Coronavirus: USS pensions could become ‘much less generous’

Radical changes may be on cards after stock market crash and interest rate cuts, say experts

March 23, 2020
Source: Getty

Plummeting stock market prices and rock-bottom interest rates may force the Universities Superannuation Scheme (USS) to raise contribution levels sooner than expected and to offer “much less generous” pensions, experts have said.

The warning follows the USS’ declaring itself to the Pensions Regulator after triggering a sustainability metric, which saw the ratio between the scheme’s deficit and 10 per cent of employers’ contributions over the next 30 years exceed 85 per cent over five consecutive days.

The USS, whose board will meet on 26 March to “formally review the scheme’s funding position”, said the ratio was important because “uncertainty for the scheme’s future funding means an increased dependency” on universities.

The scheme’s trustee board and the regulator will now “consider the appropriate response”, but one option under consideration is to bring forward an increase in contribution levels for staff and employers planned for October 2021, when contributions were set to grow to 11 per cent and 23.7 per cent, respectively.

They currently stand at 9.6 per cent and 21.1 per cent, respectively, although the University and College Union is calling for a reduction in the employee rate to 8.4 per cent. Staff at 52 pre-92 universities recently walked out for a total of 22 days over the contribution hikes.

Other responses could include moving the scheme’s valuation date from 31 March 2020. “Our current view is that Covid-19 will have a very significant near-term impact but is less likely to have a material impact as we look further out,” a USS spokesman said.

The Bank of England’s decision to cut interest rates to 0.1 per cent – the lowest rate ever – on 19 March is also predicted to increase pensions deficits even further by pushing up the USS’ liabilities.

Delaying the USS valuation may not help the situation significantly, even if the move is permitted by the Pensions Regulator, explained pensions consultant Bernard Casey.

“Will equity prices get back to anywhere like where they were? Probably not,” said Mr Casey, who said there has been a “mispricing of assets for quite a while”.

With the USS already facing criticism for putting “too much trust in risky equities”, which have now plunged in value, the regulator may feel vindicated in pushing the scheme to invest in less risky assets, added Mr Casey.

“The USS will have to rebalance its portfolio, and this will cost it money,” said Mr Casey, who added that “the best thing [that universities] could do is bite the bullet…and make the scheme a lot less generous – which is a combination of lower benefits and higher contributions”.

John Ralfe, an independent pensions adviser, said more radical plans would be on the cards.

“Unless the stock market recovered dramatically to close to pre-crash levels over the next 12 months, the closure of the USS’ defined-benefit scheme [in which retirees receive a guaranteed pension amount] to be replaced by a defined-contribution plan [where incomes are tied to the stock market] was inevitable,” said Mr Ralfe. “Even before this coronavirus crisis, the USS [had] a large deficit, and things have now got a lot worse.

“If the market is trading at 6,000 points within three months and back at 7,200 within a year, as the 2020 valuation is nearing completion, this episode will be dismissed as a blip,” Mr Ralfe continued. “Anything less than this, and the scheme will have no room to manoeuvre to save defined benefits.”

Sam Marsh, president of University of Sheffield’s UCU branch and a UCU national negotiator for USS, said it “doesn't make much sense to complete a valuation in the middle of huge uncertainty over the future." He added that the regulator is due to issue guidance by mid-April to schemes with an imminent valuation date.

Dr Marsh added that there was “little to be gained by being alarmist about the future" following the Covid-19 financial crash.

“If state interventions around the world work to shore up the global economy then in the lifetime of an open scheme like USS, the epidemic may not have as much effect as it looks at present,” he said, adding that “USS's positive cashflow means it is well placed to take a long-term view without having to react quickly to market falls, and it's the long-term that's important for keeping the scheme open.”

Commenting on triggering of USS metrics, which was first reported by Research Professional, a UCU spokesman said the “USS has underlying strengths, and it is important there are no snap judgements made at this time”.

“The scheme needs to ensure that decisions are taken after proper consultation with all stakeholders, including scheme members,” he added.

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Reader's comments (1)

Ralfe and Casey have been saying similar things to this for donkeys years. A few years ago they persuaded BBC Newsnight to devote a whole show to how the USS was in massive deficit and that this would force universities to increase student fees, cut courses etc. They are arguing from a simplistic position based on an extreme free market view of the world that would be wrong in normal times. The reason the scheme is in deficit (and likewise other defined benefit schemes) is because of the valuation methodology that attaches a particular meaning to the word deficit. It is a notional or paper deficit not a lack of adequate resources to pay the pensions. The funding position fluctuates with the markets. The value of USS investments plummeted in the financial crisis of 2008 but then rebounded in 2009 and 2010. The main reason for the deficit today is that interest rates on government bonds are too low. But all the evidence we have shows that returns on the investments in the real economy, including the USS investment portfolio, are high enough. But the valuation methodology leads to requiring too much prudence in the assumptions made, and having to pretend that the scheme's investments are all in bonds (which lose money currently) rather than high yielding assets like shares. It makes no sense except in an extreme free market view of the world. Or rather that would the response to Casey and Ralfe normal times. But we are not in normal times. The Coronavirus pandemic is an event of radical uncertainty. It is unprecedented. A black swan event. So we cannot infer anything from it as regards the pension scheme.