Analysis of USS’s proposed valuation

USS’s consultation for the March 2017 triennial valuation commenced on 1 September. What follows is my analysis of this statement from USS regarding the funding position of the scheme. I think there are three main headlines:

1. The deficit on past accrual is less of a problem than in 2014. That deficit of just over £5 bn is actually smaller, both in absolute terms and relative to the size of the scheme, than the £5.3 bn deficit recorded for the March 2014 valuation after the last round of cuts was agreed. Moreover, USS is proposing that deficit recovery contributions remain unchanged at 2.1%. So the level of funding of past accrual does not justify any new call to cut DB benefits.

2. The significant threat to DB arises from USS’s claimed rise in the cost of future accruals. According to USS, “the cost of funding future pensions promises has increased by 35%. The proposed assumptions result in an increase of 6%-7% of pay, from the 26% of pay paid by employers and members now [18% employer, 8% member], for the current package of benefits offered.”

3. A reversal of the Test 1 mandated shift of the portfolio from equity and other growth assets to gilts and other ‘liability-matching’ assets would (a) transform the deficit into a surplus and (b) eliminate the increase in the cost of future accruals. In the linked spreadsheet, I calculate the average discount rate over the 20 year period of years 11–30, with and without Test 1 ‘de-risking’. Eliminating the shift into gilts would increase investment returns by an average of 0.8% per year during those 20 years.

3(a). Impact of Test 1 on the deficit on past accruals: According to USS, a 0.1% increase in returns reduces the deficit by £1.2 bn. Therefore, reversing the shift into gilts would transform the £5 bn deficit into a £4.6 bn surplus, thereby eliminating the need for 2.1% deficit recovery payments mentioned in point 1 above.

3(b). Impact of Test 1 on the cost of future accruals: Unshackling the scheme from Test 1 would decrease the contribution rate for future service by 6.4%, thereby eliminating the need for an “increase of 6%-7% of pay” for future accruals mentioned in point 2 above.[*]

Conclusion: If the Test 1 shift of the portfolio out of equities and into gilts from years 11–20 is cancelled, it would cost less than the current 26% contribution (18% employer and 8% employee) to maintain the status quo of CRB at 1/75 accrual up to £55,550.

Question: Is there a sound case for Test 1? If not, then we are being pressured into making drastic cuts to DB on an unsound basis.

As readers of my blog posts will know, I have been making the case that there is no sound case for Test 1. See, in particular, this sequence of posts:

1. Self-sufficiency in gilts is a costly means rather than an end in itself

2. Test 1’s self-sufficiency in gilts is a self-defeating Catch 22

3. The importance of positive pension scheme cash flows

For further posts about pensions and USS, please click here and scroll down for titles that are relevant.

[* According to Appendix D of the full consultation document, which was publicly posted on the 12th of September, a 0.1% increase in returns reduces the contribution rate for future service by 0.8%.]

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