A breach of trust: employer underpayments, the deficit, and the role of the USS trustee

Number 43: #USSbriefs43

Deepa Govindarajan Driver, University of Reading

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This is a USSbrief, published on 17 August 2018, that belongs to the OpenUPP (Open USS Pension Panel) series. It was submitted to the UCU-UUK JEP (Joint Expert Panel), the Pensions Regulator (tPR), USS and Universities UK (UUK) by the author and Academics for Pensions Justice on 17 August 2018.

This USSbrief expresses grave concerns about the USS Trustee’s repeated approval of employer underpayments between 1999 and 2008. A long-standing, flawed, and incomplete narrative about the surpluses and deficits in the USS fund has been strategically employed to persuade scheme members to accept the erosion, and ultimately the elimination, of Defined Benefit (DB) pension provision. This is detrimental to the interests of scheme beneficiaries (existing pensioners, contributing members, and any dependents with a contingent interest) — to whom the USS Trustee has a duty — while prioritising the interests of employers — to whom the USS Trustee does not have a duty. Indeed, the Trustee’s approach to employer underpayments demonstrates a consistent pattern of behaviour where the Trustee prefers the interests of its members’ employers over the interests of members themselves.

The brief uses publicly available information to review USS actuarial valuations and employer underpayments from 1999 to 2008. I scrutinise the context of such underpayments across three triennial valuation cycles, as well as a recent attempt to explain these underpayments by Bill Galvin, the CEO of USS Limited. My analysis questions decisions made by USS Limited (the Corporate Trustee) in allowing payments which were not only below the rates of contribution determined by the Scheme actuary as appropriate to meet future liabilities, but also insufficiently sensitive to the financial climate in which USS was operating and the longer-term risks which it faced. I suggest that underpayments have seriously eroded the Scheme and have led to the notional actuarial deficit that has emerged. This deficit in turn has been presented by employers as justification for undermining employee pension benefits, without due acknowledgement of their role in causing the deficit. This puts the burden of protecting the interests of employers directly on the shoulders of USS members.

It is widely known that in 1997, following the 1996 valuation which showed a surplus of some £0.8bn with regard to past service costs, employer contributions were reduced from 18.55% to 14% of salary while scheme members’ contribution remained at 6.35%. Employer contributions were eventually raised again to 16% in 2009 (following the 2008 valuation), and then to their present level of 18% in 2016 (following the 2014 valuation).

This USSbrief is concerned with decisions to maintain the lower level of contributions for nine years following the 1999, 2002 and 2005 valuations. I show that for each of these three cycles, USS made a highly questionable decision to maintain employer contributions at 14%. In each case, moreover, this was despite advice from USS’s own actuaries that employers’ contributions needed to be higher than 14% in order to cover future service costs. (In this respect, I am building on an observation first made by Michael Otsuka, with respect to the 1999 valuation.)

This analysis calls into question the rationale for holding the employers’ contribution rate at 14% over this period. I also argue that the underpayments may have contributed significantly to the substantial scheme deficits that began to emerge after 2005. These have culminated in the current deficit, which employers have used to justify undermining employee pension benefits, and which the USS Trustee has done nothing to address. It was incumbent on the USS Trustee to act in the interests of the scheme members, and these decisions demonstrate their failure to do so. The brief ends with a call to action — both to the Joint Expert Panel (JEP) and to the Pensions Regulator.

The 1999 decision not to increase employer contributions

For its 1999 valuation, USS moved from a ‘projected unit’ method to a ‘market value’ approach. Under the new methodology, the value of the scheme’s current assets was determined by their current market price on the valuation date. This change had a significant impact on the balance sheet, since at the time over 80% of the scheme’s assets were held in equities, whose market prices are characteristically volatile and may also be overstated during the peak of the cycle. (See the 1999 valuation, appendix C). While the market-value-based valuation showed a surplus of £1.4bn, the actuaries noted that if ‘exactly the same assumptions adopted for the 1996 valuation’ had been used, the 1999 valuation would have shown a deficit of £1.2bn. (See 1999 valuation, appendix G).

The Scheme’s performance in 1999, as today, depended on three key factors: employer contributions, employee contributions and investment returns. We might expect that investment and actuarial experts at USS understood that markets in 1999 — at a point immediately prior to the collapse of the ‘dotcom’ bubble in early 2000 and around the time of the Asian crisis — were expressing irrational exuberance. The Pensions Commission noted that ‘from 1974 to 2000 the average real return on UK equities was 13%, compared with a twentieth century average of about 5.5%.’ Equity markets were noticeably overinflated and investment returns were abnormally high. The transition to a market-value method of estimation, and the consequent presence of a notional surplus, should therefore have been considered with a great degree of caution. Any deterioration in the market value of assets — which were at the time largely held in equities and therefore heavily subject to market movements — could have been predicted by any competent actuarial expert to cause a significant and drastic erosion of any such notional surplus.

At each valuation, the required contribution rate is assessed by the actuary, and changes to this rate are used to recalibrate contributions so as to ensure that scheme liabilities can be successfully met. The Pensions Regulator requires that employers adhere to such contribution rates, and it is the duty of the Trustee to ensure that such requirements are suitably met or to take action where this is not the case. In 1999, the USS actuarial valuation, even under the market value method, recommended an employer contribution rate of 16.3%. However, the Trustee decided to allow employers to contribute a lower rate of 14%. This is of particular concern in light of the Trustee’s duty to act in the interests of beneficiaries, given what we know about the instability in the broader economic context at the time.

The USS Trustee failed to properly protect the interests of scheme members in this time of easily identifiable economic instability. The presence of a notional surplus in an overinflated market was used to justify a reduction in employer contributions. Bill Galvin’s letter of 23 May 2018 does not clarify whether any precautionary mechanisms were put into place to ensure that employers were bound to a commitment to make good any such underpayments in adverse circumstances (for example, where the valuation might turn out to have been over-optimistic or incorrect). Failure to protect the integrity of the fund in the event of errors is an egregious failure to protect the interests of the scheme members in its own right. It is one thing to play fast and loose with the employers’ contributions levels to the detriment of the beneficiaries, but another thing entirely to do with without a planned safety net.

Even in the absence of a planned safety net for this specific decision, pension fund trustees are required to monitor the schemes on an ongoing basis. To do so they may undertake a range of activities including interim valuations, reviews of positions and assessment of rates of contribution. Even if the USS Trustee had been unable to predict the dot-com crash, that crash should have been a trigger for reevaluating fund management decisions. A period of introspection and review at USS would have offered an opportunity to understand both the cause of the diminished investment return and its impact on the Scheme’s position. At the same time, the Trustee should have reconsidered the justification for the 14% employer contributions. That the Trustee did not do so is a further example of its failure to give proper consideration to the interests of the scheme members.

The 2002 valuation

Moving forward to the next triennial valuation in 2002, the Scheme still enjoyed a positive cashflow, but the notional surplus had diminished. What is more, this surplus had depleted much more quickly than anticipated. In fact, the main section surplus, which had been expected to last over 11 years at the reduced employer contribution rate, had instead dropped rapidly from £606.4 to £87mn in just 3 years (the overall deterioration in surplus was from £1443 to £162mn; see page 3 of the 2002 valuation). This should have set off alarm bells for the Trustee. Instead, a misjudged decision was taken to erode a significant proportion of what remained of the notional buffer.

With the consent of the actuary, employer contribution rates were maintained at 14%, even though this figure continued to be below the contribution rate required by the actuarial valuation, which required 14.25% with respect to future service. This is a troubling decision, given the experiences of the downturn and the significant erosion of the investment return component of the fund. It becomes even more problematic in the context of the interests of beneficiaries, when we recognise that the conclusion of the valuation was that the Scheme was only just on an even keel: ‘the assets of the Scheme at the valuation date were 101% of the accrued liabilities based on projected Pensionable Salaries’. At a time when the sustainability of investment returns was clearly in doubt, this decision to maintain an artificially low contribution rate shows a failure to properly protect the interests of beneficiaries. This is yet another occasion when the USS Trustee has preferred the interests of others over those of the beneficiaries.

The 2005 valuation

Data provided at the next triennial valuation in 2005 confirms that this was a misguided and risky strategy, with a deficit of over £6.5bn accruing as a result. This took the overall valuation of the fund from an £87mn surplus in 2002 to a £6.5bn deficit three years later. The 2005 actuarial valuation notes that the ‘assets of the scheme at the valuation date were 77% of the accrued liabilities based on projected pensionable salaries with a past service deficit of £6,568 million’. This was a natural result of investment returns that were around £3bn below expectations, but it was further exacerbated by the prolonged cross-subsidy of employers’ underpayments that had been carried out, exhibiting callousness towards the Scheme’s long-term sustainability. In spite of this, and the fact that the actuarially determined rate was 14.3%, employer contributions were allowed to remain at 14%.

USS’s persistent failure to act in beneficiaries’ interests

The Trustee’s repeated prioritisation of the employers’ preferences in these three periods is a cause for grave concern: first as a matter of principle, and secondly because it clearly eroded any buffers that might provide the Scheme members with comfort in times of distress. This demonstrates a consistent pattern where the USS Trustee disregards the interests of the fund’s beneficiaries.

It is equally worrying is that there is no publicly available evidence of substantive, clear and candid consultation by USS Ltd alerting members to this disproportionately swift deterioration, or raising red flags about the potential detriment to members and the potential inter-generational unfairness of changes to the Scheme that might be necessitated by taking on such risks.

Nor is it clear, given the actuarial mandates for higher employer contributions, why the Trustee did not pursue employers more effectively to maintain their contributions at the appropriate level suggested in the valuation. Proper consideration of the interests of the members would necessitate the USS Trustee to take action to recoup the losses. A review of the available documentation suggests that trustees may have simply fallen in with what they perceived to be employer preference (which was always below the actuarially mandated rate of employer contribution), putting downward pressure on the Scheme’s assets. Therefore the Trustee also appears to have reverse-engineered acceptable actual contribution rates by calling on the supposed surplus, turning it into a serious deficit. This demonstrates a fundamental lack of regard for the interests of the scheme beneficiaries, while preferring the interests of employers. The fact that it is the members’ interests that are the subject of the USS Trustee’s duty makes this course of behaviour particularly concerning.

Bill Galvin’s letter of 23 May 2018

In 2018, several USS members wrote to the Trustee to ask for details about the period of employer underpayments, and to highlight concerns about its contribution to the deficit that was being used to support the move from DB to DC. What is fascinating about Bill Galvin’s reply of 23 May 2018 is that while it reiterates the details of why the underpayments were originally permitted by the Trustee, it is worryingly silent about whether concrete assurances were taken by USS from employers so as provide an adequate buffer for adverse circumstances. There is also little evidence in the letter of warnings to members of the potential detrimental consequences of prolonged underpayment by employers. Much like a credit card bill that quickly adds up when only the minimum balance is paid, the approval of the underpayment was a ticking time-bomb.

Galvin appears to be both dismissive and cavalier in his response to the genuinely held concerns of members. He subverts any meaningful discussion by noting that ‘historically, employer contribution rates have not been particularly relevant for members as, prior to 2011 (when the concept of cost-sharing was first introduced by stakeholders via the Joint Negotiating Committee), their contribution rate was fixed’. The point is not just whether or not members should have been consulted but also what USS Limited should have ensured in the background, irrespective of this. This consideration of members’ interests is essential in order for the USS Trustee, and Bill Galvin as CEO of USS Ltd, to fulfil the duty to scheme beneficiaries.

USS Ltd’s worrying failure to challenge employers’ desire for continued underpayments reflects the Trustee’s consistent practice of preferring employers’ interests, as advocated by the employers’ representation bodies (UUK and the Employers Pension Forum, or EPF) (see also USSbriefs1). Until the strike of 2018, many Scheme members appear to have been unaware of these drops in contributions and the adverse effect on the Scheme position. Instead, UUK, the EPF and USS have insisted that the deficit represents a crisis in need of rapid resolution, while glossing over their historic role in allowing it to be created over the course of several valuations. This shows a fundamental and continuing disregard for the interests of scheme beneficiaries.

A call to action

The fact that this destructive course of action was allowed to continue unchallenged over the course of multiple valuations exposes the selective, one-sided way in which valuations and their consequences have been handled. If there was no ‘crisis’ in 2005, when employers were allowed to maintain a low contribution rate that had already helped create a £6.5 billion deficit, why is there suddenly a ‘crisis’ in 2018 now that misguided accounting standards, valuation methodologies and a host of other factors have exacerbated that deficit? It is hard not to conclude that the USS Trustee is only willing to identify a crisis when it is in the employers’, not the members’, interests to do so. Hence my call to action:

  1. I call on both the Pensions Regulator and the JEP to commence full investigations of the decisions and communications surrounding this protracted reduction in employer contributions. This reduction raises questions not only about the amount that may be owed to Scheme members as recompense for previous underinvestment in the Scheme, but also about whether the USS Trustee has acted in the interests of the Scheme’s members as opposed to its sponsoring employers.
  2. I urge the JEP to recognise the effect of the underpayments alongside its deliberations on the current valuation methodology. I caution the JEP that a decision to ignore these underpayments and focus exclusively on the methodology of the 2017 valuation makes it impossible to understand how the USS Scheme has reached the present state of affairs.
  3. I urge the Pensions Regulator to review the circumstances surrounding the underfunding of the USS scheme between 2000 and 2009, and to hold those responsible for the relevant decisions accountable. This will require the Pensions Regulator to take a detailed look at its predecessor’s procedures and its own, which allowed this underfunding to go unchallenged for such a significant period of time. This will involve evaluating the measures undertaken to safeguard members’ interests during the prolonged period of employer underpayment; reviewing the Trustee, Scheme Actuary and employers’ deliberations, and the quality of any communications to members about the potential downside of continuing the underpayment year on year; reviewing whether the moneys that should have been paid into and retained within the Scheme were then deployed on or off the employers’ balance sheet; and ensuring that appropriate remedial action is put in place so as to provide members and beneficiaries with suitable protection of their promised pension benefit.

A final warning

The facts surrounding the underfunding of USS show just how easy it is for a corporate trustee to disregard the interests of scheme beneficiaries, while protecting the interests of their employers, notwithstanding that this goes against their duty to members. The employers hold the power in the sector, while employees carry the full burden of any decisions.


The author would like to acknowledge Andrew Chitty, for assistance with research, tabulation of research data and other contributions; Academics for Pensions Justice and Jaya John John for their valuable input; Dennis Leech for reading an early draft; Sam Marsh for reading a late draft; and the anonymous contributor who shared an early version of Bill Galvin’s letter about the underpayments.

This is a USSbrief, published on 17 August 2018, that belongs to the OpenUPP (Open USS Pension Panel) series. It was submitted to the UCU-UUK JEP (Joint Expert Panel), the Pensions Regulator (tPR), USS and Universities UK (UUK) by the author and Academics for Pensions Justice on 17 August 2018. This paper represents the views of the author only. The author believes all information to be reliable and accurate; if any errors are found please contact us so that we can correct them. We welcome discussion of the points raised and suggest that discussants use Twitter with the hashtags #USSbriefs43 and #OpenUPP2018; the author will try to respond as appropriate. This work is licensed under a Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International License.