The importance of USS’s plans to replace ‘gilts plus’ monitoring between valuations

In their latest public statement on the new valuation on which a consultation will shortly be launched, Universities UK writes that “It is possible that contingent (or trigger) contributions (higher contributions activated by a material change in the funding position) may be proposed by the USS Trustee”. Since these higher contributions would be automatically triggered by deterioration in the scheme’s funding position between valuations, USS’s method of monitoring changes in the level of the scheme’s funding during this period takes on special significance.

At present, USS employs a ‘gilts plus’ method of monitoring the scheme’s funding level between valuations. The upshot is that their reported funding level dramatically fluctuates between valuations solely as the result of changes in gilt yields which drive adjustments to the discount rate and the CPI assumption. As I explain in this December 2016 blog post ‘Alarming deterioration in USS funding is based on an incoherent valuation methodology’, this method is at odds with USS’s ‘best estimate minus’ method of determining the discount rate at each triennial valuation.

‘Best estimate minus’ involves USS’s ‘Fundamental Building Blocks’ approach to providing a best estimate of the expected long term rate of return on the assets actually held in their portfolio. This best estimate 50% likelihood of such investment returns is then prudently adjusted downward to returns that are 67% likely. Such a ‘best estimate minus’ method of monitoring the scheme’s funding level is more stable and reliable than a ‘gilts plus’ method.

In their September 2017 consultation document, USS expressed the following highly sensible intention to move to such a ‘best estimate’ method of monitoring funding level between valuations:

It is the trustee’s view that a model calibrated to the latest view of the expected return on assets will be a more reliable indicator of the change in the employers’ long term risk exposure resulting from market movements in between valuations. (p. 4)

USS intends to supplement Test 2 by ongoing monitoring of the required contribution rate for the current benefit using a model that calibrates to the underlying internal rate of return assumptions used by the trustee rather than a fixed margin over gilts. …Estimating the required contribution using a model calibrated to the latest view of the expected return on assets will be a more reliable indicator of the employers’ short term risk exposure. (p. 42)

It is important to the credibility of any automatic triggers USS imposes as a condition for taking on greater investment risk that such triggers are based on genuine changes in the long term expected returns on the assets held in the scheme, rather than the crude proxy for the discount rate that the gilt yield provides.

[UPDATE: Please see this linked Twitter thread in which I comment on statements regarding triggers in a letter from the Pensions Regulator regarding USS that has recently been released.]

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Professor, Dept. of Philosophy, Logic & Scientific Method, LSE

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