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Risk in the time of Corona: USS deficit hit £37bn at lowest point

Image: Martin McQuillan for Research Professional News

Universities asked to commit to pension scheme for the long term as shortfall grows

During market turmoil in March the deficit the Universities Superannuation Scheme faces if all employers cease contributions reached £37.4 billion, a USS spokesperson has confirmed. It has since recovered, but only slightly.

With stock markets taking a pounding during the Covid-19 pandemic, £10 billion was wiped off the value of the University Superannuation Scheme last month. In a letter to employers on 30 March, USS chief executive Bill Galvin called on universities to pledge their long-term commitment to the scheme.

He is seeking approval for a rule change that will stop institutions exiting the pension arrangements. “Without a rule change, we will need to reduce our appetite for investment risk. This will have a material impact on the [2020] valuation outcome,” which he confirmed would go ahead over the next 15 months.

However, Research Professional News has learned that the deficit in the pension fund may be bigger than first thought, with one measure hitting £37.4bn on 12 March, the day the pension scheme was forced to self-report to the Pensions Regulator.

In his letter to employers Galvin said, “the scheme’s ‘technical provisions’ deficit in respect of past service benefits has increased substantially from the £3.6bn established by the 2018 valuation, measuring over £11bn in recent days”. The USS trustee board has chosen not to take corrective action at this point but to review contribution rates as part of the latest valuation.

The announcement on 30 March of a £11bn deficit refers only to the ‘technical provisions’ (TP) of the scheme, the method whereby USS identifies the contribution rate required to fund the defined benefit section of the scheme.

This requires scheme managers to provide a best estimate for future returns in the fund’s investments. USS is required by law to be prudent in its own valuations and sets the Technical Provisions using an estimated 67 per cent probability of achieving or bettering expected investment returns—a 50 per cent probability rate over 30 years is a more common assumption for investment success.

The effect of this probability assumption is to reduce the value of the investment returns needed in any budget calculation for funding existing benefits. However, there remains an estimated one-in-three (or 33 per cent) chance that future investment returns will not be enough to cover liabilities.

A TP calculation assumes the scheme will remain open and employers and members continue to make contributions. It also assumes that the USS will have ongoing recourse to employers to make up any shortfall if investment returns failed to meet expectation.

However, the pension scheme also has a ‘self-sufficiency’ measure of how much funding would be needed to pay all existing liabilities were employers unable to make future contributions. This is agreed with the Pensions Regulator as a 5 per cent risk rate, meaning that USS undertake that there should be a 95 per cent probability of the scheme being able to cover all liabilities in an adverse scenario.

While a 5 per cent risk rate is considered high for the pensions industry, USS managers are confident that they would be able to pay existing benefits on this basis.

At the 2018 valuation date the scheme was £20.8bn short from being able to deliver a self-sufficiency plan if required. A £3.6bn deficit was identified in the technical provisions at this time.

The size of the self-sufficiency shortfall, after a month of stock market losses, reached a low of £37.4bn before recovering slightly in recent days. On 12 March the TP deficit was £12.1bn, that has now bounced back to £11bn. USS is unable to provide an exact figure for the self-sufficiency deficit as of today.

The difference between technical provisions and the self-sufficiency measure identifies the reliance of the USS scheme on the continuing commitment of employers to cover the gap. This is known as the employers’ covenant—the willingness and ability of universities to support the scheme.

USS is considered to have a strong covenant because of the longevity of higher education institutions. However, USS uses the self-sufficiency calculation as its proxy for how risky the scheme is to fund.

The primary objective and legal responsibility of the trustee board is to ensure that the benefits members have already built up can be paid as and when they fall due. The second objective of the board is for USS to remain open and affordable and open to members.

However, legally this second objective cannot be at odds with the board’s main fiduciary responsibility to existing liabilities.

Funding defined benefits on a self-sufficiency basis may be prohibitively expensive and so any pension fund board must try to strike a balance between being able to evidence a self-sufficiency option for the scheme while taking account of what employers and employees can afford to pay in contributions to keep the scheme open.

Research Professional News has been told that a self-sufficiency strategy would only become the USS trustee board’s target in extreme circumstances, but at the same time it is legally obliged to ensure sure that the benefit promises that have been made to members can always be kept even if the fund’s investments take a downturn.

Members of the University and College Union at 52 universities went on strike for a total of 22 days this academic year in protest at contribution rises in the pension scheme. Contributions have already grown to 9.6 per cent for staff and 21.1 per cent for employers and are due to grow to 11 per cent and 23.7 percent respectively in October 2021.

In his letter to vice-chancellors on 17 March, Bill Galvin said: “We will not rush to judgement on how to deal with the current circumstances. We will remain vigilant and continue to monitor market indicators; we will continue to monitor the way in which the sector’s potential support for the scheme in the long and short term might be affected; and we will keep you informed of the Trustee Board’s considerations.”

Speaking yesterday, a USS spokesperson said: “In common with our peers, we are dealing with extremely difficult short-term conditions—but any decisions we take now should be consistent with our long-term strategy to secure members’ benefits and protect the sustainability of the scheme. We recognise the challenges presented by Covid-19 and will keep the valuation timetable and process under regular review, being flexible where we can.”