USS responses to employer questions on whether one needs to be cautious, in light of the dependence of the March 2023 valuation on a rise in interest rates which might reverse

Below are the first two questions that employers posed in a webinar with USS on the 2023 valuation, plus the responses from Kate Barker, Chair of USS, and Aaron Punwani, the Scheme Actuary. (See this video, from 29 minutes.)

‘The first question asks to what extent the panel think that this dramatic improvement in sustainability over the long term is not simply a freak result of the exceptional economic circumstances over the past year. Some commentators, notably Michael Otsuka, have urged caution over cashing in unless there’s real confidence that the 2026 valuation and beyond won’t take us back to the nightmare scenarios of the last decade. And the second question is a similar theme: The positive valuation outcomes are largely a result of the relatively recent increase in interest rates. Does that also mean that should, when there is economic recovery, with lower long-term inflation and interest rates, future valuations would look less positive — i.e., fortunes could reverse as fast as they improved. Do we therefore need to be more cautious on contributions and future benefits in order to best protect the interests of individual members as well as employer entities?’

Kate Barker (Chair of USS): ‘I think these are really good questions that get to the heart of what’s happening with this valuation. I want to be clear what the Trustee is doing in setting forward the numbers that we set forward. So, we priced, as we should, the technical provisions where we stand with regard to the promised benefits on the basis of financial conditions at March ’23, and then specifically, at the request of stakeholders, we’ve also priced the benefits that prevailed prior to ’22. But it’s certainly true that the future service costs in both cases are probably rather lower than we might have expected even a few months ago, because gilt yields have of course continued to rise. And it’s also therefore true that a decline in gilt yields … would have potentially quite a big effect on the scheme. Now we’re very clear — and I commented on this in the Forward [to the consultation material on the 2023 valuation] — that none of us has any real idea what’s going to happen to gilt yields in the future. The best we can do, and we do talk about that in the supporting information, we say a little bit about ‘were gilt yields to fall by this [amount], this might be the changed position’. But in terms of how much caution should we take and what form that caution should be — whether it’s caution about improving benefits, whether it’s caution about how much to reduce contribution rates by, whether it’s caution about whether to use some of the surplus in going back to fill the hole that exists between ’22 and ’24 — those are all really important questions, but to my mind they are questions for the stakeholders. So what we’ve done in the pack, particularly in the supporting information, is to try to give estimates which are relatively preliminary, since it’s often quite difficult to make good estimates about what might happen in the future if this changes, to try and show what the probabilities are of making changes. And it’s clear from those that if contributions rates were held as high as 26%, then the chance of having to move contribution rates up is much smaller, clearly if contribution rates are moved down further, then the prospect of going up from there is a little bit higher. But how to balance all the conditions that lie around, and I’m acutely conscious as I talk about this of the issues of the cost of living that affect everybody, how to balance contributions today with the risk of high contributions tomorrow, seems to me as a matter that is properly for the stakeholders to think about, and that’s exactly what they will think about in the Stability Working Group.’

Aaron Punwani (Scheme Actuary): ‘Very much to support Kate’s response there. In terms of the direct question, are current conditions freak economic circumstances, and might they reverse: They might do. There will be just as many commentators who might say the last decade has been an aberration and real yields as they now are, is more normal, and it’s very, very difficult to predict where that is. And that’s why, exactly as Kate has just described, what we’ve sought out to do is provide a balanced, straight down the line, revelation of the results at the valuation date, which does show good news. And then we can all have a collaborative discussion as to how much of that good use to use up versus how much to hold back for stability, through the working group. I think the alternative whereby we held back the good news and presented a less favourable position would have been disingenuous, actually.’