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16 April 2024

The arc of the covenant

When taking investment risk to fund the pensions promised to members, we are relying on the scheme’s sponsors – its participating employers – to effectively underwrite that risk.

More specifically, we are relying on something we call the employer covenant – their collective legal obligation and financial ability to make good the position if, for example, investment returns are lower than required and a funding deficit emerges.

The stronger the covenant, the greater our capacity to take investment risk with appropriate confidence.

And, all things being equal, taking risk is expected to lower the contributions required of members and employers to fund the pensions being promised (because investment returns are assumed to make a greater contribution over time than if we took no risk).

Given the resources of our sponsors are not infinite, there is a limit to the amount of risk we can reasonably and responsibly plan to take in funding the scheme whilst still keeping members’ pensions safe and secure.

In order to make such decisions on risk, we need to assess the strength of the covenant which is a complex judgement.

Changeable competitive, economic, demographic, and political conditions influence the prospects of the UK’s Higher Education sector in future – for better or worse.

We are keenly aware of the financial challenges facing some employers in the UK’s Higher Education sector, which impact some institutions more materially than others.

The subset that forms the USS employer group includes some of the longest-established and most successful universities in the world – but the scheme’s participating employers are different sizes, with different specialisms, and strategies.

We lay out the considerations we take into account in forming a covenant assessment in a little more detail below.

The USS universe

More than 330 employers were participating in USS on 31 March 2023.

They all have a legal obligation to financially support the scheme now and in the future.

In the covenant assessment for the 2023 valuation more than 95% of the scheme’s liabilities were accounted for by the 126 degree-awarding Higher Education institutions that submitted financial data to the Higher Education Statistics Agency (HESA).

We’ve seen speculation about what might happen if one or more of these institutions were to become insolvent – something that has never happened to a mainstream, not-for-profit HE institution in the UK.

It certainly raises some important questions, but a key feature of USS should give us and our members some comfort as far as the security of their pension is concerned; USS is a so-called last man standing scheme. That means if one or more participating employers were to become insolvent, their share of the scheme’s liabilities would fall to the remaining employers.

But the different dynamics in play across the HE sector do give us food for thought as trustee when it comes to how the scheme will be funded in future.

USS is among the 9% of private defined benefit (DB) pension schemes in the UK still open to new members. According to the Pension Protection Fund, USS members now account for almost a third of the fewer than 740,000 people in the UK still actively paying into a private DB scheme.

As an open scheme, one of our primary considerations in thinking about the covenant is the ability of employers to fund the scheme on an ongoing basis through regular payroll contributions. That is, whether the contributions required are affordable, sustainable, and do not have a significant impact on employers’ core activities.

We also need to consider if and how those changeable conditions I mentioned earlier could affect the ability of employers as a whole to support the scheme over time.

Consistent with this, the covenant assessment considers a range of factors relating to our specific employer group including balance sheet strength and financing arrangements, profitability, cash generation, market position and outlook.

Assessing the covenant

We monitor developments in the HE sector on an ongoing basis, by keeping abreast of news and engaging with employers and their representative bodies, and report our findings quarterly to the USS Board. We review employers’ financial data in detail every year using, primarily, the financial data published in April by HESA which aggregates the financial statements of all UK Higher Education Institutions for the last financial year. We also survey employers directly each Spring to gather additional information not included in the HESA data.

We commission an in-depth review of the strength of the covenant at least every three years to inform the scheme’s full actuarial valuations.

Our most recent assessment (for the 2023 valuation) was conducted by our covenant adviser, PwC, based on interviews with a representative sample of employers that encompassed detailed reviews of historical and forecast financials and analysis of potential downside scenarios. We overlaid this with advice from UK HE sector specialist adviser Nous who provided analysis of the outlook and prospects of the sector, including key risks and opportunities.

PwC’s advice was that, in its opinion, the scheme’s employer covenant is Strong. This is the highest rating in the 4-point scale (Weak, Tending-to-Weak, Tending-to-Strong and Strong) that it and The Pensions Regulator (TPR) use to assess covenant strength. TPR agreed with our overall covenant rating for the 2023 valuation.

PwC made a number of points in its assessment of the covenant, notably:

  • Its positive structural characteristics including sector-wide coverage, its joint-and-several, mutual nature (i.e., the last man standing structure), its single contribution rate linked to eligible payroll, and the strong international competitiveness of USS employers.
  • The growth and financial performance of USS employers – their liquidity and balance sheet position since the 2020 covenant assessment – were stronger than expected, despite the considerable obstacles to performance presented over that period by the COVID-19 pandemic. This illustrated their substantial financial and operational flexibility and resilience.

There were seven dimensions to PwC’s assessment – six of which were rated strong.

Forecast performance for USS’s employer group was the only aspect rated as tending-to-strong. PwC noted that, while their financial position and performance had improved compared with the 2020 valuation, sampled employer forecasts indicated a period of declining profitability and moderately negative cash flow over the medium term.

Six of the seven dimensions (including Forecast performance) had improved between 2020 and 2023.

Nous advised that the UK’s HE sector remains well-positioned in the global market, it expects the sector (and most USS university employers) to continue to grow by capitalising on strong international demand over the next 30 years, and it sees capacity within the sector to implement cost savings to mitigate potential future shocks.

It’s important to be clear here that in taking a 30-year-view, we aren’t assuming the HE sector will look entirely the same (or even that particular institutions won’t come under real stress). We are instead considering if it is likely to continue to be capable of supporting the scheme on an ongoing basis.

Our conclusion that the covenant is strong overall takes into account that there are important differences between institutions and the operating environment can present greater challenges for some institutions than for others.


Three main risks were explored with the sample of employers we spoke to as part of the 2023 covenant assessment as potential downside scenarios within PwC’s analysis of USS employers’ expected future performance:

  • Disruption to the ability of Chinese students to attend UK universities.
  • Disruption to the ability of international students in general to attend UK universities.
  • An extended period of higher-than-expected increases in staff rates of pay.

Our sample was also asked to consider a combined scenario involving both disruption to international student mobility and higher-than-expected pay increases. The downside scenarios considered were significantly more severe than any subsequent developments have been in practice.

All the institutions that modelled these scenarios found that, while there would be challenges, they had the means to mitigate them and remain viable in all cases – a finding that underscored the resilience of the USS employer group.


The scheme’s 2023 valuation reported a funding surplus of £7.4bn and resulted in employer contributions falling from 21.6% of payroll to 14.5% (the difference being worth around £710m a year to USS’s employer group as a whole).

The reduction in employer contributions came into effect on 1 January 2024. We expect this will provide some relief for employers that may be struggling to manage the effects on operating cost of recent high inflation and other dynamics.

Key takeaways

  • As an open private DB scheme, our approach to funding and risk is based on the ability of participating employers as a whole to support the scheme on an ongoing basis.
  • The so-called last man standing feature of the scheme provides considerable protection for members’ benefits.
  • USS’s last valuation reported a £7.4bn funding surplus, and the reduction in employer contributions introduced on 1 January 2024 is worth around £710m a year in total to our participating employers.
  • While we are keenly aware of financial challenges facing some employers in the UK’s Higher Education sector, we note they impact some institutions more materially than others. The subset that forms USS’s employer group includes most of the longest-established and most successful universities in the world.

Richard Barker
Covenant Lead