them in future. An outlook of lower expected future investment returns is now a widely held view among actuarial firms and investment consultants.

Inflation is also key. Members’ benefits increase in value every year to and through retirement, broadly in line with the consumer price index (up to certain caps). So, in relying on investments to pay the benefits promised to members, we need to have sufficient confidence in the returns we can achieve relative to inflation. Expected inflation is also now higher than it was on 31 March 2020. These twin effects increase the prudently assessed cost of funding new benefits, known as the future service cost.

In July 2021, we thoroughly assessed how things looked a year on from the valuation date. If existing benefits continued to be offered, and assuming that the substantial commitments from employers could be carried across, we estimated a deficit on 31 March 2021 of £7.1 billion, deficit recovery contributions of 6% and a future service cost of 36.7%.

Other schemes serving the higher education sector have seen similar issues. Superannuation Arrangements of the University of London (SAUL) reported in 2021 that its future service cost stands at 35% of payroll; it was 21.6% in 2014. In September 2019, employer contributions to the Teachers’ Pension Scheme, of which many employees of post-92 institutions are members, increased from 16.48% to 23.68%. It is also conducting a 2020 valuation.

The Joint Negotiating Committee (JNC), made up of an equal split of representatives from UUK and the University and College Union (UCU), recommended changes (now being consulted on) that would see total contribution to the USS remain at the current overall rate of 31.2% of payroll. In September, the Pensions Regulator shared its view that “the appropriate overall contribution rate should be at least 1% to 2% of salaries higher”.

It should be clear that the prudent conclusions and outcomes we have reached regarding the overall contribution rate required under the 2020 valuation do not rest on the market values of one day. It is incorrect and misleading to claim otherwise.

As trustee, we need to have sufficient confidence that the benefits being promised to members can be paid when due. We hope that the costs of these promises might come down in future, which could potentially allow benefits to improve – but we cannot today depend on it.