How did we get here?
We’re calling for a more sustainable footing for the USS scheme so that it can provide the reliable value for money expected of a pension scheme.
The factors that have lead to the difficulties of the current valuation are complex and include matters related to the structure of a pension scheme itself, as well as changes in national legislation and demographics. This page aims to outline the key factors that have contributed to the current valuation.
The fundamentals of a pension scheme
National interest rates have remained consistently low, which means that – on its own – money you save won’t grow significantly over time. This is difficult for pension schemes that promise a set amount (a Defined Benefit) when you retire. This is because it becomes difficult to predict what will be needed now to guarantee that set amount in the future.
Which means we are faced with a situation where pensions can become more difficult to predict and, in turn, more expensive.
Defined Benefit or Defined Contribution: what's the difference?
USS is currently a hybrid scheme: it has components of both a Defined Benefit and Defined Contribution model. Both provide the long-term reassurance that pensions are designed for but do so in different ways.
DB or DC
Defined Benefits (DB) provide a guaranteed output – you know exactly what you’ll get when you retire. The input (i.e. the price of being able to guarantee this) is not fixed. Employers and employees must predict what needs to be saved now in order to provide this guarantee, sometimes up to 60 years in advance. At a time when interest rates remain static, this prediction becomes difficult.
Defined Contributions (DC) provide a guaranteed input – you'll know exactly what you need to contribute. This is then invested and what you receive is dependent on how these investments perform. As such, the output you receive is changeable.
In this way, DC schemes fundamentally change the notion of risk. Those who take the risk gain the benefits and, because there is no need to predict what that payout might be far into the future, the Pensions Regulator can generally permit lower contribution rates.
Legislative changesThere have been legislative changes in recent decades that have influenced how pensions are valued.
- The Finance Act (1986) introduced rules to reduce pension fund 'surpluses'. Whilst these surpluses did exceed the levels of funding required at that time, they also served as a buffer against future market uncertainty or static interest rates.
- The Pensions Acts (1995 and 2004) introduced more stringent requirements for pension schemes to predict what will be needed at the current time to meet all obligations in the future. Regulators now require Defined Benefit pension schemes to evidence that they are meeting their obligations with as much certainty as possible, yet predictions over the long timescales involved are inherently highly uncertain and sensitive to input assumptions. The cost of providing this certainty has to be met by the present members paying in to the scheme.
Demographic and structural factors
- USS also experienced a prolonged period with little change; member contributions, for example, increased by 0.1% across a 36-year period. Arguably, this means it has been perhaps less prepared to adapt to a prolonged period of low interest rates than other pension schemes.