October 2019 newsletter: The USS deficit – someone sees it, the Regulator, and it wants something done about it, too

In the July 2019 issue, Bernard Casey1  and John Ralfe2  [respectively, a retired academic and one-time senior economist at the OECD, and an independent pension consultant] took issue with an article ‘Now you see it, now you don't' — Is the university pension fund really in deficit?’.  The author of the original article added a response questioning some of the points that had been made.  Here, Casey and Ralfe exercise their right to reply.  They explain how the Pensions Regulator is demanding action.  They also point out how the deficit has potentially severe consequences for higher education in the UK.

In July, we argued that the underlying economics of defined benefit (DB) pensions — including USS — were quite straightforward.  The payment of a DB pension—- based on salary and years of service — is an unconditional obligation and is to be treated in the same way as any other unconditional payment obligation.  Examples such as a bonds or private placement were given.  DB pension promises are bond-like.  They promise a series of payments at regular intervals, and the pension issuer is subject to a credit rating like other bond issuers.  As with other bonds, future payments are discounted according to the appropriate discount rate.

We also pointed out that the underlying economics of a DB pension apply to all countries — whatever their national pension regulations.  So, now, we want to look at UK regulation and how it applies to USS

The figures for USS

The Pensions Act 2004 requires all UK pension schemes to have an actuarial valuation every three years that fixes the size of the actuarial deficit and deficit payments.  The results are submitted to the Pensions Regulator (tPR).  The most recent USS ‘funding update’ — for 2019 — showed a deficit of £5.7bn.  However, the underlying assumptions are chosen by USS and its actuary, and they can be massaged to give an answer that is appropriately low. 3

If one uses the internationally recognised FRS102 standard for pension accounting, which calculates discounts using AA corporate bond rates, the deficit for 2019 was £11.8bn.4  

As well as the triennial valuation, USS is required by law to produce a valuation that shows the obligations the Pension Protection Fund (PPF) lifeboat would have to take on if USS were to default.  The assumptions set by the PPF for USS are the same as those it sets for all 6,000 pension schemes, and, unlike those actuaries can employ, they cannot be chosen to produce more attractive outcomes.  The PPF liability for March 2017 was £23bn — three times that given in the full actuarial valuation and one third higher than the FRS102 valuation.

Whatever the claims some make about how ‘well-funded’ it is, USS has one of the lowest PPF funding levels of any large UK pension scheme.  A third of large pension schemes — over 10,000 members — are more than 100 per cent funded, but USS is in the bottom fifth of the large funds table5.   Back in 2008, USS had a PPF surplus.  In a mere nine years, it has managed to lose some £25bn.

Moreover, unlike the average scheme, USS's actuarial funding target is lower than that required by the PPF.  Even if USS were ‘fully funded’ on an actuarial basis, it would still have a huge deficit on a PPF basis.

The proposed solutions

USS has proposed to make deficit contributions, starting at around £300m per year.  These are nowhere near enough to pay down the PPF deficit of £23bn.

Worse still, the UCU, which represents the academics, UUK, which represents the employers, and USS, itself, have all been busy creating a smokescreen that disguises how bad things really are.  The UCU wants its members to continue receiving a defined benefit pension.  But these are now rare as hens' teeth in the private sector, and this is where the universities are.  The universities want a quiet life, with no strikes.  They also want to avoid making big deficit contributions — after all, there are suggestions the current fee rates be reduced downward (see the Auger Report), that student numbers may well fall below those projected, and that European funding is in retreat.6   The USS does not want to own up to the fact that its problems have been largely self-inflicted.  For years it has been betting that investing in equities would somehow save the situation.

What the Regulator wants

Clearly unmoved by all drama of the last two years, tPR has now sent a third strong letter to USS.7   The regulator classifies pension providers according to the strength of the covenant they put behind their pension plans.  It categorises USS not as ‘strong’ (the top category) — only as ‘tending to be strong’ (the second category).  It said that the 2017 and 2018 actuarial valuations were ‘at the limit of what we consider to be compliant with legislative requirements for prudence’.

The regulator wants to see more money from universities, and to see it more quickly.  However, even to pay down the PPF deficit over 10 years — longer than the average deficit recovery period — universities would have to make annual deficit contributions of over £2bn.  This is more than their current cash contributions for new pension promises and deficit contributions combined.

What is to be done?

How can universities possibly find this money?  If they were to find it, core teaching and research would be devastated, and some universities may well go bankrupt.  USS is not a mere footnote for the concern of a handful of pension accountants and pension economists.  The scheme’s deficit is so large that it threatens to undermine the whole UK higher education sector.  University teachers are planning more strike action.  Strikes were called off last year only when plans to move from a defined benefit to a defined contribution pension were scrapped. This solved nothing.

But it is not bad news for everyone.  Those ploughing through the small print in the USS's annual report will see that two of the schemes' in-house investment teams were each paid an eye-watering £1.75 million.  This is despite USS missing its performance targets by miles — both against a five-year and against a one-year benchmark — by miles.  Nice work, if you can get it.


1. Bernard H Casey, SOCialECONomicRESearch, London and Frankfurt (b.casey@soceconres.eu).

2. John Ralfe, John Ralfe Consulting, www.johnralfe.com (JohnRalfe@johnralfe.com).

3. The actuary, in consultation with the scheme, can choose assumptions about the discount rate used, the expected growth of salaries and the mortality rate of scheme members.  A higher discount rate, higher mortality rate and lower salary growth rate all result in lower liabilities.

4. As we outlined last time, some say the discount rate for USS could be AAA, not AA — reflecting the AAA status of some universities.  This would increase liabilities further.

5. See https://www.ppf.co.uk/news/purple-book-2018

6. On the Augar report (Post-18 review of education and funding: independent panel report), see https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/805127/Review_of_post_18_education_and_funding.pdf; on student numbers see Office for Students, Financial sustainability of higher education providers in England (April 2019), at https://www.officeforstudents.org.uk/media/cf54b6ee-714e-45c3-ade9-56bc685b861d/report-on-financial-sustainability-of-higher-education-providers-in-england.pdf; and on research funding see ‘Spiralling costs, high debt and Brexit: can UK universities survive?’ in Financial Times, 05/02/2019) at https://www.ft.com/content/46582248-133a-11e9-a581-4ff78404524e


Editor’s note: after the Newsletter went to press, the actuary for the USS produced a new valuation. A revised table (revisions in bold) and authors’ comments follow.

The review was launched without any fanfare and placed not under the link “valuation 2018”, where it might have been expected. We have modified the table above to include this new valuation, with the additional rows marked in red. It is to be presumed that tPR had no access to this information when it was sending out its third strong letter. The PPF deficit for 2018 is better than that of 2017 because assets had increased in value.