Why Trinity’s departure and the abandonment of Test 1 render a shift to 100% DC problematic
This post is a sequel to ‘Why it makes no sense, under the dual discount rate, for any USS employer to advocate 100% DC’. There I showed how the new dual discount rate provides a rationale for USS to increase deficit recovery contributions (DCR’s) in the event of DB scheme closure and a move to 100% DC.
In this post, I draw attention to two further rationales USS has for increasing DCRs in the event of scheme closure: one having to do with the abandonment of Test 1, and the other having to do with the departure of Trinity College from USS.
First some background: in 2017 USS adopted a more positive attitude towards DB scheme closure. Back then, they maintained that closure would reduce the deficit on past accrual from £7.5bn to £6.1bn, which would justify a reduction in DRCs from 6% to 3.5%. The was on account of the fact that Test 1 allowed for a rise in the discount rate in the absence of any further build-up of DB liabilities over the next 20 years.
Things are, however, very different today, for the following two reasons (beyond that which the dual discount rate presents):
1. The elimination of a Test 1 rationale for decreasing DRCs in the event of scheme closure.
Test 1 has been scrapped and replaced with new Risk Metrics A-C which are insensitive to the level of future DB accrual over the next 20 years and hence which are not biased against future DB accrual in the manner of Test 1.
This scrapping of Test 1 was a hard-won gain that the Joint Expert Panel secured. As JEP1 wrote: ‘Rather than being used as a “stop-and-check” reference point, Test 1 is being used as a constraint on benefit design and a driver of investment strategy. The Panel does not consider this helpful’ (p. 8, my emphasis added).
2. New worries regarding employer commitment to the scheme arising from the departure of Trinity College
These worries are captured by this USS statement from December 2020:
These worries would be compounded if employers decide to close DB and move to 100% DC. With DB closure, employers would have less and less interest over time in the legacy DB liabilities, as they would increasingly be merely for people who are no longer working for their university. Since they would no longer be able to provide their employees with future DB accrual if they remained in the scheme, employers would have no incentive to remain and every reason to try to exit USS. The wealthier ones, nervous about scheme calls on their assets, would hope that gilt yields rise sufficiently to make it affordable to buy their way out of USS via payment of Section 75 debt. Perhaps this explains why some employers are so resistant to a moratorium on exit that lasts very long. Even with UUK’s proposed 20-year moratorium on exit, USS would have to worry that, once those 20 years are up, there would be a stampede among wealthier employers for the exit if the gilt yield had risen sufficiently, and they would therefore make sure to de-risk to a position close to self-sufficiency before those 20 years are up.
It is significant that Trinity College’s case for withdrawal involved a scenario in which DB closes and USS ramps up prudence and moves to self-sufficiency as a result:
Trinity College did not express a worry that the DB scheme would remain open. Rather, their worry was that the scheme would close, thereby pushing more and more employers into insolvency through higher and higher DRCs prompted by USS’s move to self-sufficiency. Trinity was a harbinger of a more general stampede towards the exit by other wealthy employers, as soon as this becomes affordable for them, in order to try to escape the same dire consequences of scheme closure that prompted Trinity’s exit.
Conclusion
As I concluded in my previous blog: future accrual of DB in some significant form is the only game in town, and employers had better figure out how to make this work, rather than pushing for 100% DC.
Postscript
The red-underlined passage in this Universities UK employer consultation document implies that UUK has received indication from USS that a shift to 100% DC would place upward pressure on DRCs, since they would hope for a small change only if they expect any changes to be upward rather than downward:
