Aon has criticised the methodology and assumptions underlying the Universities Superannuation Scheme trustee’s response to the USS valuation, accusing it of being overly prudent and failing to properly justify several of its assumptions.
In response, the University and College Union has said it is “increasingly difficult” to imagine any resolution to the long-running valuation debacle that does not end in a “profound change” in the way USS is governed.
As a consequence of the 2020 valuation — which saw the USS deficit quadruple to more than £14bn — the USS trustee, having been advised by the Pensions Regulator, laid out three illustrative scenarios, in the most favourable of which contribution rates would have to be hiked to between 30.7 per cent and 42.1 per cent of payroll.
Under the least favourable scenario, that figure would be as high as 56.2 per cent.
It is increasingly difficult to see a resolution to this valuation that does not involve profound change in the way USS is governed
Jo Grady, UCU
This ignited a row between the USS and its negotiating partners, who accused the trustee of failing to justify several of its assumptions, including the level of prudence in setting the discount rate, as well as not properly considering the strength of covenant support promises made by employer group Universities UK and its members.
Almost 4,000 people signed a letter in January attacking the proposals. The letter accused the valuation methodology of having “little empirical or theoretical justification”.
Then, in March, USS chair Dame Kate Barker rejected a request by UUK to conduct a formal review of the assumptions underlying the valuation and its resultant scenarios, arguing that there would be no justification for doing so unless new information was presented, or until UUK could offer an alternative plan.
Aon slams USS covenant ‘hall of mirrors’
Aon’s report, prepared for UUK, which is consulting on its own alternative set of proposals to those put by the USS trustee, marks the consultancy’s latest entry into an increasingly bitter feud between USS, employers, members and unions.
It finds a number of grounds on which to criticise the assumptions the USS trustee is sticking to, not least over the discount rate, where it says the trustee is being “overly prudent”.
UUK had proposed that the pre-retirement discount rate be set at gilts plus 3.5 per cent a year, a suggestion rejected by the USS trustee without, in Aon’s view, any proper reasoning.
The USS trustee has confined the range of potential discount rates to the bottom third of the range offered in its September 2020 consultation. While the original range was from gilts plus 2 per cent to gilts plus 3.5 per cent, the trustee’s three scenarios use a range of gilts plus 2 per cent to gilts plus 2.5 per cent.
“Our principal issue with the trustee’s material is that they have not explained why UUK’s suggestion of gilts plus 3.5 per cent per year is unacceptable,” the report stated.
There are references to the “employers having strong views”, and to the USS trustee believing it has “given appropriate weight and consideration to UUK’s formal response to the technical provisions consultation”, but “no explanation for why UUK’s response has been rejected”.
The report continued: “We believe there is scope for the USS trustee to revisit the discount rate — particularly in light of different covenant support and benefit packages, which may enable a resolution to the valuation. We also note that favourable market movements after the valuation date may help.”
Aon also criticised what it called a “hall of mirrors” response to questions about covenant support and the level of prudence, “where we are invited to compare the prudence in the 2020 and 2017-18 valuations using five different ‘lenses’ (or in fact 10, since many of the lenses are shown in multiple ways)”.
“This attempts to show that prudence is unchanged if looked at differently. It is true that there is no uniformly accepted definition of prudence, and therefore different perspectives are possible. Our view is that the analysis does not demonstrate what USS thinks it does,” Aon said.
It also questioned the trustee’s three integrated risk management metrics and their bearing on the level of prudence chosen.
The report argued that it is unclear how the trustee intends to use them, and questioned the merits “of spending a lot of money and resources developing metrics A to C and attempting to explain these to the stakeholders, if some other unspecified logic is used to override it”.
The report raises concerns about the risk framework used, which it said is more suited to a closed scheme with a “much better hedged investment strategy”. It also pointed out that a valuation date of February 28 would see a dramatic improvement in the scenario 3 funding position, with the deficit slashed from £15bn to £5bn.
UCU backs Aon criticisms
The UCU, which has loudly opposed the USS trustee’s proposals and strongly hinted that industrial action might be used to thwart them, welcomed Aon’s comments.
UCU general secretary Jo Grady told Pensions Expert: “We support Aon’s criticisms and we expect to see USS employers take them into account when they respond to the trustee’s proposed contribution rates.
“Aon’s commentary is closely aligned with the work of the Joint Expert Panel convened by UUK and UCU to address the issues with the scheme, and with the work of UCU’s own advisers, First Actuarial.”
TPR publishes USS Q&A
The Pensions Regulator has published a Q&A document explaining its role in the USS valuation process.
It details how TPR approached the issue of employer covenant, explaining that its rating of the USS covenant strength of “tending to strong” was influenced by the size of the scheme in the context of the sector, and that it was in agreement with the trustee covenant adviser’s own assessment.
Covenant strength could be improved by additional cash contributions, or the pledging of contingent contributions or contingent assets.
But it warned that, unless action was taken to address the scheme’s “substantially increased deficit”, significant contribution increases would be required just to sustain members’ current benefits.
She added: “USS should adopt Aon and the JEP’s recommendations regarding the pre-retirement discount rate and it should also take the recovery of the scheme’s assets following the valuation date into account.”
UCU was critical of UUK’s own proposals, put to consultation earlier this month, accusing it of backing “unnecessary and damaging cuts” to USS pensions.
Grady continued this attack, though placed most of the blame for events squarely with USS itself.
“It is truly extraordinary that UUK’s advisers are still unsure whether USS has introduced new, more aggressive standards for prudence in the setting of technical provisions or kept them the same as in 2018,” she said.
“This uncertainty is entirely USS’s fault, and it is not an acceptable basis for concluding any valuation of a pension scheme. It is increasingly difficult to see a resolution to this valuation that does not involve profound change in the way USS is governed.”
The USS trustee has been approached for comment.
