USS consultation closes on Friday 22 May

If you are a member of the USS pension scheme and have not yet responded to the consultation, please try do so before it closes on Friday. The more responses received the greater the chance of moving the proposal. The Sheffield UCU responses to the questions are below. Feel free to copy and paste them if you want to (including the s which give paragraph breaks).

Respond to the consultation: http://www.ussconsultation.co.uk
(you will need your NI number and USS member number from a USS statement)

Our full response to the consultation in conjunction with the other campus trade unions (Unite and UNISON) can be read at the following link: union_response_uss_consultation

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Question 1: Do you have any comments on the proposed change to end the link to final salary?
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Breaking the link to final salary for past service is indefensible. On USS’s own calculations, this amounts to a reduction of £4.8bn in the pensions workers will receive in exchange for contributions they have already made (and will continue to make for the next twelve months) into the final salary scheme. Severing this link flies in the face of the assurances to USS members in 2011 that the changes introduced then – including a substantial increase in employee contributions – were, in the words of the Employers Pension Forum, “designed to ensure that the scheme will be both sustainable and affordable over the long term”. The Hutton Report on reforms to public sector pensions called for the preservation of the final salary link for past service in the transition to CRB. It deemed this necessary in order to maintain the “trust and confidence” of employees in their pension scheme. Thus there are compelling reasons to maintain the final salary link for past service.

I have major problems with the way the fund has been valued, in particular

– the calculation of the discount rate, which, as far as we can tell, has been downgraded from the rate used in 2011 due only to a fall in gilt yields and in spite of strong performance in the intervening years; 
– the pay growth predictions, which are at an unrealistically high level that we believe the sector has no intention of matching and likely to vastly over-estimate liabilities; 
– the `reliance on covenant’ measure, sometimes referred to as Test 1, which we believe to be misleadingly named, inappropriate and damaging to the scheme; 
– the contradictory nature of the assumptions, in that while pay growth points to a buoyant economy and healthy higher education sector, the uprating by CPI in Test 1 suggests a stagnant sector and the discount rate points to falling dividend yields (i.e. a recessionary economy).

The case USS and our employers make for breaking the final salary link is unconvincing: that this is needed to offset a rise in their assumed deficit on past service. The main source of this increase is the nearly £7.6bn that the fall in gilt yields has added to their assumed deficit. This huge increase, however, is an artefact of USS’s widely discredited `gilts plus’ method of setting the discount rate. It is lamentable that USS and our employers rest their case for such a large reduction in benefits on an unjustified and unjustifiable valuation methodology. Neither the USS trustee nor the Employers Pension Forum has offered any detailed, let alone convincing, response to the critiques of the methodology from various sources, including First Actuarial, the statisticians who wrote to the trustee in the autumn, and various employers such as Imperial, Warwick, and the LSE. Most tellingly, they have failed to respond to the following point made by the statisticians:

“By their nature, the scheme’s real liabilities must vary slowly on a decadal timescale. Liability estimates that show rapid variation on a scale of months to years (as they do for USS) are an indication of instability in those model-derived estimates, not the underlying reality. We would urge you to change to a more stable methodology, rather than allowing the actuarial assumptions tail to wag the investment strategy dog, by `de-risking’ into Gilts and substantially reducing members benefits. The wild swings in actuarial valuations we are now seeing are either the classic symptoms of a controlled system with (highly undesirable) positive feedback or the `chattering’ you get with a controlled system where the control needs to be smoothed over time.”

Before it severs the final salary link for past service, USS must offer, for public scrutiny and debate, a detailed and compelling response to the critiques of the valuation methodology. It must do so in order to establish the trust and confidence of scheme members that a £4.8bn cut in pensions is in fact necessary.

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Question 2: Do you have any comments in relation to the proposed treatment of transfers in for final salary section members?
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The proposal to withdraw from the public sector transfer club may create recruitment issues. There may be also be a disincentive to apply for promotion if success would mean placement in an inferior USS scheme without the ability to transfer service from other schemes.

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Question 3: Do you have any comments in relation to the proposed treatment of Money Purchase and/or Added Years Additional Voluntary Contributions (AVCs) for final salary section members?
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I do not agree that USS should be able to cancel the contract members signed to purchase additional years’ service in the final salary section, effective from 31st March 2016.

All of the literature about the AVCs purchased indicated that the additional years would be added to earned service and that it would be linked to future final average salary. USS should honour the original commitment and enable members to continue to purchase additional years’ service in line with the original contract.

It is not a reasonable alternative to offer members the ability to take out a new contract in an inferior (CRB) section of the scheme.

I note that USS considers that it can modify the benefits members will earn based on future service in the scheme, but I do not accept that it can alter the added years’ AVC. USS should honour all AVC service, in line with the original terms.

I understand that up to 31 March 2016 the fund enables members to purchase service in the final salary section of USS. I would expect the money-purchase fund value at 31 March 2016 to be clearly identified and increases accrued to that part of the money purchase fund should be used when calculating the additional service purchased in the final salary section.

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Question 4: Do you have any comments in relation to the proposed treatment of transfers in for current and prospective CRB section members?
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I am concerned that there may be issues in relation to transfer from USS and non-USS institutions within the UK HE sector.

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Question 5: Do you have any comments in relation to the proposed treatment of Money Purchase and/or Revalued Benefits Additional Voluntary Contributions (AVCs) for current and prospective CRB section members?
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I want all contracts to be fully honoured. The closure of this facility reduces USS’s attractiveness to potential members.

I understand that up to 31 March 2016 the fund enables members to purchase service in the CRB section of USS. I would expect the money-purchase fund value at 31 March 2016 to be clearly identified and increases accrued to that part of the money purchase fund should be used when calculating the additional service purchased in the CRB section.

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Question 6: Do you have any comments on the proposed new career revalued benefits section of the scheme?
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Although the proposal is to improve the CRB section by improving the accrual rate, I am concerned that USS is failing to match the benefits available from the Teachers’ Pension Scheme, the other major pension scheme in the higher education sector for similar posts. USS should be planning to improve both the accrual rate and revaluation rate in the CRB section in the future.

The revaluation should be in line with uncapped CPI for active members.

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Question 7: Do you have any comments on the proposed level of the salary threshold or the proposed approach to the revaluation of the salary threshold?
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I do not accept that there should be a threshold; defined benefits should be based on members’ full salary. However, as a minimum, the salary threshold should be linked to the top of the nationally agreed pay spine. This requires urgent review.

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Question 8: Do you have any comments on the proposed application of the salary threshold for part-time employees?
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There should be equal treatment in the scheme for part-time and full-time staff. As such, actual earnings should be used to determine the level of contributions payable, rather than full-time equivalent salary.

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Question 9: Do you have any comments about the proposed creation of a defined contribution section for employer and member contributions on salary above the salary threshold (£55,000 as at the implementation date)?
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This move from DB to DC is bad value for money.

According to a recent Canadian Public Pension Leadership Council study on `Shifting Public Sector DB Plans to DC’: “It is widely recognized within the pension industry that DC pension plans are less efficient generators of pension income than are DB arrangements or other pension design alternatives.”

Through the modelling of these inefficiencies, the study indicates that “for an efficient \$10bn DB plan, converting to individual account DC arrangements to provide the same value of pension benefit would increase the ongoing cost of the plan by about 77 percent and increase the required contribution rates accordingly. The portion of the final benefit coming from investment returns would drop from 75 percent to 45 percent.”

In addition to its modelling, the Canadian study draws on “experience and evidence from other jurisdictions” in reaching the conclusion that “Large, well-run DB plans are more efficient at producing retirement income than are DC plans. Several US states that have looked at converting DB plans to DC have concluded that it would cost considerably more to maintain similar benefits. Two states that had converted to DC at least partially converted back because of concerns over how little income they were producing for retirees (Nebraska and West Virginia).”

The USS consultation modeller itself reveals an unfavourable comparison between the new CRB defined benefit (DB) pension that a \textsterling55,000 salary will generate with the equivalent annuity that one could purchase if one earns \textsterling 55,000 in the new defined contribution (DC) section. What such a comparison reveals is that one needs to keep one’s DC pension pot invested for a long time, and at a fairly high rate of return, in order to generate enough wealth to purchase an annuity that matches or exceeds the CRB DB pension. Even at the USS consultation modeller’s highest rate of return of 7.5\%, one needs to keep one’s DC pension pot invested for over 30 years in order to purchase a matching annuity. See this spreadsheet for more details: http://tinyurl.com/p4zdz7p

Academics in USS won’t, however, start putting much money into their DC pension pots until they’re earning higher salaries later in their careers. Perversely, members will end up making more and more DC contributions when they will yield less and less of a pension per pound contributed. This flaw in the system will be magnified if the default DC fund involves the common practice of `lifestyle’ de-risking of one’s pension pot into lower-risk, lower-return assets as one nears retirement.

This problem would be mitigated somewhat if USS members are allowed to keep their DC pension pots invested in USS funds throughout their retirement. Under this scenario, pension income would be generated via a gradual drawing down of their pot in retirement, rather than via an exchange of their entire pot for an annuity at the beginning of their retirement.

A move to collective DC would provide further mitigation. Under CDC, USS could make use of investment and longevity risk pooling, plus a continual and long-term investment of the collective fund in return-seeking assets, in order to try to achieve the target of a pension that is equivalent to the CRB DB pension. See the response to question 10 for further comments on CDC.

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Question 10: Ahead of any further engagement by the trustee about the defined contribution section, do you have any comments on the range of funds to be provided (including the default fund), the charges payable by members, or any other aspects of the defined contribution proposition?
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USS has not yet provided details of the default DC option they will provide for members, free of management and investment charges. If, however, their default option takes the most common form, it will involve `lifestyle’ or `life-cycle’ de-risking, where investments are shifted from equities into less volatile assets such as bonds as a member nears retirement.

Such de-risking comes at a significant cost. In `The Value and Risk of Defined Contribution Pension Schemes: International Evidence’, Edward Cannon and Ian Tonks found that the median lifestyle or life-cycle de-risked pension pot across sixteen different OECD countries was only 73.4% as large at retirement as the median pot that had been invested in equities throughout. For the UK in particular, the median de-risked pension pot was only 59.5% as large as the median pot that remained invested in equities throughout. Moreover, from 1948 to 2007, lifestyle de-risking would have made a UK pensioner more than marginally better off only during the years immediately following the burst of the dotcom bubble in 2000. In almost all other years, even those preceded by fairly sharp downturns in the stock market, such de-risking would have left members poorer in retirement than a high wire strategy of remaining invested purely in equities throughout one’s career. Cannon and Tonks also show that investing purely in bonds, or else 50% in equities and 50% in bonds, yields worse results than lifestyle de-risking. All of these investment strategies involve a flattening of the market volatility of equities only at the cost of a substantial amount of levelling down into lower-return assets.

The Employers Pension Forum maintains that USS’s default DC option will be “designed to be the most appropriate investment choice for the scheme membership”. We can see now, however, that there is no appropriate investment choice for an individual with a DC pension pot. USS members will be forced to navigate the Scylla of highly volatile equities and the Charybdis of levelling down.

If we are to tame volatility in return-seeking equities without levelling down, we must instead turn to a form of DC known as `collective benefits’ defined contribution (CDC), which allows for the efficient pooling of investment and longevity risks among employees. The reaping of economies of scale and investment expertise during retirement is a further advantage of CDC over individual DC pots. CDC would enable employers to provide better pensions in comparison with individual DC without contributing a penny more in contributions. Moreover, CDC would neither create any obligation to increase employer contributions in the future nor add any debt to their balance sheets, since the benefits to employees do not constitute a promise.

CDC should be the default DC option. Please see this note for further remarks regarding the inadequacies of lifestyle de-risking and in defence of CDC: http://tinyurl.com/phgfk4d

If, however, members opt for individual DC pots over CDC, USS should make passively managed index funds available with management costs no higher than that which is strictly necessary to cover actual costs. Whatever shape the DC section takes, all costs, management fees, and investment fees must be explicitly stated.

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Question 11: Do you have any comments on the options the trustee should make available for members as to how they might use their defined contribution account at retirement or upon leaving the scheme?
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According to the Canadian study mentioned above, “much of the investment returns that drive DB pension plans come from returns made during the individual’s period of retirement.” Under the DB portion of our hybrid pensions, for example, the USS investment team will be on call to invest our collective USS pension fund expertly and optimally throughout the period of our retirement, so as to generate enough income to cover the pensions they’ve promised. In a typical DC pension pot scheme, by contrast, “at retirement the amount accumulated in an individual’s account is turned over to the individual, and the benefits of low-cost professional management are lost for the subsequent period of individual’s retirement. By one estimate, 60 cents of every dollar of retirement income is earned after retirement.” The benefits that are lost include both the lower administrative costs of economies of scale that come with the management of large funds and the investment expertise of the fund managers. Individuals will also need to contend with longevity risk in trying to figure out what they should do with their pension pots once they retire. These considerations are all the more relevant given the new freedoms over drawdown of pension accumulations.

It is therefore important that USS provide individuals with the opportunity to keep their DC pension contributions invested in USS pension funds throughout their retirement. Collective Defined Contribution (CDC) provides this.

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Question 12: Other/General Comments
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The proposal on which UCU members were balloted in January included “an agreement to continue a review of the contested funding methodology adopted by USS” and “an agreement with the employers that any improvement in the USS funding position should be used to improve benefits rather than be used by USS for further de-risking”.

In their 2 December submission to the USS AV Consultation, UUK stated that “compelling arguments have been put forward for assuming de-risking occurs in 20 years’ time, rather than by assuming arbitrarily that de-risking is carried out on a linear basis over a 20 year period”. UUK also called for “breathing space for the [de-risking] strategy to be reviewed at the next triennial valuation due at 31 March 2017 (rather than de-risking being rushed through)”. UUK wrote to “urge the trustee to accept” a delay in the start of de-risking for 10 years, as “a compromise between the trustee proposal and an alternative approach of `bullet’ de-risking in 20 years’ time”. It appears, however, from p. 11 of their consultation document, that the trustee intends to stick to linear de-risking over 20 years.

Such a refusal to accept UUK’s compromise is contrary to the spirit of the two agreements mentioned in the balloted proposal. If there is to be a genuinely open review of the contested funding methodology, irreversible steps should not now be taken which presuppose a given outcome to that review. The immediate commencement of de-risking would be an irreversible step, since it would, in USS’s own words on p. 11 of the consultation document, “produce lower returns and therefore increase overall pension costs”. Resources to fund an eventual improvement in pension benefits will be permanently lost if de-risking begins now.

Please see the following note for a defence of First Actuarial’s approach to the valuation, which implies the unsoundness of a strategy of de-risking: http://tinyurl.com/q2palz8