How far USS has fallen from past parity with public sector pensions
USS once offered a pension on a par with those promised to civil servants, teachers, and local government workers: inflation-protected annual income from retirement to death, worth 1/80th of final salary for every year in which one had paid into the scheme, plus a lump sum of three times the value of one’s annual pension.
All of these schemes have now switched from final salary to career average (CARE) DB accrual. This switch has been accompanied and followed by large cuts in the value of this accrual in the case of USS but not the public sector schemes.
The following graph vividly demonstrates how far short of public sector pensions USS has now fallen:
1. USS before (blue) and after (yellow) the UUK cuts*
The shortfall of the yellow line, relative to the blue line, shows how much less of an annual pension a 40-year-old USS member earning £40k can expect in retirement in exchange for contributions this year, as compared with contributions paid in 2021–22.
Before the UUK cuts took effect in April, such a member could expect a pension of £590 per annum in today’s pounds throughout retirement, in exchange for one year’s contribution of 9.6% of salary.
Courtesy of UUK’s cuts, a higher 9.8% contribution now yields a smaller pension of £440 on average per annum during the first 20 years of retirement, on the assumption of 2.5% CPI inflation on average over the next several decades. If, however, USS’s most recent long term inflation forecast of 2.8% comes true, that pension will be reduced to £400. If inflation runs a bit higher at 3%, that pension will be reduced to £370.
These cuts are bad enough in comparison with the pension USS promised as recently as last year. They are brutal in comparison with the public sector pensions with which USS was once on a par.
2. USS versus TPS (green)
The comparison with the Teachers Pension Scheme (TPS), in which university lecturers in the post-92 sector are enrolled, is the most striking. As the green line indicates, a 40-year-old post-92 lecturer earning £40k is promised a pension of £1050 per annum in exchange for the same 9.8% member contribution as a USS member. That’s nearly 2.5 times greater than the current USS pension on the assumption that inflation will run at 2.5% and nearly 3 times greater if inflation runs at 3%.
Most of the difference between a TPS pension and the current USS pension is down to inflation revaluation. Since the graph plots monetary values in real, inflation-adjusted terms (i.e., in ‘today’s pounds’), a horizontal line represents pensions accrual (dashed line) or annual pensions in payment (circles, diamonds, or squares) which are revalued to precisely match the rate of CPI inflation. A downwardly sloping line represents pensions accrual or payments which fail to keep up with inflation, whereas an upwardly sloping line represents accrual or payments which increase at a greater rate than inflation.
The steeply upwardly sloping green line during the subsequent career of a 40-year-old TPS member (who remains in the scheme until retirement) represents the revaluation of their accrual at a rate of CPI plus 1.6% per annum up until point of retirement. On account of increments and promotions, a teacher’s final salary is expected to exceed their salary in earlier years by more than the rate of inflation. Hence, revaluation 1.6% in excess of inflation is a means of compensating for the de-linking of the TPS pension promise from final salary and the move in 2015 to a career average (CARE) scheme.
By contrast, when USS switched from 1/80th final salary to 1/80th CARE for new members in 2011, there was no above-inflation revaluation to compensate for the severing of the link to final salary. On account of this lack of compensation, it was estimated that this shift to CARE reduced the average member’s future accrual to about 75% of the value of the 1/80th final salary promise.
3. USS versus LGPS (orange)
In response to unfavourable comparisons between USS and TPS, attention is often drawn to the fact that the latter is an unfunded pay-as-you-go (PAYG) scheme, whereas USS is funded. Some maintain that a funded scheme is more intergenerationally fair than a PAYG scheme, since members and their employers fully fund member pensions out of contributions plus returns on the financial assets into which they’re invested. By contrast, it is claimed that the generous accrual rate of TPS has the upshot that future taxpayers will be forced to subsidize the pensions promised to teachers and post-92 lecturers.
However sound the above line of objection to a comparison of USS with TPS, it cannot be deployed in response to the damning comparison between USS and the Local Government Pension Schemes (LGPS) which can be made. This is because, like USS, LGPS schemes are funded.
At present, the average LGPS employer contribution is 22.9% — a bit higher than the current 21.6% USS employer contribution. For anyone earning less than £67k, the LGPS member contribution rate is lower than the current USS 9.8% rate. For someone earning £40k, it is only 6.8%.
In exchange for this lower member and overall contribution, LGPS promises someone earning £40k a fully inflation-protected pension of £810 per annum. Prior to April, a USS pension promise was worth about 75% of the value of an LGPS promise. Today, a USS promise has been reduced to about half the value of an LGPS promise, courtesy of the draconian cuts UUK pushed through JNC in February.
How does LGPS manage to fund a much better pension than USS?
It’s simple: by means of a combination of an investment strategy now 70% weighted towards growth assets and a moderately prudent discount rate.
The average LGPS discount rate was CPI+1.8% at the last triennial valuation in 2019, when its constituent schemes were on average 98% funded. Returns of CPI+1.9% would have been sufficient to fully fund the promises at that valuation date, and it was estimated that such a level of return would be achieved 62% of the time (see box on p. 3).
By contrast, the discount rate USS adopted for its 2020 valuation is a paltry CPI+0.29%, where such a level of return was estimated to be achievable about 75% of the time.
LGPS schemes are about to launch 31 March 2022 valuations, and it is regarded as “likely that most LGPS funds will have a funding surplus at the valuation date”.
Why the big difference in approach to the valuation of LGPS in comparison with USS?
LGPS is ineligible for PPF protection and operates under an entirely different set of regulations and regulatory practices.
These regulations and practices are more reasonable on account of an implicit assumption that LGPS has a government guarantee (although there is apparently no formal government guarantee) combined with the strength of the employer covenants grounded in the limited tax raising powers of local authorities. USS has compared the higher education covenant to the covenants of local governments.
The huge discrepancy in the manner in which USS and LGPS are regulated is unjustifiable. Some would claim so much the worse for LGPS — e.g., an actuary who argues that LGPS should be valued at the cost of liability-matching bonds, on the basis of spurious arguments to do with intergenerational fairness.
I would say so much the worse for USS.
[*] The annual value of a USS pension depicted in the above graph reflects a conversion of the 3x DB lump sum into additional pension income at USS’s current reverse commutation rate. This is to allow for a like-for-like comparison with TPS and LGPS, neither of which now provides a lump sum. All other figures regarding the value of a USS pension are derived from assumptions which were set by UUK and deemed reasonable by USS for the statutory consultation modeller.
Acknowledgements: Thanks once again to Jackie Grant, Sussex UCU’s pension officer, for bringing the magnitude of UUK’s cuts to life with her brilliantly designed graphs. See links below for her spreadsheets which she used to produce the above graph and a second graph below.
Appendix
1. Link to spreadsheet which contains the underlying formulas and assumptions which generated the above graph:
2a. Link to spreadsheet which plots a the differences between USS, LGPS, and TPS for a 40-year-old earning £60 rather than £40k:
2b. As this graph illustrates, UUK’s cuts are worse for a 40-year-old earning £60k than for one earning £40k:
