Covenant and Prudence in the USS 2020 Actuarial Valuation

Kevin Wesbroom
4 min readApr 15, 2021

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As somebody who in a previous incarnation was involved in a number of USS actuarial valuations, I have watched the unfolding saga of the 2020 valuation with a mixture of amazement and depression. Are people really talking about contributions of 50 or 60% of salary to provide these benefits? Since it appears to be open season on this actuarial valuation, and everybody can air their views — which naturally are all correct! — let me add my own, for what they are worth.

The good news is that I don’t propose to get into the details of the whole valuation process and assumptions, tempting though that is. The Pensions Regulator warned against that in his seven page letter setting out his views on this valuation in which he cautioned — “we believe it is appropriate for the Trustee and stakeholder to adopt a holistic approach to the valuation process and output, rather than focus too much on individual elements.” But that does not stop the Regulator from then giving its views on some of the individual elements!

I must admit that being able to see the Regulator’s detailed views on one scheme’s actuarial valuation made me think back to the days (just before current USS Chief Executive Bill Galvin joined them) when they professed their intention to be “a referee not a player” in pension scheme funding. This feels less like a referee and more like a player on the pitch with the ball firmly at his feet!

There are two particular aspects of the 2020 valuation that strike me as worthy of discussion — covenant and prudence. Prudence has already taken centre stage for many commentators — too much say many, but too little say others who believe the answer is bonds, now what is the question?

To be clear I am not a deficit denier. We have to accept that the prospects for future returns are lower and so the cost of benefits has increased — but by how much? There have been some very good analyses of historic projections and outcomes, which suggest we have moved towards the “too much” end of the scale. Many seem to have overlooked that USS is one of those unusual schemes in the UK — a private sector DB scheme still open to future members and future accrual. Should open schemes be treated the same as closed schemes?

Certainly, the Pensions Regulator seems to suggest that open schemes are just closed schemes in waiting — their latest Funding Code states that “as much as possible, we want the funding regime to apply consistently to all schemes.” But should the same degree of prudence be applied to calculating the cost of future service benefits as for past benefits (and hence deficit contributions)?

I think not — and could find support in going back to the original European Union legislation which defines Technical Provisions in relation to accrued benefits — not future accruals. At a more fundamental level perhaps we should be asking ourselves just what is the purpose of an actuarial valuation for an ongoing open scheme — is it to determine the “exact” values of the liabilities and hence deficit and future service costs? Perhaps it should be much more deciding what is a fair contribution rate to be applied to the current generation of members and employers. Well, until the next valuation when we can take a broader perspective and reflect on events like the bounce back in share values, and even the recent reduction in liabilities, as interest rates spiked. Viewed through that lens, contributions of 50 or 60% fail this fundamental test.

The other part of this valuation that grates for me is the obsession with “exact” values of covenant. And how that covenant assessment seems to be increasingly tied mechanically to future investment returns and the contributions that would need to be paid in the next few years. Once again, I am not an denier of the concept of Integrated Risk Management , but I do object to the spurious accuracy applied to a concept which is inherently subjective, and should be painted on the funding process with a very broad brush. Thankfully we have moved on from the widely discredited Test 1 valuation methodology, replacing it with a Dual Discount Rate, which is more appropriate for a scheme of USS’ size and structure. But we still seem to be trying to trade pound for pound extra covenant today versus contributions tomorrow. That feels an unhealthy route to pursue, which is fundamentally changing the nature of funding UK pension schemes.

My final thoughts about this valuation concern the benefits themselves. At least in part, the current problems relate to the basic nature of the benefits provided. Those benefits are guaranteed — and one thing we have learnt over the history of pensions is that guarantees cost. The cost of delivering a guarantee may become more than the parties are prepared to pay.

Giving flexibility in terms of benefits could open up the possibility to use not prudent funding but best estimate funding. If guaranteed benefits were materially lower, but target benefits retained on a discretionary or best endeavours basis, we may find ways to deliver benefits that members want at a price that they and their employers can afford. The ultimate presentation of this might be Collective Money Purchase benefits — now a reality following the Pensions Act 2021 — but other more immediate approaches are possible.

One way or another it feels to me that a sensible outcome to the percentage of salary contributions for this valuation should start with a 3, rather than a 5 or 6. And to forestall any future amazement or depression, I am talking in tens not hundreds!

Kevin Wesbroom is a professional trustee with Capital Cranfield. He writes in a personal capacity and the views expressed are not those of his current employer or his previous employer Aon, adviser to Universities UK

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Kevin Wesbroom
Kevin Wesbroom

Written by Kevin Wesbroom

Professional pension trustee and qualified actuary. More than 40 years in pensions and still learning!

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