The UK’s Universities Superannuation Scheme (USS) has set out to sponsoring employers its thinking so far about the methodology and investment strategy for its 2020 valuation, including changes such as implementing a dual discount rate approach and taking more investment risk in the long-term.

According to USS, a dual discount rate approach is, all else being equal, more likely to lower the contributions needed to fund future pension promises than a single discount rate approach, and may lead to greater stability of contributions over time.

USS is at the centre of a long-running dispute between employers and members about the rising cost of university pensions. This week universities are due to face the last of 14 days of strike action by members of trade union University College Union (UCU), including over pensions.

USS missed the statutory deadlines for the 2017 and 2018 valuations by a number of months due to delays in decision-making by stakeholders. In a bid to avoid a similar fate for the 2020 valuation and recognising challenges ahead, USS yesterday issued a technical discussion document to sponsoring employers – four months before the start of formal consultation with Universities UK (UUK), which represents employers.

There will be a six-week engagement phase about the proposals included in the document, with employers asked to provide UUK with their feedback on the questions raised by 17 April and to share their responses with USS.

Covenant, risk appetite views key

Reflecting feedback from stakeholders and recommendations made by the joint expert panel (JEP) appointed to try to find a solution to the USS dispute, the discussion document proposes several potential changes, including:

  • alternative ways of assessing the strength of the scheme’s covenant to further inform the employers’ risk capacity;
  • determining an investment strategy that is better aligned with risk appetite; and
  • using a pre- and post-retirement dual discount rate approach aligned with the choice of investment strategy.

The scheme emphasised that, together with market conditions as at the valuation date of 31 March 2020, responses from employers on the key issues of covenant and risk appetite would have a significant bearing on the outcomes of the 2020 valuation, whatever the methodology.

“The views of employers on the key issues of covenant and risk appetite will be hugely important”

Bill Galvin, USS Group chief executive officer

Bill Galvin, USS Group chief executive officer, said: “The views of employers on the key issues of covenant and risk appetite will be hugely important and will influence the decisions we need to make in May ahead of the more formal consultation stages.”

He emphasised that USS had not made any decisions.

“We will consider feedback and alternative approaches with an open mind, in the context of the fiduciary duty owed by the trustee to ensure pension promises made are secure,” he said.

With regard to employers’ covenant, USS said it is aiming to secure its covenant rating of “strong” and to be confident that it will stay like this for at least 30 years.

It is,therefore, asking employers if they support measures discussed during the 2018 valuation to protect the covenant: debt arrangements, pari-passu arrangements for new debt, and a permanent rule change on employers exiting the scheme.

On investment strategy, USS has proposed an approach based on combining a low-risk investment strategy for pensioners and a growth strategy for active and deferred members before they reach retirement. The dual discount rates, an approach suggested by the JEP, would necessitated by such an approach.

“The net effect”, said USS, “is an investment strategy that, relative to the 2018 approach, takes less risk in the short-term and more risk in the long-term”.

Market conditions and trigger events

In a note to the heads of sponsoring employers about the valuation discussion document, USS drew their attention to current market conditions, and the likelihood that these would remain volatile in the short to medium-term.

It noted that USS was currently running very close to its risk limits, which made it more challenging to assess the longer-term implications for its funding position of temporary or permanent changes to the prospects for economic growth and returns.

Against this backdrop, it revealed that USS had last week narrowly avoided a trigger event – the ratio of the self-sufficiency deficit in the scheme to the present value of 10% of employer payroll contributions over 30 years exceeding 85% for five consecutive days – that would have required the trustee board to consider “the appropriate response”.

“It is therefore reasonably likely that the trustee board will have to respond to such a trigger event in the near future, and perhaps even before the March 31 valuation date,” the scheme said.

“Following a formal trigger event, if the trustee board considered that a short-term response was required, the available responses might include an accelerated valuation, a request for higher contributions sooner than October 2021, an acceleration of the ‘de-risking’ path envisaged under the 2018 valuation or a combination of the above.

“We will continue to monitor these conditions and to keep you informed of the trustee board’s considerations.”

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