Is there really a black hole in the USS? It depends on your assumptions

The case for restructuring the Universities Superannuation Scheme is ever-weakening in the face of analysis from academics, actuaries and economists. It is also the subject of an application to court, issued before the chair of the USS board, Dame Kate Barker, published her article in Times Higher Education defending the board’s insistence that benefits need to be cut and or contributions increased. The High Court is now an appropriate forum for testing the bases of the board’s proposals, but the chair’s highly contestable claims, published last week, cannot stand unchallenged. Like any quantitative analysis, the USS’ claims depend on assumptions. Let us examine eight of them in more detail.

A 2021 valuation would not make any difference
Even under the implausible assumptions that the USS used for the March 2020 valuation, the board estimates the scheme’s deficit to have halved, to £7 billion, by March 2021. However, the USS claims a 2021 valuation would make little difference to the amount members would have to pay in future. This is partly because, rather than paying off the deficit over 18 years, as in the 2020 valuation, the trustee would contract that period to a maximum of 13 years. It has not explained why.

Is there even a deficit at all? The £7 billion figure assumes a reduction in the rate of return from the already implausible 0.29 per cent + CPI used for the 2020 valuation to a truly dismal 0.02 per cent + CPI for a 2021 valuation. Both rates are far lower than has ever occurred for a globally diversified portfolio since records began in 1870. They are lower than the 0.9 per cent + inflation investors received between 1890 and 1920. In this period, about 20 million people died in a highly destructive world war and 50 million died from the Spanish flu pandemic (for which there was no vaccine). Is it reasonable to assume that future returns will be so low?

The USS’ deficit quadrupled from 2018 to 2020
The trustee radically changed its assumptions between the 2018 and 2020 valuations, assuming far worse investment returns, from the already low 0.92 per cent + CPI to 0.29 per cent + CPI. Little credible evidence has been provided to support this change, despite about 4,000 members demanding answers in a formal complaint. Had the 2020 assumptions been similar to those made in 2018, the scheme would not have a deficit.

The USS assets fell in March 2020
The chair notes that the value of the USS’ assets fell from £74 billion at the beginning of March 2020 to £67 billion by March 2021. Strangely, she fails to mention that it increased by more than £23 billion, reaching almost £90 billion, by August 2021: more than any estimate of the deficit in March 2020.

Throughout the 2020 valuation process, the USS stated to both employers and members that final recommendations would integrate the latest data on asset values. However, the USS’ actuary took no account of these changes when signing off the contribution rates. Why? Is this in members’ interests?

The USS has extracted meaningful covenant support
Over the past two years, the trustee has absorbed a great deal of university managers’ and staff’s time negotiating a series of rule changes designed to give it more confidence that employers would support it if it ran out of money. These changes include locking in employers for 20 years (very few employers could afford to leave anyway) and a process for monitoring universities’ debt. As a result, rather than reducing the assumed rate of return from 0.92 per cent + CPI in 2018 to 0 per cent + CPI, the USS has generously offered to only cut it to 0.29 per cent + CPI. But given that most of the employers’ assets have always stood behind their covenant to the USS, the benefit of these changes seems marginal: surely effort would have been better expended on other issues?

Short-term movements in asset prices predict long-term returns
The chair claims that because the price of assets has increased since March 2020, we should expect real-terms returns to be lower in the long term. However, there is little evidence that short-term asset price movements strongly predict future long-term asset returns for growth assets such as company shares.

The Pensions Regulator thinks rates should be higher
The regulator has made several statements and recommendations about the USS and its valuation. However, to date, it has not backed them up with quantitative evidence. Moreover, at no point has it used its power to mandate the USS trustee to do anything. If it did recommend that the trustee do something detrimental to members (such as assuming a rate of return that is wildly implausible and astronomically costly), should the trustee not use its own judgement to reform the USS, rather than meekly comply?

Higher future inflation increases the costs of providing defined benefits
High inflation would appear to be good for the scheme, as it would erode the real value of its promises – members’ pensions. However, real investment returns are generally considered not to be strongly related to inflation: in economics, this is known as “money neutrality”. The Chancellor of the Exchequer could easily increase the UK’s inflation target, but this is unlikely to greatly change the real rate of return on a globally diversified portfolio.

The primary responsibility of the USS trustee is to ensure that accrued benefits can be paid when they become due
Throughout the 2020 valuation, the USS made this argument, but it is incorrect. The USS has many responsibilities, one of which is to treat the different scheme members fairly. However, to date, it has refused to assess the impact of its proposals on different groups of scheme members.

Moreover, despite what was agreed by the Joint Expert Panel, the USS has made no attempt to reform the scheme’s governance. Its board remains comprised of 12 directors, most of whom now have scant connection to UK higher education and many of whom (exceptionally including the current chair) are appointed solely by the board itself, with no external oversight. We cannot resolve the crisis that has engulfed the USS without major reforms, starting with allowing members to elect and recall the directors.

Have the existing directors acted in members’ interests? Are their claims about the deficit plausible and supported by credible evidence? Many of those on the picket lines yesterday and today insist not. Ultimately, the courts will decide.

Neil Davies is a senior research fellow in the MRC Integrative Epidemiology Unit at the University of Bristol.