The USS valuation and the question of affordability

Is a USS defined-benefit scheme affordable? Yes, but only if USS drops its ‘recklessly prudent’ approach to valuation.

In September 2017 USS proposed a valuation of the scheme’s assets and liabilities. They concluded that if the scheme was to continue providing pensions at their current level there would need to be an increase in both employer and employee contributions to the scheme. Employers contributions would have to increase by about 4% (from 18% to around 22%), and employees would have to increase their contributions by about 2% (from 8% to about 10%).

This valuation assumed a level of investment risk: making assumptions about what proportion of the fund is to be invested in  riskier assets aimed at growth (such as stocks and property) and what proportion in assets with lower expected returns but assumed lower risk (such as bonds).

UCU’s response to the September valuation was to maintain that USS was investing too conservatively. A modest shift towards more growth assets would maintain pensions benefits at their current level with no increase at all in contributions. (Useful discussion of UCU’s response, by Michael Otsuka of LSE here)

In UUK’s consultation on the September valuation, 53% of employers accepted USS’s level of investment risk. 5% agreed with UCU that USS was investing too conservatively. But 42% argued that USS should invest yet more conservatively, even though this would inhibit overall USS asset growth. USS decided to follow the 42% minority and invest more conservatively, accelerating the ‘de-risking’ of the USS portfolio by shifting investment from growth assets to bonds, leading to a revised and more conservative long-term valuation of the scheme’s assets, approved in November 2017 by USS trustees.

The implication of the revised November valuation is that, in order to continue to provide pensions benefits at their current level, employer contributions would need to rise by 7.4% (from 18% to 25.4%) and member contributions by 4% (from 8% to 12%). The employers claim such an increase is unaffordable.

Such an increase is unnecessary. The November valuation is, in UCU’s view, so damaging to returns on investment that it is ‘recklessly prudent’. UCU is calling for a shift to a less conservative valuation, e.g. that adopted in September 2017. A shift back to the September valuation would make it possible to fund the UCU proposal for a slightly modifed Defined Benefit scheme via increases of a little more than 2% in employer contributions and a little more than a 1% in member contributions.

In other words, it would be possible to preserve a pension scheme almost as good as USS currently provides out of a  modest increase in contributions. That the employers and USS trustees refuse to do this, insisting instead on retaining the ultra-cautious November valuation and abolishing defined benefits altogether, is a political choice rather than a financial necessity.