On the significance of USS’s misrepresentation of tPR

It undermines the integrity of the consultation and USS’s case for an immediate shift to bonds

The Annual Funding Statement 2019 of the Pensions Regulator (tPR), which they released yesterday (5 March), contains the following sentence in apparent rebuke to USS:

We do not assess the appropriateness of schemes’ TPs or discount rates based on predetermined relationships to gilt yields or other indices. (p. 5)

Here tPR flatly contradicts the following statement in USS’s 2018 Actuarial Valuation, which they issued to employers for consultation on 2 January:

the final discount rate adopted for the 2017 valuation of gilts + 1.20% is still above the level the Regulator views as appropriate for a “tending-to-strong” covenant (p.13)

Even if it was not deliberate, USS’s misrepresentation of tPR guidance in their consultation document is a serious matter. The Regulator’s stance regarding the acceptability of the valuation plays a significant role in shaping the employers’ response. The consultation is therefore undermined by USS’s inaccurate statement of tPR’s views.

1. Employers and scheme members are owed answers to the following questions

It is therefore essential that USS provide employers and scheme members with answers to the following two questions:

Is this the first you have heard from tPR regarding your misrepresentation of their views about the appropriate level of a scheme’s discount rate, measured as a margin above the gilt yield?

If not, when did tPR inform you of your misrepresentation and why did you not publicly correct the record at that point?

Since employers are due to submit their responses to the consultation in seven days, it is crucial that USS provides these answers now, as a matter of urgency.

2. This misrepresentation is material because it undermines USS’s case for an immediate shift to bonds

The responses of UUK, UCU, their actuarial advisors, and the USS trustee to the valuation have been significantly shaped by claims of the USS executives regarding tPR’s resistance to a discount rate for past liabilities which exceeds a specified margin above the gilt yield. These claims explain UUK’s current focus on JEP recommendations regarding deficit recovery contributions (DRCs) and the smoothing of the contribution rate for future service, which do not bear on the discount rate for past liabilities. In their 14 January Initial Thoughts on the valuation, for example, Aon writes the following:

If the “gilts plus” measure were the main concern, then [rather than delaying re-risking by ten years] it may be better to incorporate some of the other JEP recommendations (e.g. smoothing of future service contributions and allowing for investment outperformance in the recovery plan), as this could provide an easier path [from USS’s ‘lower bookend’ contribution rate of 29.7%] to c.29.2% . For example, if the USS Trustee were to incorporate [JEP recommendations] 1–4, 7 and 8 [as numbered by USS], then based on our estimates this would give close to 29.2%, but without worsening the “gilts plus” position compared with the 2017 Technical Provisions consultation.

In their most recent document on Contingent Contributions, Aon suggests some modest smoothing of future service as a pathway to 29.2%, on grounds that “this does not increase the risks being taken in respect of the past service deficit” in a manner that would increase the discount rate as measured as a margin above the gilt yield.

Aon also notes that “Other approaches are possible”.

Most conspicuously, another possible approach is the JEP’s recommended delay in of the shift of the portfolio towards bonds, which USS themselves recommended in their September 2017 valuation. Both JEP and USS recommended a 10 year delay, though it appears that a lesser c. 5 year delay would be sufficient to lower the contribution rate from 29.7% to 29.2%.

JNC has endorsed such a delay at several points in the past. Moreover, UCL’s submission to the JEP consultation, authored by Phil Harding, who is the lead UUK negotiator for JNC as well as UCL’s Finance Director, states that “we’re not convinced that USS needs to shift its investment strategy towards a low-risk stance, either in practice or as an assumption that underpins the valuation”.

A delay in the shift towards bonds enjoys such support for the simple reason that USS’s case for initiating this shift now — rather than in five or ten years or more— is weak on the merits. See here for an account of the weakness of their case for such a delay.

In the light of USS’s misrepresentation of tPR’s views regarding an appropriate level above gilts of the discount rate for past accrual, UUK must emphasise the case for a delay in the initiation of the shift towards bonds by at least five years. Among other things, such a delay would give JEP space to first pronounce on the case for any such de-risking in Phase II of its inquiry. If UUK does not strongly challenge USS’s case for an immediate shift, that will amount to a failure to protect the interests of scheme members as well as employers.