The JEP Report

The report of the Joint Expert Panel on USS was published on Thursday 13 September. The JEP’s report – agreed, as required by the Terms of Reference, by consensus among all six panel members and the independent chair – provides independent vindication of almost all of UCU’s criticisms of the 2017 valuation process. The widely-discussed and elaborately complex “Test 1” is found to have been both the central plank of the valuation and essentially unfit for that purpose; the nature of USS as a large, open, multi-employer scheme in a robust sector with a secure future to have been neglected by both the USS Trustee and the Pensions Regulator; and the September UUK consultation with employers to have been comprehensively mishandled. The early “de-risking” of the Scheme’s assets proposed in November is found to be unnecessary and damaging, offering little additional protection to the Scheme while substantially increasing its deficit and the cost of future benefits.

The overall picture presented is one of a valuation in which, as UCU has argued, caution was layered upon caution at every possible stage, with the cumulative effect of massively understating the financial health of USS. To give just two examples, between the 2014 and 2017 valuations:

  • the margin of prudence applied in setting the discount rate (i.e. the assumed future investment return) was increased from 15% to 17% above a 50/50 “best estimate” of expected returns;
  • the level of investment performance allowed in excess of the discount rate for setting deficit recovery contributions was reduced from halfway to best estimate to zero.

The latter change alone increased the contribution rate needed for deficit recovery by around 4% of total salaries, and the USS Trustee failed to provide an adequate rationale for either change in its submissions to the JEP.

The Panel’s view of the much-discussed Test 1 is damning, and concurs with the assessments of UCU members like Sam Marsh (now a UCU representative on the JNC). The Test is found to have been almost the sole determinant of the valuation result, and to have acted less as a true test of the scheme’s financial condition than as a driver of investment strategy which increased both the deficit and the cost of future provision. The Panel does not consider this to have been “helpful”. The Test itself, moreover, was so sensitive to “very subjective” input assumptions as to be capable of producing almost any result, depending on what was put in. The preoccupation with gilt rates which it involved also increased the chances of wild short-term fluctuations in the relation between assets and liabilities, when in a suitably diverse investment portfolio (i.e., one which is not “de-risked” into bonds) poor gilt yields will in practice be compensated for by improved performance in other investments.

A recurring theme throughout the report is that the Trustee’s supposed concern with USS’s long-term funding position disguised an irrationally short-term perspective, in which present economic conditions were considered in isolation from any reasonable judgements about long-term trends. Despite expecting gilt rates to revert to historic norms in the medium term, for example, the Trustee imposed the full cost of current, rock bottom rates on USS in this valuation. The general sensitivity of the valuation to short-term economic conditions is captured in the fact that merely updating the November valuation with March 2018 data would reduces the assessed deficit by nearly 50%. These problems were compounded by the self-perpetuating features of Test 1, whereby exceptionally low gilt rates increased the assessed deficit and reduced the Scheme’s assumed risk tolerance. This meant further de-risking into gilts, which increased the deficit further, locking USS into a vicious cycle and driving it into the worst-performing investments.

As Financial Times pensions correspondent Josephine Cumbo tweeted, the Report makes uncomfortable reading for the Pensions Regulator. There was “no evidence”, the JEP concludes, to support tPR’s suggestion – made to the Trustee in writing and forwarded to employers in the middle of the September employer consultation – that the USS covenant was less than “strong” (the highest of tPR’s four categories). On the contrary, the Panel agreed with the view of USS’s own expert advisers that the covenant provided to USS by the sponsoring employers was uniquely strong among DB schemes. Moreover, the Regulator’s pre-emptive interventions had the effect of “closing down options for discussion and negotiation and unduly influencing the outcome of consultations with employers”. This further pushed the Scheme into an inappropriately risk-averse investment strategy, depressing expected investment returns and forcing up both the deficit and the cost of providing benefits in the future.

The JEP report concludes with four recommendations for modifying the 2017 valuation. The cumulative effect of these is to reduce the total contribution rate required to fund status quo benefits and recover the Scheme deficit from the 37.4% of salaries given by the November valuation to 30.08% (or 29.18% without the 1% DC Match). In the JEP’s view, these four proposed adjustments are “consistent with the Trustee’s fiduciary duties and the objectives of the Regulator”. If all four changes are made to the 2017 valuation, and the cost shared in the 65:35 ratio agreed in the Scheme rules, status quo benefits (minus the Match) could be maintained until 2020 at a contribution rate of around 9.1% of salary for Scheme members and 20.1% for employers.

Given that the Panel endorses so many of UCU’s arguments about the 2017 USS valuation, it might seem that the end of the USS dispute is in sight, with all that remains being for its recommendations to be implemented, and the sharing of the 3.18% increase in total contributions to be ironed out. The problem remains, however, that the JEP still has no formal status within the constitutional structure of either USS or the regulatory regime surrounding it. Despite its deliberately conciliatory tone, the report dissents sharply from the positions of the USS Trustee and tPR on the valuation process so far – but its conclusions can only be implemented with the consent of both. So the suggestion of the UUK actuarial advisers Aon, quoted in the final annex to the report, that delaying de-risking of the investment portfolio and increasing the reliance on the employer covenant “would be too much for tPR and the trustee to accept” is troubling. (For more thoughts in this area, see this useful Twitter thread by Mike Otsuka)

The JEP report provides powerful support for the position that UCU has taken throughout the USS dispute, and shows that we were unquestionably right to strike in defence of USS pensions earlier this year. All eyes must now be on the response of the USS Trustee.

– Sam James, Cambridge UCU Acting President

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