• Contributions may have to rise to as much as a third of salary.
• A report suggests governance conflicts in USS’s overall objectives.
Given the less-than-healthy state of the UK’s defined benefit pension schemes, it is no surprise that the largest such fund in the country also has the largest deficit.
The Universities Superannuation Scheme (USS) reported just over £60bn (€67.8bn) in assets under management at the end of March this year. However, increasing longevity and, in particular, ultra-low government bond yields have led to liabilities topping £70bn. USS’s official deficit following its 2017 actuarial valuation is roughly £5bn, but other valuations have put the shortfall as high as £12-17bn.
If it were a company pension scheme, the deficit would mean difficult but manageable discussions between trustees and the employer to hammer out a recovery plan. With USS, however, the situation is far more complicated.
The scheme caters for more than 350 academic institutions across the UK, and had more than 390,000 members at the end of March. Universities’ main source of income is tuition fees. Currently, each university student pays an average of £9,188 a year to study for an undergraduate degree, according to analysis by the Student Loan Calculator website published earlier this year.
In the 2016-17 financial year, USS employers contributed 18% of salary to the defined benefit section of the fund, while employees contributed 8%. Following the publication of the annual report, however, USS’s trustee board said contributions might have to increase by as much as 6-7 percentage points in total.
Graduate debt is already a controversial issue in the UK, with both the government and the opposition Labour party recently attempting to court young voters with curbs on student loans. Asking students to pay for retirement benefits they are unlikely ever to replicate for themselves is unpalatable.
Enter Frank Field. The chair of the Work and Pensions Committee, a cross-party group of politicians from the UK’s lower house of parliament, has enjoyed significant media attention in the past 18 months.
In August, Field wrote to several parties involved with USS, including chair of trustees Sir David Eastwood, TPR chief executive Lesley Titcomb, and Janet Beer, president of Universities UK, the higher education sector’s representative body.
Among the questions posed to the trustees about recovery plans and investment policies, Field asked: “What assessment have you made of the strength of the employer covenant and its capacity to bear the necessary burden of deficit repair contributions without passing the cost to students and/or the taxpayer?”
Although its funding position has deteriorated since 2008, USS has not stood still during this period. It has developed a sophisticated in-house investment team, now led by chief investment officer Roger Gray, running nearly three-quarters of the scheme’s total assets.
This shift has helped shave the fund’s investment expenses down from 47bps in March 2014 to 32bps in March 2017, even as the scheme’s assets under management grew by 44%. The in-house team’s running costs made up less than half of the £71m in investment management costs recorded in 2016-17.
USS has also branched out into unlisted assets, acquiring stakes in a UK motorway services company and the Green Investment Bank as well as partnering with Credit Suisse to access private debt markets.
Last November, the scheme hired Peter Elwin to a newly created head-of-research position to support a shift to high-conviction equities. Dutch consultancy Ortec Finance was hired in January to provide asset-liability management services, alongside its existing provision of performance measurement and analysis tools.
In addition, the scheme has switched from a final-salary-benefit approach to a capped career average scheme, a move aimed at reducing future liabilities.
Over three, five, and 10-year time horizons to the end of March this year USS has outperformed its strategic allocation benchmark – but crucially these returns have not kept pace with liabilities as bond yields have fallen and return expectations have been cut.
USS set out three options for addressing the shortfall in its consultation sent out to employers last month: they can increase contributions, pledge contingent assets, or accept the prospect of reducing pensioner benefits at some stage in the future.
Pressure is mounting on USS’s board. On September 19, the Financial Times published a letter co-signed by 54 university academics calling for the scheme to answer questions about its data.
The letter described USS’s assumptions as “curious”, questioning the scheme’s figures for wage growth, future returns and mortality.
“There may be a sizeable deficit, but on the basis of the evidence that the USS has presented, it is impossible to judge,” the academics said.
One large union has argued that these should not be the only options. The Universities and Colleges Union called in the advice of UK consultant First Actuarial, which has also advised the Communication Workers’ Union in its pension negotiations with Royal Mail.
In a report from September 15, First Actuarial’s Hilary Salt and Derek Benstead argued that a short-term focus on keeping risk down had led to a greater chance of more contributions being needed. They put forward that USS could take on more investment risk, as it is still an open scheme.
Salt and Benstead wrote: “The risk is that the more the employers say they do not wish to take risk (where the risk they are mainly concerned about is the risk of their immediate contribution rate going up), the more the trustee interprets this as meaning they must set a higher funding target and lower ‘investment risk’, two actions which are guaranteed to put the employers’ contribution rate up. To control the employers’ cost, the members’ future benefits are then likely to be cut.”
The report will form part of the negotiations between employers, the scheme, unions, and the regulator over USS’s next deficit recovery plan.
Considering its size and the unique nature of its membership, USS should expect this level of scrutiny. How it responds to these and other queries over the next few months as funding negotiations continue will likely dictate whether USS’s CEO Bill Galvin and his colleagues are requested to take a trip to Westminster to face MPs’ questions.