Four key issues for the USS Joint Expert Panel

Number 27: #USSbriefs27

John Murray, formerly of Zurich Insurance

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This is a USSbrief that belongs to the OpenUPP (Open USS Pension Panel) series, and has been submitted to the UCU-UUK JEP (Joint Expert Panel).


The key issues to be addressed are as follows.

1. Investment strategy — equities not bonds

The switch from equities into bonds as proposed by the managers should be reversed forthwith. Their intended action will destroy value and end what is left of the defined benefits scheme. It will not remove risk nor provide certainty (other than the certainty of ending defined benefits). It will, however make life easy for the (well paid) managers.

Gilts are an inappropriate investment for pension funds for the following reasons:

  • being issued for a finite period, after which they are redeemed, it is impossible to match the term of pension liabilities;
  • because of this, the scheme runs the reinvestment risk when the gilts are redeemed;
  • first of these is the availability risk — governments do not issue debt to suit pension schemes and there may be no gilts available;
  • then there is the interest rate risk — the return on gilts is currently destroying value (versus inflation) and there is no guarantee that this will change (whatever the managers might say);
  • the pro-cyclicality risk further depresses returns on gilts as the market becomes limited.

All of these risks could be avoided by investing most of the portfolio in a spread book of equities, which form of investment has historically outperformed all others since 1900 (see Credit Suisse: Investment Yearbook 2018 edition).

Investing in equities does introduce short-term volatility, but USS, by virtue of its sheer size, positive cash flow (annual income pretty well equals annual benefits which means that it does not risk having to sell on a falling market in order to pay pensions) and uniquely strong covenant is ideally placed to ride out the bumps and for its membership to benefit from the superior return available on this form of investment. Note that the current high value of the stock market is irrelevant here to the extent that the fund is already invested in this class of securities.

2. Gross valuation of the fund not the issue — discount rate is key (follow the FTSE 100 companies’ practice)

The calculation of the gross value of the fund’s liabilities is not difficult to establish nor likely to be contentious. What matters is the rate of discount used. For the reasons explained above, using the low risk rate makes little sense for USS (since it does not reflect a sensible investment policy). In this respect it is instructive to note that most FTSE 100 companies are now discounting their pension liabilities on an accounting basis (see ‘UK’s biggest companies see pensions swing back to black’, 22 May 2018) and are showing no deficits, although the article did say that there would still be deficits if they used the ‘trustee basis’ — so at least common sense has intervened here.

3. Do not consult the Regulator

The function of the Regulator is not to protect the interests of the fund members but to look after the Pension Protection Fund. In effect this has come to mean closing defined benefit schemes, although there is plenty of evidence that this is only exacerbating deficits in closed funds (see First Actuarial’s ‘Report for UCU: Progressing the valuation of the USS’, September 2017). It is clear that the Regulator has already been approached by USS managers to support their proposed policy. This should not have happened and his reported view should be disregarded because THE FUND VALUATION AND ITS FUTURE CONDUCT ARE THE RESPONSIBILITY OF THE TRUSTEES NOT THE REGULATOR. The Regulator should not be consulted until a firm and agreed position has been taken by the members, the employers and the trustees.

4. Challenge the management’s view

It seems quite clear that the scheme managers have frightened the employers by following the same line that has already led to the unnecessary closure of many defined benefit schemes. This is no reason for USS to go down the same road — there are arguments in abundance for derogating from this path (even for seeking a formal derogation if necessary) and retaining the current defined benefits.

Since it is clear that the management’s main interest is an easy (and well-remunerated) life for themselves some effort will be needed in getting the employers on side, especially as the day job of vice-chancellors (like private sector CEOs) is not operating pension funds.


This is a USSbrief that belongs to the OpenUPP (Open USS Pension Panel) series, and has been submitted to the UCU-UUK JEP (Joint Expert Panel). 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 #USSbriefs27 and #OpenUPP2018; the authors will try to respond as appropriate. This work is licensed under a Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International License.

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