Is there a good outcome from the USS 31 March 2020 valuation?

This blog comes courtesy of David Spreckley from Isio’s Public Service pension team.  Isio is the former pension function of KPMG comprising around 500 pension professionals.  Isio has advised widely within the Higher Education sector, including extensively on USS issues.

Even the lowest contribution rate in the USS consultation is likely to be unacceptable. So how can an agreement be reached and what could this look like? We pose several questions to home in on a possible outcome. 

Can the lowest USS contribution rate be squeezed?

Aon’s advisory note suggests the lowest total contribution rate of 40.9% could be reduced to around 33% with a longer recovery period.   Given the regulatory backdrop, this might be a difficult outcome for UUK to achieve.

A total contribution just north of 50% (sitting at the lower end of ‘strong’ covenant rating) feels most likely, taking into account employer support discussions and the challenging backdrop to the Autumn covenant review.   A longer recovery period might help but, even if the USS allows it, there is still a funding gap to bridge.

What shape could benefit reform take?

A move to DC will be contentious.  Academics have successfully protected their DB pensions over the last three years – removing DB could motivate academics into damaging strike action.

Continuation of DB accrual at a meaningful level is desirable for both members and employers, but can reform around DB be enough to bridge the funding gap?

What level of Deficit Reduction Contributions are likely to be acceptable?

Employers have legally committed to increase deficit contributions to 6% of pay from October 2021 and perhaps this represents a baseline.  But even a 6% deficit contribution leads to an unaffordable outcome unless strong reliance is placed on employers for the future.

If USS was a single employer trust the USS would almost certainly be looking for security.  The employer would also be thinking about how best to use its assets.  

Asset Backed Funding is a relatively employer friendly approach giving the pension scheme certainty over contributions.  This would enable a longer-term view and lower contributions and could be delivered at scale via the USS.

What impact will ‘cost-sharing’ have?

A cost-sharing mechanism that applies to both future and past service costs leads to perverse outcomes when stretched – how reasonable is it really to ask a young academic to fund pension shortfalls of older colleagues?  

Given the size of deficit, UCU could make a reasonable case that cost-sharing is broken and so should not be the default on a failure to agree. 

If cost-sharing is broken, what then?

The financial case for moving to low cost DC has never been stronger, but DB benefits are very valuable to members.  

A no detriment position is unrealistic and some reduction to DB looks inevitable - a best-fit benefit provision which provides the most value for money could be covenant enhancing and allow stakeholders to focus on how best to address the past service deficit.

Bringing this together, what does it mean?

Even with a ‘best fit’ benefit reduction and a sensible employee contribution rate, universities could still face contributions of 40% or more unless strong covenant enhancing measures are provided – this is unlikely to be popular with employers.

Allowing for post valuation experience could help, but structuring contributions through a more employer friendly asset backed structure might just enable a landing zone in the mid to low 20% range – still challenging, but not inconsistent with what has already been committed. 

It’s a difficult choice: pay more in cash and keep the balance sheet clean or use the balance sheet to facilitate lower cash contributions.  Finding a way to offer both options for employers (or a blend between the two) on a fair exchange basis might be the last piece of the puzzle.