A is for Assets, but also for Assumptions.
In the Universities Superannuation Scheme pension (USS), the assets are held as investments, mostly in stocks and shares but also partially in Gilts (see ‘G’) and in other asset classes. The USS pension scheme assets are currently valued at around £78bn and were posted at around £68bn in the last published scheme accounts.
Assumptions. These are the factors that drive a valuation (see ‘V’), and help to define the technical provisions (see ‘T’). The assumptions include the discount rate (see ‘D’), future inflation, salary growth and life expectancy. Most University leaders will usually only cite life expectancy, as that is the one that most people think they understand straightforwardly (see ‘M’ for mortality assumptions). In the 2014 valuation, the assumption of salary growth was 20% over three years to 2017. It was in fact 6%, but that is one factor that drove the argument from some employers for the closure of the final salary Defined Benefit aspect of the scheme (see ‘D’).
B is for Benefits.
Your benefits are the pension you receive in retirement. It’s not so much a ‘benefit’ as, in fact, money you have earned, deferred salary, which is to say the part of your salary that you have contributed toward in your monthly pay-slip (see ‘C’).
C is for Contributions but also for Covenant.
Your contributions are the part of your salary that you pay, pre-tax, toward your pension, and also the contributions that the employer makes in addition, also defined as a percentage of your salary. Not to be confused with ‘Defined Contribution’ which is a form of pension where you know how much you put in (your monthly contributions), but have no idea how much it will pay out (your benefits) in retirement (see ‘D’).
The Covenant is another word for the ability of the employers collectively to cover any shortfall in the funding position (see ‘F’), and it is a legal obligation. The Pension Regulator (see ‘R’) defines the strength of a Covenant as, at best, ‘strong’, then ‘tending to strong’ or other categories. An assessment of the strength of the Covenant is part of any valuation process (see ‘V’). In 2020, employers were offered two routes; ‘Strong’ if they signed up to Covenant strengthening measures and ‘Tending to strong’ if they did not. The implication of the latter would be significantly higher contribution rates (see ‘C’).
D is for Discount Rate, but also for Deficit, De-risking, Defined Benefit and Defined Contribution.
The discount rate is the rate by which the USS assume the assets (see ‘A’) will grow in valuation calculations (see ‘V’). If you know you need to pay £100 in a year’s time, and assume an asset growth of 5% in the interim, the amount you need to set aside to fulfil that debt when it is payable is now £95.24 (£95.24 +[£95.24 x 5%] = £100). You then ‘discount’ your future debt by 5% to measure what assets you need to hold now to be certain of honouring it. But the lower you set your discount rate, the more you need to hold now to pay future debt (see ‘E’ for ‘Excessive prudence’). If, for example, you construct a discount rate around expected low returns from gilts (See ‘G’) instead of your actual asset mix (see ‘A’) then this will create a lower predicted asset growth than using other assumptions.
Deficit. Every three years, a pension scheme must do a valuation (see ‘V’), which has to employ prudent assumptions (see ‘P’). This involves estimating if your assets (‘A’) will cover your future liabilities (see ‘L’). The more ‘prudent’ the assumptions you use for the valuation, the more likely you are to predict a deficit, which is when the assets are deemed to be insufficient to cover projected liabilities (see ‘E’ for Excessive Prudence and ‘F’ for Funding Position).
De-risking. When you ‘de-risk’ your investment portfolio, this might mean you move more of your assets (see ‘A’) from high-yielding but more volatile stocks (they go up and down in value more over time, which is utterly normal) to low-yielding gilts. These pay less in the long run, so de-risking straightforwardly contributes to increasing your projected deficit (see ‘D’). There is usually no-need to ‘de-risk’ an ongoing portfolio such as the assets of a healthy pension scheme. It is, however, usual and sensible to ‘de-risk’ a personal portfolio gently as you approach the point at which you might wish to rely on the sum invested. USS use the euphemism ‘lifestyling’ for this latter form of de-risking which is appropriately applied to the Defined Contribution element of your pension in the ten years up to your assumed or chosen retirement age.
Defined Contribution and Defined Benefit. These are simply types of pension. A Defined Benefit pension scheme is one in which you know exactly what you pay in, and the formula that will define exactly what you will get out as pension in retirement. ‘Final Salary’ and ‘Career Average’ are the two most common types of DB pensions. The USS scheme was a fully Defined Benefit Pension until 2016, after the 2014 valuation (see ’V’) – one that was subsequently proven to be utterly wrong – predicted a deficit (see ‘D’) which implied it was necessary to include a Defined Contribution element for those earning above a certain salary cap. Defined Contribution pensions are those where you know how much money you will pay in, but not at all what might come out as pension in retirement. In 2017 the USS suggested to employers twice that they needed to take a little extra risk in order to sustain the Defined Benefit portion of the scheme, but employers refused and a large minority of them called for a switch to complete Defined Contribution, on the basis of a valuation (see ’V’) – that again was subsequently proven to be utterly wrong – which had predicted another deficit (see ‘D’). The UCU (See ‘U’) was having none of it and enacted a successful round of industrial action that resulted in the formation of the JEP (see ‘J’). The USS employ the euphemisms ‘Income Builder’ (for the Defined benefit element of the pension) and ‘Investment builder’ (for the Defined Contribution element of the pension) (see I’).
E is for Excessive Prudence.
A valuation (see ‘V’) is required to use prudence (see ‘P’), which is defined as a predicted outcome that is more than 50% likely to occur. The more over-cautious you are (excessively prudent) the lower your projected surplus or the higher your projected deficit. You might for example ‘assume’ your assets will grow at only the rate of inflation, or that salaries will grow at 20% over three years.
F is for Funding position.
The funding position is another way of expressing a valuation (see ‘V’). A funding position considers your assets (see ‘A’) against your present and prudently (see ‘P’) estimated future liabilities (see ‘L’) and expresses them as a percentage: e.g. ‘95% funded’.
G is for Gilts.
Gilts are low-yielding but steady investment vehicles, often in the form of government bonds. If you use these to construct a discount rate (see ‘D’), as part of a collection of prudent measures (see ‘P’) you can project a deficit (see ‘D’) in an otherwise healthy and immature (see ‘I’) pension scheme.
H is for Hybrid scheme.
USS has been a hybrid scheme since 2016, when a Defined Contribution (See ‘D’) element of the pension was opened for people earning above a certain salary cap, in addition to the Defined Benefit (Career average) pension. These changes were a consequence of the 2014 valuation (see ‘V’ and also ‘D’ for Defined Benefit/Contribution).
I is for Immature, but also for Income Builder and Investment Builder.
‘Immature’ is the word used to define any pension scheme where the money coming in to the scheme from contributions (see ‘C’) is larger than the amount going out in liabilities (see ‘L’) which, in this calculation, are the benefits being paid to retired members (see ‘B’) each year. In other words, immature pension funds are cash positive. This has been the case for the USS scheme pretty much since its inception. This means it has never needed to dip into its assets (see ‘A’) to pay pensions and these assets can just keep growing healthily, unless you de-risk them prematurely (see ‘D’). In the published 2020 USS accounts, for example, the scheme had £2.71bn in contributions coming in and £1.97bn going out in liabilities. This ‘cash flow positive’ status of the scheme has been a consistent feature of the accounts over the decades.
The Income Builder is the name applied by USS for the Defined Benefit (see ‘D’) element of your pension, the part that guarantees you a known income based on a formula in relation to your salary over your career. The Investment Builder is the name applied by USS for the Defined Contribution (see ‘D’) element of some people’s pension, and is formed mostly of salary over a certain threshold, but also of Additional Voluntary Contributions and/or of funds moved into the pension.
J is for Joint Expert Panel (JEP) but also for Joint Negotiating Committee (JNC).
The JEP was formed in 2018 as a means of resolving the industrial action that year, which was initiated over the proposed ending of the Defined Benefit scheme in USS (see ‘D’). The panel produced a first report which reviewed the 2017 valuation, including an assessment of the methodology, assumptions and process underpinning it. They offered a series of credible adjustments to the methodology. A second report from the JEP set out a path which could provide an opportunity for lower contributions (see ‘C’) than the USS had then scheduled. The USS ignored all but a few of the recommendations, which were nonetheless supported broadly by both UUK and UCU (see ‘U’).
The Joint Negotiating Committee (JNC) is made up of five members appointed by UUK and five by UCU (see ‘U’) and an independent chair. The committee has a range of responsibilities, including propose rule changes for the pension scheme, approving any rule changes made by the USS Board and deciding how any change to contributions (see ‘C’) should be structured following any valuation (see ‘V’).
L is for Liabilities.
Simply put, the liabilities of the scheme are the pensions to pay by the scheme. Liabilities are what is owed, but future liabilities cannot be known precisely, so need to be calculated using a range of metrics for a valuation (see ‘V’) and applying Excessive Prudence (see ‘E’) can result in the construction of a projected deficit in the pension scheme (see ‘D’).
M is for Mortality assumptions, which is another way of saying life expectancy.
Life expectancy is one of the assumptions (see ‘A’) that contribute to a valuation (see ‘V’) as it is necessary to make an intelligent guess of how much longer people will live in retirement, as that impacts on how much money will need to be paid to them over the course of their retirement. This estimated amount is part of the technical provisions (see ‘T’) that are used to measure against the Assets (see ‘A’) to define a Surplus or a Deficit (see ‘D’) in any valuation. The Office for National Statistics indicates that ‘annual life expectancy improvements have slowed down’ in the last decade. They will publish life expectancy figures post-Covid in Autumn 2021.
N is for Normal Pension Age.
This is the age at which it is assumed most people will retire at, and was set at 65 but went up to 66 on 6 October 2020. If you retire early, you may see a reduction in your benefits (see ‘B’) proportionate to how close to the normal retirement age you retire. This means the higher the Normal Pension Age, the longer you must work to retain your full benefits.
O is for Overfunding.
This is when a Valuation (see ‘V’) reveals that there is a surplus and not a deficit (see ‘D’). It has been possible to define a prudent valuation of the USS in recent years that results in this position.
P is for Prudence.
This has a specific meaning in valuation terms, and a ‘prudent’ valuation is required everything three years by the Pension Regulator (see ‘R’). ‘Prudence’ here means a projection that is more than 50% likely to happen, but there is no regulation on how high the prudence level needs to be set above 51%. Recent analysis indicates that the 2020 plans from the USS include something close to 80-90% prudence levels, which contribute to a deficit being projected (See ‘E’ for excessive prudence).
Q is for Quantitative Easing.
Quantitative Easing is a monetary policy in which the Bank of England buys longer-term investment vehicles such as gilts (see ‘G’) and this adds new money to the economy. This is not directly a part of any Pension scheme or valuation, but there are significant impacts of Quantitative Easing on both Defined Contribution and Defined Benefit (see ‘D’) pensions. It impacts DC pensions because it lowers the value of the annuities that you might buy with your DC pot of money upon retirement to gain a regular income. It impacts DB pensions as their assets (see ‘A’) include gilts (see ‘G’), often in increased amounts as a result of any de-risking (see ‘D’) and the Quantitative Easing will result in these gilts having a lower return rate, tending to zero. This in turn increases the size of the technical provisions (see ‘T’) in any valuation (see ‘V’).
R is for (The Pension) Regulator.
tPR is the government body created to oversee and regulate pension schemes and it requires a valuation (see ‘V’) of Defined Benefit schemes (see ‘D’) every three years.
S is for Self-Sufficiency.
Self-Sufficiency is when a pension scheme reaches a certain level of assets (see ’A’) so that it can sustain itself by investing those assets on a low risk basis and pay members’ benefits (see ‘B’) as they arise without relying on an employer covenant (see ‘C’).
T is for Trustee, but also for Technical Provisions.
The Trustee Board of the USS is the board of directors. It is made up of 4 people nominated by UUK (see ‘U’) 3 nominated by the UCU and 5 independent members. They have a fiduciary duty to act in the best interests of the scheme’s beneficiaries. They decide contribution rates (see ‘C’) and manage the scheme’s investments (see ‘A’).
The ‘Technical Provisions’ is a term that means the amount that a Defined Benefit (see ‘D’) scheme needs to cover all its accrued liabilities (see ‘L’) within a valuation (see ‘V’).
U is for Universities UK (UUK) but also for the University and College Union (UCU).
UUK is the body that represent University managements collectively in a range of issues, including USS.
The UCU is the trade union that represents Academic and Academic-Related colleagues in Universities, Colleges and other institutions. When it comes to the USS pension scheme, the UCU represents all members of the scheme, not just its members.
V is for Valuation and VMDF.
Defined Benefit schemes (See ‘D’) such as USS are required to deliver a prudent valuation (see ‘P’) every three years by the Pension Regulator (see ‘R’). The valuation involves considering whether the Assets of the scheme (see ‘A’) are enough to cover all the liabilities (see ‘L) that have accrued to date, but there is no required or defined methodology that might be used to construct a prudent (see ‘P’) valuation.
The Valuation Methodology Discussion Forum (VMDF) was set up by the USS Trustee (see ‘T’) to provide input and feedback on the approach for the 2020 valuation, and to support the overall valuation process. It was not a decision-making body. Its creation arose from recommendations made by the Joint Expert Panel (see ‘J’) around valuation governance and alternative paths to the valuation.