The case for a credible evidence-based 2021 USS valuation

Number 109: #USSbriefs109



Neil Davies, University of Bristol

Photo by Victor on Unsplash

What’s going on with the valuation?

The good ship ‘Titanic’ University Superannuation Scheme (USS) is continuing full steam ahead towards its 2020 valuation. The 2020 valuation estimates the USS’s assets at the end of March 2020 and then estimates how much it would need to have had at that time to fulfil all its future pension payments promised for coming years. The USS has estimated that as of March 2020, it had between £9.8bn and £14bn less than it needed to pay our pensions over the next 80 or so years. As a result, the USS argues that the amount we pay for pensions each year needs to increase, and the future pensions we earn each year needs to be substantially cut.

Why was a 2020 valuation a bad idea?

The USS is not required to have a 2020 valuation by law — it is optional, at the discretion of the Trustees who run the scheme on behalf and for the benefit of USS members. The law only requires the USS to conduct valuations every 3 years, in the case of USS by March 2021. So, is it reasonable for the USS to conduct an optional valuation as of March 2020, and was it in members interests?

First, the 30 March 2020 was perhaps an inopportune moment to value the scheme’s investments (Figure 1). Worldwide stock markets fell by 19% in the 39 days prior to the valuation date. In the 3045 days included in Figure 1, there were only a handful of 39 day periods that experienced greater declines, all of which were in March and April 2020. Furthermore, since March 2020, as can be seen in Figure 1, the value of worldwide stock markets have increased by 52%. In March 2020, the USS estimated its assets were worth £66.5bn. Yet in June 2021, it estimated its assets had increased by £18.8bn, to £85.3bn, an increase substantially greater than the upper estimate of the deficit in March 2020.

Figure 1: The value of worldwide stock markets 2009 to 2021. The red vertical line indicates the date of the 2020 USS valuation

The original rationale for an early, optional, 2020 valuation was agreed with employers as part of the resolution to the 2018 valuation. Employers’ original thinking behind this was that this would enable them to replace the 2018 valuation with a more favourable valuation in 2020. The motivation for this was to avoid increases in employer and employee contribution rates that were agreed as part of the 2018 valuation. Clearly, our employers’ cunning plan backfired somewhat. However, remarkably the USS further claims:

“Even if we had not planned to hold a valuation as at 31 March 2020, it is highly likely we would have concluded that a valuation was the most measured way to respond to and investigate the pandemic’s impact on the Scheme’s funding position.”

The financial turmoil that convulsed markets in March 2020 affected every one of the 5000+ pension schemes in the UK. Yet weirdly, the USS appears to be almost the only pension scheme in the country that voluntarily conducted a discretionary valuation, one not required by law, at the depths of the COVID induced financial panic. It is almost as if the Trustees of other schemes concluded that it might not be in members’ interest to conduct an unnecessary valuation at the outset of a once in a generation pandemic.

As part of the valuation process, the USS is supposed to keep its figures updated for what is called “experience”, i.e. how financial markets and the value of its assets and liabilities have changed since the valuation date. Great, right? Worldwide assets have increased by 50%. Even the USS has managed to increase its assets by 28%, and these assets now exceed any of its estimates of the amount needed to pay our pensions in 2020, even those that assumed no real return on its investments until 2102. So we just update the value of our investments to reflect today’s asset values, and there’s no problem right? Sadly not — the USS claims that future asset returns will be lower.

Now, pensions law requires that pension schemes need to have evidence to justify changes to their valuation methodology. For the 2020 valuation, after extensive discussion with The Pensions Regulator (TPR), the USS proposed assuming a maximum return of 0.2% above inflation. This is reduced from 0.92% above inflation in 2018. These reductions in the assumed rate of return are due to the USS making ad hoc and unprecedented changes to its assumptions about investment returns (especially the level of prudence it used, see here and here for details).

Previously, the USS has argued that falls in the rate of return on UK government debt (the “yield”) implies that the returns on a world-wide globally diversified portfolio will also be lower. However, between March 2020 and March 2021, the yields on UK government debt rose. In an increasingly desperate attempt to maintain the pretence that the scheme is underfunded, USS are claiming that they need to further reduce the assumed rate of return (the discount rate). In the USS Financial Monitoring Plan (a monthly update on scheme funding), they’ve assumed returns of up to -0.89%+CPI, and so the scheme’s deficit remains the same size despite the increase in its assets.

So the obvious question for the USS is: would it be reasonable and prudent to have not pressed ahead with an optional 2020 valuation at the depths of a pandemic, and submit a March 2021 valuation as required by law?

The USS has considered this, and published an entire “USS Brief” (imitation is the…), on the potential benefits and contribution rates of a 2021 valuation. In this document, the USS repeatedly claims that expected future investment returns have fallen since the depths of the COVID-19 pandemic in 2020. Indeed their expectations of future growth have fallen so much, they have offset much of the increase in asset values. The USS merely asserts that future asset returns will be lower. They present no credible evidence to support its claims about future asset growth. How pessimistic are the USS’s assumptions?

Figure 2: USS assumed rate of return (discount rate) assumed in the 2011 to 2018, and proposed for the 2020 and 2021 valuations

The changes the USS has made to its assumed rate of return above inflation are shown in Figure 2. Over the period 2011 to 2021, the USS has reduced the assumed rate of return from over 3% per year to 0.02% in 2021. It is these changes to the assumed rate of return that is driving the changes in the scheme. Are these changes justified? Are these changes to the assumed rate of return supported by evidence? Despite repeated requests from members of the board of Trustees, the Joint Negotiating Committee (JNC), and its stakeholders, the USS has consistently failed to provide credible evidence to support these changes. However, fortunately, economists have published lots of evidence about historical returns. For example, one reasonable source of evidence about investment returns is Jorda et al. (2019). They have compiled a dataset of investment returns to a range of assets, including equities and bonds for 16 countries between 1870 and 2015. Fortunately, unlike USS, Jorda et al. (2019) provide both their data and their statistical code. We can use this data to estimate the 30 year real returns of a USS-like portfolio of assets, this is shown in Figure 3.

Figure 3: 30-year returns for a globally diversified investment portfolio 1870–2015, weighted by GDP. Data from Jorda et al. (2019). Most optimistic USS rate of return assumption for 2020 valuation is indicated by the upper red line.

The lowest return ever recorded in the dataset was 0.92% above inflation per year between 1890 and 1920. During this period around 40 million people died and much of Europe was blown to bits in the First World War, and 20 to 50 million people died from the Spanish flu pandemic. So is it reasonable to assume a maximum rate of return of 46 fold lower than the lowest return ever seen between 1870 and 1985?

Thus, the USS’s claims that members would be no better off in a 2021 than 2020 valuation are only true, if expected future returns are reduced from CPI+0.2% in 2020 to 0.02%+CPI in 2021. Even given a return of 0.02%, the estimated deficit would be far smaller than estimated in 2020.

So yet again the USS has failed to act in members’ interests or in the interests of the communities they serve — such as their students. Yet again, they have failed to provide credible evidence and analysis to support their claims. However, despite the continued pitiful performance (financial and actuarial) of the scheme, and the palpable fury of many members, there is little USS members can do within the scheme rules. The Board of Trustees that oversees the USS is entirely unaccountable to members. Members have no say in the appointment of many of the board members, and astonishingly the current chair of Trustees was appointed merely at the discretion of the 12 board itself.

If it is to regain any confidence and trust of members, the USS needs urgent governance reform. UUK has recently proposed a review on USS governance. However, given none of the Joint Expert Panel’s recommendations for reform of the scheme’s governance have been implemented by UUK or the USS board, members may be a little sceptical. As a result, members’ best hope maybe industrial action against their employers, and legal action against the USS Board of Trustees.

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 hashtag #USSbriefs109; the author will try to respond as appropriate. This work is licensed under a Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International License.




A set of papers written by University Staff and Students, on University Staff and Students, for University Staff and Students.