USS revamps covenant assessment model in face of funding challenge

The £41.6bn scheme instructed an external covenant assessor to undertake a more “granular” approach to gauging the ability of the scheme’s participating employers to support the liabilities of the scheme, according to its 2014 annual report and accounts.

The £41.6bn scheme instructed an external covenant assessor to undertake a more “granular” approach to gauging the ability of its participating employers to support the liabilities of the scheme, according to its 2014 annual report and accounts.

The covenant assessment considered the strength of individual institutions as well as a sector-wide perspective. This involved visiting 40 of the largest institutions and a further sample of 19, representing a total of 80 per cent of the scheme’s liabilities.

Ahead of its previous valuation in 2011, the scheme’s board used a “top-down analysis” of the sector, together with information from the funding councils as the basis for its covenant assessment.

A spokesperson for USS said since 2011 there have been changes in the higher education sector that have affected institutional funding.

The spokesperson said: “At the same time USS, like all defined benefit pension schemes, has continued to face substantial funding challenges which have placed an increased focus on the support available to the scheme from its sponsors.”

The assessment involved a qualitative and quantitative analysis of the employer covenant and the level of investment risk they are able to bear.

USS, like all defined benefit pension schemes, has continued to face substantial funding challenges which have placed an increased focus on the support available to the scheme from its sponsors

Universities Superannuation Scheme

The scheme’s spokesperson said the latest covenant assessment “confirmed a continuing strength and resilience within the scheme’s sponsoring employers, which supports a reasonable reliance on the sector continuing to be a world leader in higher education provision”.

However the review recognised it is likely that there are a number of developments, such as removing the cap on student numbers and global competition, which will have an impact on the sector, the spokesperson added.

In July, the Pensions Regulator introduced a new DB code of funding which integrated investment, funding and covenant risk. In 2010 the regulator defined employer covenant as “the employer’s legal obligation and ability to fund the scheme now and in the future” rather than an employer’s willingness to make pay.

Simon Kew, director at covenant specialist Jackal Advisory, said assessing affordability of the scheme’s liabilities and who is “on the hook” to pay is vital.

“What you have to focus on are the facts as they are, and the facts are the accounts; less factual are the management accounts and forecasts and budgets,” said Kew.

Aidan O’Mahony, partner at consultancy Aon Hewitt, said schemes have undertaken more thorough covenant assessments as a result of increased deficits but also increased focus from the regulator on covenant strength.

“The first question the regulator asks if anything goes wrong is, ‘show me your covenant’,” said O’Mahony.

The scheme’s funding level was estimated at 85 per cent at March 31 2014, up from 77 per cent at the same time the previous two years.

In 2011 the scheme put in place a 10-year recovery plan, following a consultation with employer representation body Universities UK.

This involved employers paying 16 per cent of salaries for the first six years and an additional 2 per cent above the future cost of accrual for the remaining four years.

However the scheme’s board expects its 2014 valuation to reveal a deficit “substantially greater” than that reported in 2011, meaning the recovery plan will therefore need to be reviewed once this is complete.