USS Dispute – UCU’s formal response to unofficial briefing

Michael MacNeil, UCU’s National Head of HE, writes: “In early July, many branches received a briefing from Malcolm Povey, an HEC member, outlining his views on the USS dispute. Branches were informed that I had provide a brief commentary on the accuracy of the points made in that briefing with advice from our National Pensions Official. Branches were informed to contact me if they wanted a copy of the response.

The UCU committee dealing with the dispute, the Superannuation Working Group (SWG) has considered the matter further and I have been asked to circulate their formal response to the briefing.

There are serious errors in Malcolm Povey’s “Briefing” on USS which warrant a reply.

The “briefing” focuses on two elements of the scheme as it stands which are said to threaten its sustainability, and it asserts as an “inescapable conclusion” that institutions participating in the scheme “are using the [2011 valuation] report simply as a platform to cut their contributions to our pension scheme”. This response will take those in turn.

The first threat is identified as the two-tier structure introduced in October 2011 despite UCU’s efforts, on the basis that it will cause a flight of staff from active membership of the scheme. It is true that, should younger staff decide not to join, or to withdraw from active membership, the cost of meeting the liabilities already accrued would increase, and not just as a proportion of the salary bill for those still members; the deterioration in the scheme’s cash-flow position would require a more conservative investment strategy that would trade a reduction in return for the liquidity needed for reliable satisfaction of liabilities as they fall due.

It is a large assumption, though, that new staff will find the career revalued benefits (CARE) section so unattractive that they will prefer to stay outside of any occupational pension scheme in circumstances where they would have remained in USS as it was before the 2011 changes. Since April 1988, when mandatory membership of USS was ended by the Thatcher Government, a substantial proportion of eligible staff has always chosen not to join the scheme – or at least not to join it straight away. USS has been monitoring changes in the pattern since last October. These are early days, but so far no such change has been discerned.

While evidently the scheme will for many entrants to the profession appear less attractive than it would have done had it not been for the changes imposed from last October, it would be irresponsible to campaign on the entirely false basis that it is now a poor use of money for staff in any but the most unusual circumstances. It is generally accepted that there is a level of contributions in relation to current income, above which cash-flow considerations cause people to opt out, but the scale of the ultimate benefits will often be at most a secondary factor in the decision to do so. What that level is has been a topic of negotiation in the statutory public service schemes, but the contributions contemplated there are generally higher than those ordinarily paid in either section of USS, especially at the FTE salary levels of those becoming eligible for USS.

Prediction of future behaviour is hazardous, but a significantly increased level of opt-out from USS active membership seems unlikely under anything like the present rules.

The second threat to the viability of the scheme which Malcolm identifies is inflation. It is not clear why price inflation should threaten the scheme’s viability, though it would probably reduce members’ standard of living in retirement, especially inasmuch as the rate of indexation is capped and in so far as the index used understates real increases in the cost of living for pensioners. That is why the removal of the cap has been a major negotiating objective of UCU.

However, a claim that inflation threatens the viability of the scheme, i.e., the capacity of USS under the present rules to meet past service liabilities and/or those accruing from future service, would be difficult to sustain. It is not obvious that USS would find it more difficult to grow the scheme’s assets in real terms at levels of price inflation significantly above those we are currently experiencing. Indeed, to argue that it would, serves only to lend credence to the employers’ view that a cap on indexation is necessary. In so far as an increased pace of price inflation might result in an even greater increase in the yield on UK Government bonds, the viability of the scheme would tend to be enhanced by the increased rate at which the present value of future liabilities could properly be discounted.

If it is argued that inflation is a threat because the new indexation regime will put staff in the sector off joining USS, or cause existing members of the scheme to withdraw, in other words that the second threat Malcolm describes has a similar basis to the first, then one has to respond that the argument is equally without substance. Indeed, inflation may be even less likely than the two-tier structure to represent a material threat to the viability of the scheme, as distinct from a serious detriment for members and prospective members relative to their expectations prior to 2011 – a detriment which we have been attempting to reverse as a negotiating objective.

It will not help UCU members for the union to base a campaign on supposed threats to the viability or sustainability of USS which will not be recognised as substantial by employers, by USS or by well-informed members or influential opinion formers.

Equally, it will not help UCU members for the union to misstate the primary objective of the employers. Of course many senior managers in institutions participating in USS, and probably even more lay members of their governing bodies, would aspire to a lower rate of employer contributions to the scheme. Such people may derive some comfort from the low numbers projected for employer contributions ten years hence by the recovery plan submitted to the Pensions Regulator following the 2011 valuation. They would be deluded to derive very much, though, and it is doubtful whether many do.

For the foreseeable future the pressure on contribution rates is going to be upward, not downward. As the rules of USS stand, in the event that a future actuarial valuation leads the trustee board to conclude that higher rates are necessary to sustain the scheme under its present rules, 65% of the money perceived to be required will be met by the employers, with the remainder met by increased member contributions and/or reduced benefits from future service.

The reason why the pressure on contribution rates will be upward is that financial outlook for USS is worse now than it was on 31 March 2011, to which date the report Malcolm uses is directed. The UK (and indeed the global) economy is in a worse place and facing a bleaker future for longer than was the case eighteen months ago.

While quantitative easing may have had some favourable impact on equity markets, it has had a much greater unfavourable effect on the solvency of sterling pension schemes, by reducing the inflation-adjusted rate of return on UK sovereign debt (“gilts”). The adjustment for inflation is drawn from the expected long-term rate of increase in UK prices implicit in the market price of index-linked securities of which it is taken to be virtually certain that the nominal capital investment is safe. The rate matters because it determines the rate at which the Pensions Regulator will expect the scheme actuary in assessing the scheme’s solvency to discount the present value of its liability to pay future benefits. If virtually risk-free investments are going to yield a significant real rate of return, one may use a relatively high discount rate and so reduce the value of the scheme’s liabilities. If, as has recently been the case, they are set to give a nil return (or worse) in real terms, the scheme’s liabilities are at best the sum (at today’s prices) of all the entitlements to benefit accrued to date.

To believe that the 2014 valuation of USS will not produce, on the same assumptions as in 2011 as to longevity, salary movement etc., a greater deficit and a more demanding and longer-term recovery plan, is to believe that capitalism will turn the world around dramatically and in short order. It may; but let us not kid ourselves that we shall persuade our members, let alone the employers, to share the belief that it will.

Even if and when on existing actuarial assumptions the outlook is more favourable, it is far from clear that the response will be a reduction in contribution rates for either employers or members. At present the USS fund is invested more in assets that are primarily chosen to yield a relatively high return than in assets chosen for the low level of risk they pose of loss of capital. The risk of volatility in the valuation of the assets is deemed acceptable in the light of the scheme’s positive cash-flow, projected to last some years into the future, so that the trustee company will be able over that period to meet liabilities as they fall due, even if at any given moment assets have fallen in value. However, even today the risks of the investment strategy are almost certainly greater than we would wish to assume if the alternative were not immediate increases in contribution levels. It may very well be that a high priority, in a more favourable economic moment, would be to revise the investment strategy so as to reduce its down-side risks, which would in turn require the actuary to value future asset growth at a lower level, thus reducing or eliminating the scope for contribution reductions. Moreover, throughout the next couple of decades at least, the proportion of scheme income required each month for payment of benefits may be expected to grow, so the more time elapses before de-risking opportunities present themselves, the higher will be the priority that taking them will have over contribution reductions when they do.

In this context, what seems much more likely to motivate employers over the medium term than a drive to reduce the rate of their contributions is a determination to stabilise them. It is not in the interests of UCU to give comfort and encouragement to the employers by overstating their ambitions.”

This document was approved by:

Roger Brookes – UCU representative, Joint Negotiating Committee

Alan Carr – UCU representative, Joint Negotiating Committee

Pauline Collins – UCU representative, USS Advisory Committee

Joe Devlin – UCU appointed Director on the USS Board

Joe Gluza – UCU representative, USS Advisory Committee

Angela Roger – UCU appointed Director on the USS Board

Bill Trythall – UCU appointed Director on the USS Board