Potential joint proposal on USS reform

Southend1

A potential joint proposal for reform of the USS has been developed over the last two months of intense negotiations between Universities UK and University and College Union negotiators.

http://www.employerspensionsforum.co.uk/en/pension-schemes/uss/15jan.cfm

The proposal is subject to both employer and employee support at the 29th January JNC meeting. The UCU is currently putting the proposal to a consultative ballot of their members in pre-92 institutions. The employers’ representatives will support the proposal at the JNC if the UCU members of the JNC also support it.

This revised proposal seems significantly better than the employers' original proposals last year.

I realise everyone's individual circumstances are different but according to the calculator on the UCU website, if I pay the additional voluntary 1% DC contribution on top of the increased 8% DB contribution then my pension at retirement will be only slightly less than I could expect under the current arrangements. (I have 35 yrs to go to retirement). So it doesn't seem to be the end of the world.

One thing I am worried about is the inflation capping on CRB benefits. As I have a long way to go to retirement, it seems to me that a few years of high inflation when I am nearing pensionable age could wipe out a huge chunk of my pension.

Also I can understand why the employers want to put a £55k cap on DB pensionable salary, as this will limit the potential for the cost of future pensions to spiral but I am worried that the proposal to increase the cap amount by CPI rather than JNCHES pay scale increases will mean that over time the amount that can be accrued in the DB section of the pension becomes worth less and less. Call me cynical but the introduction of the DC section could well be a stepping stone on the way to closing the DB section and moving everyone to DC.

One other query I have about the DC section that it isn't clear how it will operate. E.g. Will there be a choice of investment funds. I expect the detail will become clearer in time.

I'd be interested to hear what other USS members and forum regulars think about the new proposals and in particular whether they will be enough to secure the future of USS as a DB scheme.

kidmugsy

Southend1 wrote: »

This revised proposal seems significantly better than the employers' original proposals last year.

Is it a "delay and pray" policy, or is there some substantial thinking behind it? None of the stuff I've just scanned through gives me the first idea.

Southend1 wrote: »

my pension at retirement will be only slightly less than I could expect under the current arrangements. (I have 35 yrs to go to retirement).

Bless you, I guffawed. 35 years: the optimism of the young.

Southend1 wrote: »

One thing I am worried about is the inflation capping on CRB benefits. ... a few years of high inflation when I am nearing pensionable age could wipe out a huge chunk of my pension.

That seems to me a reasonable fear: in 35 years a burst of high inflation is presumably possible. Governments will have to wriggle out from under their debt mountains somehow, and inflation may seem more attractive to them than default. But what could USS do about it at reasonable cost? Have you seen the yields on index-linked gilts? Click "table" at
http://markets.ft.com/research/Markets/Bonds

Southend1 wrote: »

Call me cynical but the introduction of the DC section could well be a stepping stone on the way to closing the DB section and moving everyone to DC.

I wonder whether that would be a better policy anyway: if it's near inevitable, would it be better just to get on with it? Lord knows.

Southend1 wrote: »

One other query I have about the DC section that it isn't clear how it will operate. E.g. Will there be a choice of investment funds. I expect the detail will become clearer in time.

That will be the least of your worries, I'd think. What I'd concentrate on in your shoes is whether the DC section would be secure if the DB sections became insolvent. What provisions might bring that desirable state of affairs about?

Southend1 wrote: »

I'd be interested to hear what other USS members and forum regulars think about the new proposals...

A bunch of us had a long natter about this a few months ago: you might like to look for the thread. In so far as there was a conclusion, it was that everything turned on the value of the discount rate to be used in valuing liabilities. Yet I saw no substantial reference to the matter in the bumf you've linked to. Has it been agreed to change that rate? If so, how, and by what logic is a change justified? That's what I'd want to know in your shoes.

Southend1

kidmugsy wrote: »

Is it a "delay and pray" policy, or is there some substantial thinking behind it? None of the stuff I've just scanned through gives me the first idea.

i think there is an element of both to be honest

Bless you, I guffawed. 35 years: the optimism of the young.

Don't understand this comment... Is it unreasonable to expect to retire at 68? I already have just over six years in USS and £35k in a DC scheme from previous employment. I currently earn £25k with no expectation or likelihood of any increase above cost of living rises in the short to medium term. I would like to have a retirement income c. £16-18k and intend to make some additional pension or isa provision for retirement once my mortgage is repaid in around 20 years time (or less I hope!).

That seems to me a reasonable fear: in 35 years a burst of high inflation is presumably possible. Governments will have to wriggle out from under their debt mountains somehow, and inflation may seem more attractive to them than default. But what could USS do about it at reasonable cost? Have you seen the yields on index-linked gilts? Click "table" at
http://markets.ft.com/research/Markets/Bonds

i don't know, I'm not sure I understand the implications of this although I know that QE has depressed bond yields and this has had an impact on pension funds.

I wonder whether that would be a better policy anyway: if it's near inevitable, would it be better just to get on with it? Lord knows.

Is it near inevitable though? I sincerely hope not!

That will be the least of your worries, I'd think. What I'd concentrate on in your shoes is whether the DC section would be secure if the DB sections became insolvent. What provisions might bring that desirable state of affairs about?

Good question. If the proposal moves forward I'll be sure to raise this during the consultation

A bunch of us had a long natter about this a few months ago: you might like to look for the thread. In so far as there was a conclusion, it was that everything turned on the value of the discount rate to be used in valuing liabilities. Yet I saw no substantial reference to the matter in the bumf you've linked to. Has it been agreed to change that rate? If so, how, and by what logic is a change justified? That's what I'd want to know in your shoes.

I think I read and posted on that thread a while back. I know the discount rate is crucial but I'm afraid I don't fully understand it. Are you able to explain what it means in terms that a bear of very little brain like me could understand?

Thanks for your answers! :beer: My comments are in red.

Southend1

http://www.employerspensionsforum.co.uk/download.cfm/docid/75E06AFF-85E6-4F60-8D7BBE93B28E75E2

Pages 4 to 9 of this document seem to explain the rationale surrounding the discount rate if that helps?

hugheskevi

I couldn't see any mention of the Normal Pension age - that is very important in assessing value.

Like a number of CARE schemes, the design looks to be more valuable to older members, given the low CPI revaluation rate. It would be interesting to see the value of the pension as a % of pensionable salary by age.

Unlike public service pension schemes, but like private sector DB schemes, the final salary definition is as at the scheme closing date. That will be quite a significant loss compared to what they would have got for some members (typically those who have a reasonable number of years of service so have something to lose, but still quite a way to go with the anticipation of several promotions - you might well fall into this category, as although you may not expect any immediate progression over the next 35 years you would expect the difference between your salary growth and CPI to be significant).

Worth considering that the new scheme will be contracted-in, so members will be accruing more State Pension. Even if the scheme was not being reformed it would not have been surprising if it had been changed to reflect the lost contracting-out rebate.

Not that it is significant, but I found the 1% matching quite amusing - it seems to have been thought that a token gesture was necessary, as 1% truly is the very least that could be done

Southend1

hugheskevi wrote: »

I couldn't see any mention of the Normal Pension age - that is very important in assessing value.

normal pension age is currently 65 and will increase in line with increases in state pension age

Like a number of CARE schemes, the design looks to be more valuable to older members, given the low CPI revaluation rate. It would be interesting to see the value of the pension as a % of pensionable salary by age.

Unlike public service pension schemes, but like private sector DB schemes, the final salary definition is as at the scheme closing date. That will be quite a significant loss compared to what they would have got for some members (typically those who have a reasonable number of years of service so have something to lose, but still quite a way to go with the anticipation of several promotions - you might well fall into this category, as although you may not expect any immediate progression over the next 35 years you would expect the difference between your salary growth and CPI to be significant).

In the short term this won't have much effect for me because my pensionable salary is currently higher than my actual salary due to a recent pay cut. However in the long term, as you say, the difference between salary growth and CPI could well be significant, and this is a worry for me.

Worth considering that the new scheme will be contracted-in, so members will be accruing more State Pension. Even if the scheme was not being reformed it would not have been surprising if it had been changed to reflect the lost contracting-out rebate.

I'm basing my guesstimates of future retirement income on having a full single tier state pension though I believe it could actually be a little higher as I have about 5-6 years NI contributions before joining USS when I was contracted in.

Not that it is significant, but I found the 1% matching quite amusing - it seems to have been thought that a token gesture was necessary, as 1% truly is the very least that could be done

I think the purpose of the 1% matching is to get members used to the concept of a DC scheme to soften them up for potential future closure of the DB section.

kidmugsy

Southend1 wrote: »

Pages 4 to 9 of this document seem to explain the rationale

Thanks for that.

Southend1 wrote: »

I think I read and posted on that thread a while back. I know the discount rate is crucial but I'm afraid I don't fully understand it. Are you able to explain what it means in terms that a bear of very little brain like me could understand?

I'll have a go. Start with the "time value of money". Suppose we lived in an economy where the prevailing risk-free interest rate is 5%p.a., and seems likely to continue to be that. Then £100 today is worth £105 in one year's time, because it would earn £5 interest.

An alternative view of exactly the same circumstance is that £105 one year hence is worth £100 today. The £105 is called the "future value" and the £100 the "present value". Now clearly any old sum of money in the future, at some time (say n years) from now, can have its "present value" calculated. For example, £200 in two years time has a present value of £200/(1.05 x 1.05) =
£200 x 0.90703 = £181.406 . That factor 0.90703 is called the "discount factor" and its value depended on only two things: the assumed 5% p.a. rate, and the time gap of two years. If instead you had used a prevailing rate of 10% p.a. you'd have found the discount factor to be 1/(1.1 x 1.1) = 0.82645

Now suppose you want to calculate the effect of a pile of liabilities, such as pension payments to be made to scheme members over the next 80 years. By far the neatest, simplest, clearest way to do the calculations is to reduce all those liabilities to their "present value": then you can simply add them up and marvel at the result. We need to know only two things: when each liability happens (we'll turn to the actuaries for advice on when we should expect these members to die), and what prevailing rate to use - referred to in this context as the "discount rate".

That's the nub of the issue. As we've seen, if we assume a high discount rate e.g. 10% p.a., our present value of a liability will be much smaller than if we assume a low discount rate e.g. 5% p.a. Thus, as in the examples, 0.8264 is noticeably smaller than 0.90703. So; what discount rate should USS assume? The larger the rate, the smaller the present value of the liabilities will be, so that if you assume a high enough discount rate, the liabilities will be smaller than the assets. Hurray! Trebles all round! Assume a lower discount rate and the scheme is in the mire.

Since the discount rate is being used for the purpose of comparing assets and liabilities, the rate to assume should presumably bear some relationship to the rate of return the assets will earn. Alas, that is unknowable - because it involves the future - and is anyway likely to be erratic rather than steady. So there is endless room for dispute. Anyway, on any reasonable assumption the gap between the assets (the smaller in USS) and the liabilities (the larger) is going to have to be closed by (a) bigger employee and employer contributions, and (b) smaller pensions.

The trustees are obliged to err in the direction of "prudence" - i.e. to try to preserve the very existence of the scheme. The union officers (for example) want to be able to preen and claim that they've won concessions from the evil employers, or the evil trustees, so they'll argue for a large discount rate because that reduces the contributions the members will have to make. Everyone involved has different incentives which, would you believe it?, influences what they think, or claim to think.

My own view is not very firmly held, but would consist of asking whether the discount rate that USS is going to adopt is different from that of, say, the Unilever, LGPS, or GSK schemes, and if so, why. "Just the facts, ma'am", as an ancient TV 'tec used to say: will it be different, and how do you justify that?

Southend1

Thanks kidmugsy. I understand the principle better now.

I always assumed that USS being a "young" scheme could afford to take a long term view and invest for growth. Would this not justify the use of a higher discount rate than a scheme with a higher proportion of deferred and retired members, which would need to be more risk averse and therefore apply a lower discount rate?

kidmugsy

Southend1 wrote: »

I always assumed that USS being a "young" scheme could afford to take a long term view and invest for growth. Would this not justify the use of a higher discount rate than a scheme with a higher proportion of deferred and retired members, which would need to be more risk averse and therefore apply a lower discount rate?

The direction of that argument sounds reasonable. But how much of a shift would it justify? What if there were a real economic crisis, with universities closing and young staff being sacked? What if USS piles into equities and other risk assets at just the wrong time? It's seductive to think that unis can cruise along in the roughly constant state of expansion they've had for fifty years. I don't believe it for a moment.

Anyway, let's see UCU argue methodically for a higher discount rate, and tabulate the USS figure against those of other schemes. The fact that they don't suggests to me that either (i) they think their members would be too dim to understand, or (ii) they think their arguments would, if made explicit and put into context, appear weak.

kidmugsy

On p10 onwards, USS explains the logic of the discount rate it has adopted.
http://www.leeds.ac.uk/comms/for_staff/USS_consultation_paper_October_2014.pdf

For comparison, here is my back-of-the-envelope calculation. First, I'll be guided by Credit Suisse and assume an equity yield about 3% p.a. above gilts, for the "next 20-30 years".
https://publications.credit-suisse.com/tasks/render/file/index.cfm?fileid=88F22B53-83E8-EB92-9D555B7A27900DAC

Then I'll assume roughly 60% equities and 40% gilts, as being a ratio advocated for private pension savers for many years by many sources. So, ignoring any benefit from annual rebalancing (in the name of "prudence") I'd end up with a yield 1.8%p.a. above gilts. USS assumes 1.7% p.a. above, which is near enough the same thing. Obviously they could have saved an awful lot of money by just asking me instead of employing consultants, but there you go!

Anyway, the crucial point is that USS's assumption is not remotely bonkers, or wicked, or whatever the union types have implied. Given that the new proposal differs only mildly from the old, may I assume that the union has given up arguing the toss about discount rate? If so, may I further assume that it will keep shtum about that retreat, lest any cynic suggest that their original statements were - how shall I phrase this? - insincere? Lightly held?

Southend1

I think the employers and the UCU now both want a slightly less prudent discount rate and they are due to discuss this with USS next week.

If 60/40 is typical then for a younger scheme like USS would you not weight slightly more toward equities? In the same way that an individual plan would lifestyle the investments within a pension?

What would be the effect on discount rate if you plug in 65/35, 70/30, 75/25 into your model?