Looks at the requirements on pension schemes to take account of the risks and opportunities of climate change in their investments and report on how they have done this
Documents to download
Universities Superannuation Scheme (2 MB , PDF)
The Universities Superannuation Scheme (USS) is the UK’s largest private occupational pension scheme by assets, with £80.6 bn of assets under management in March 2021. It is a multi-employer scheme with 343 participating employers and a total of 476,000 members. It is run and managed by its Trustee (USS Annual Report and Accounts for year ended March 2021).
Following reforms to the scheme introduced in 2016, members build up rights in a defined benefit (DB) scheme (which provides pension benefits based on salary and length of service) up to a salary threshold of £59,883.65 (2021/22). On salary above that level, they build up rights in a defined contribution (DC) scheme (i.e. where the outcome depends on a range of factors – the level of contributions, investment returns, and decisions made at retirement). Information for scheme members is on the USS website, as are scheme rules.
Members contribute 9.6% of their salary to the scheme, employers 21% (30.7% in total).
Scheme funding requirements
Like other private sector DB schemes, the USS is funded. This means contributions from scheme members and employers are paid to a fund which is invested and used to pay pensions to pensioner members.
Funded DB schemes are required to conduct valuations every three years. This involves an actuary estimating the value of the scheme’s assets and liabilities (the cost of the pension promises that have been built up). If the result is that the scheme is in deficit (assets are less than the liabilities), the Trustee must draw up a ‘recovery plan’ to repair this and submit the plan to the Pensions Regulator.
The outcome of any valuation is sensitive to the assumptions made (for example, about how long scheme members will live, earnings growth, investment returns and the extent to which participating employers are willing and able to increase financial support if needed). Also critical is the “employer covenant,” which represents the extent of the employer’s legal obligation and financial ability to support the scheme now and in the future, including dealing with downsides such as a deterioration in the funding position. This informs the trustee’s approach to investment risk (TPR, Code of Practice No 3, para 61-2).
The legislation for the pension scheme funding regime is in the Pensions Act 2004, Pt 3 (as amended) and the regulations made under it. The Pensions Regulator (TPR) is responsible for regulating scheme funding in accordance with its statutory objectives (which include protecting the benefits of pension scheme members and reducing the risk of calls on the Pension Protection Fund) (PA04, s5). The aim is not to “eliminate all risk to members’ benefits” but rather to “strike a reasonable balance” between the demands on the employer and the security of member benefits (Cm 9412, Feb 2017, Executive Summary). For more detail, see Defined benefit pension scheme funding, Commons Library Briefing Paper, CBP 4877, July 2021.
USS valuation process
The valuation process for the USS is complex, reflecting its nature as a multi-employer scheme:
- The Trustee starts the process one to two years in advance of the valuation date with an assessment of core assumptions, such as participating employers’ attitude to investment risk and their willingness and capacity to increase support for the scheme. Universities UK (UUK) consults employers as part of this process.
- Once the valuation has been done, the Joint Negotiating Committee (made up of an equal number of nominees from UUK and the University and College Union (UCU) and an independent chair) determines how any contribution increases should be shared between employers and scheme members, and/or to recommend benefit changes to manage any deficit.
The rules of the scheme ultimately enable the Trustee to impose contribution rates, a feature that is unusual in DB schemes (Joint Expert Panel report, December 2019, Annex 6).
The approach taken to risk in valuations of the USS has been the subject of intense debate in recent years. Other things being equal, a more cautious approach to investment risk will require a higher level of contributions to fund a given level of benefits, because the expected return on assets is lower.
For the 2017 valuation, the Trustee said it was “required by law to set assumptions prudently for the valuation” to allow a margin in case of adverse experience. On this basis, the USS had a deficit of just over £5bn. Taking a less cautious approach would have given a very different result. For example, on a “best estimate” view (a 50% probability that investment forecasts are met or exceeded), the scheme had a surplus of £8.3 billion. Under the Trustee’s proposals, the contribution rate would need to increase by six to seven percent to meet the cost of the current package of benefits (USS 2017 Actuarial Valuation. Consultation with UUK, 1 Sept 2017 p6-22).
In September 2017, UCU published a report by First Actuarial arguing that a focus on the flow of cash in and out of the scheme was helpful in showing what investment returns were needed. Its analysis showed that the “benefits of the USS can very nearly be paid from contributions, without reliance on the assets. There is no need to change either the contribution rate or the benefits to have a prudent funding plan. The strong likelihood is that the USS can be invested to outperform the return required to safely deliver the benefits.” The approach taken by the Trustee risked a vicious circle. It had responded to employers’ concern that contribution rates should not increase by setting a higher funding target and lower investment risk – two actions which are guaranteed to put the employers’ contribution rate up (Progressing the valuation of the USS, First Actuarial, September 2017, p7 and conclusion).
In response, the Trustee said the approach proposed by First Actuarial contained an unacceptable level of risk. Positive cash flow could not by itself justify taking more risk (USS Trustee, Response to First Actuarial Report on Technical Provisions consultation). UUK said the Trustee had a legal duty to take a “prudent” approach, taking into consideration possible risk exposure to employers of an adverse scenario. It said that “even if it were lawful, the approach proposed by First Actuarial would place much too great a risk on employers and would not provide sufficient evidence that accrued benefits are secure.” (USS valuation – questions and answers, UUK, Feb 2018, p15).
On 14 November 2017, the Trustee said UUK’s response to consultation had indicated that it should take a more cautious approach still – increasing further the deficit and the level of contributions required (UUK responds to USS consultation, p2; UUK statement on risk, 28 March 2018).
Pension benefit cuts were proposed and there was industrial action in early 2018. Talks at ACAS concluded on 12 March 2018 with UUK and UCU agreeing to retain a less generous defined benefit scheme for three years from 2019 and, for the future, to investigate different models of pension provision in which there was greater sharing of risk between employers and employees (such as Collective Defined Contribution). This agreement was rejected by UCU members on 13 March 2018.
On 23 March 2018, UUK and UCU agreed to set up an independent expert panel to review the 2017 valuation. Its work would “reflect the clear wish of staff to have a guaranteed pension comparable with current provision whilst meeting the affordability challenges for all parties.” Current contribution rates and pension benefits would continue until at least April 2019.
Joint Expert Panel
In its first report published in September 2018, the JEP said the flow of cash in and out of the scheme was positive (contributions exceeded the cost of pensions in payment) and was projected to remain so for the next 50 years. Together with the strength and long-term nature of the higher education (HE) sector, this meant that, unlike the vast majority of occupational scheme trustees, the USS Trustee could afford to take a very long-term view. The JEP recommended adjustments to the 2017 valuation which it said could have a material impact on the scale of the estimated deficit and the required contribution increases (Report of the Joint Expert Panel, September 2018).
The Trustee agreed to conduct a further 2018 valuation, to allow time for the JEP’s recommendations to be considered. In the end, it accepted two of the recommendations but rejected four on grounds that they would have introduced additional risk and TPR had said the 2017 valuation was already “at the limit” of complying with the legal requirement for prudence. The Trustee said again that prudence was a legal requirement and reflected the “nature of the financial commitments being made to USS members” (The Joint Expert Panel’s recommendations. Prudence in the 2020 valuation, USS briefings, March 2021).
In its second report published in December 2019, the JEP recommended changes to the valuation process more generally which it hoped would foster a more co-operative environment. Its chair, Joanne Segars OBE, called on employers, unions and the Trustee to come together to make this work, saying “it would be failure for Scheme members, sponsoring employers and the sector if our recommendations are not seriously considered” (Report of Joint Expert Panel, December 2019). The report was followed by a series of Tripartite meetings which resulted in changes to the valuation process, such as the agreement of shared valuation principles. The Trustee said in an update in March 2021, “there are still issues on which we disagree”, reflecting “differences of opinion, perspective and duty”(USS: the Joint Expert Panel’s recommendations, March 2021). These are differences are being tested in the course of the 2020 valuation.
In an update on the 2020 valuation in March 2021, the Trustee said that the deficit in the scheme had increased and would require increased commitments from employers. It presented UUK with different scenarios for the estimated deficit (ranging from £14.9 bn to £17.9 bn) and the required contribution rates (ranging from a total of 42.1% to 56.2%), each depending on the support measures employers were prepared to put in place (USS, Update on the 2020 valuation, March 2021, Table 2).
In April 2021, UUK launched a consultation on a package of proposals (comprising increased employer support and reductions in benefits for future service) designed to keep total contribution rates at 30.7%. Additional employer support was necessary because the Trustee was otherwise prepared to impose “impossible contribution requirements regardless of the impact on members and employers:”
Whether we agree with the rationale or not, it is clear from the scenarios set out that the USS Trustee is prepared to insist that the scheme deficit is paid off quickly – something which is materially (and disproportionately) detrimental to the immediate generation – if employers do not provide the covenant support measures the USS Trustee has requested.
The proposed employer support measures were: a moratorium on exits from the scheme, new arrangements for the monitoring of debt levels among USS employers, and the granting of equal security for the scheme on any new secured debt. Benefit reductions were also proposed, with the aim of enabling contribution rates to remain at their current levels. UUK also called for a review of scheme governance, saying “trust and confidence in the scheme have been strained in recent years” (The USS 2020 valuation. Finding the right solution, UUK, April 2021, summary and section 3).
On 21 July 2021, UUK said employers had agreed to provide additional financial backing. The Trustee had confirmed that this would enable contribution rates to remain very close to current levels, assuming UUK’s package of benefit reductions was implemented.
UCU called for UUK to join it in calling for a new 2021 valuation to replace the “flawed 2020 valuation” or face a ballot for industrial action:
UCU’s and UUK’s advisors have criticised USS’s methods and assumptions and the choosing of 31 March 2020 as the date to value the scheme, when markets were crashing due to the pandemic. The joint expert panel of pensions specialists that UCU and UUK set up has shown that defined benefits are affordable (UCU responds to UUK statement on USS support, 21 July 2021).
The next step is for the Joint Negotiating Committee (made up of employer and union representatives) to agree changes, which it has said it will do by the end of August (202O valuation timetable – USS website).
Documents to download
Universities Superannuation Scheme (2 MB , PDF)
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