The term ‘risk’ features prominently in any discussion about the current state of the Universities Superannuation Scheme. But what does it really mean? And why is it so relevant to the present debate?
In reality, there is no singular definition of risk, and there are a variety of contexts in which the term is used. The difficulty of narrowing down a definition is partly why it’s such a complicated – and often confusing – issue.
In terms of USS, we can think of ‘risk’ in two general senses: investment risk and employer risk. Both definitions relate to the likelihood that the scheme will be able to pay out all the benefits owed to its members in the future. This includes employee pensions and other things like death in service or sickness benefits.
Let’s look at investment risk first. Employer and member contributions into the ‘defined benefits’ (DB)[1] section of the scheme are invested by the USS trustee. The hope is that the return on these investments will help to pay out benefits in the future.
For example, say the scheme has £60bn in assets, but in thirty years it will need £100bn to pay everyone the pension they are owed. The trustee invests the £60bn in the hope that the return on the investments will help to fund the £100bn needed thirty years from now. If it was a roulette wheel, to raise the £100bn the trustee might be tempted to put the entire £60bn on red. Clearly, this would be extremely reckless, or ‘risky’. Understandably therefore, the Trustee has a legal duty to invest carefully, taking a prudent approach to its investments.
No matter how sensible the trustee is, there is still a ‘risk’ that the investments won’t perform well, and that in thirty years from now the scheme will only have £90bn. The scheme rules state that in such an event, the Employers will have to provide the extra money needed to fund the shortfall. As well as being potentially risky in themselves, the investments made by the trustee also therefore carry a ‘risk’ for the employers – as in the event that they don’t perform, the employers will have to spend a lot of money to bail out the scheme.
As part of the valuation, the trustee consults with the employers on how much ‘investment risk’ they want the trustee to take, and this is inextricably linked to the ‘employer risk’, or how much each employer believes they could afford to cough-up if the investments don’t provide healthy returns.
UUK’s position on risk
Many scheme members feel that the USS employers should be prepared to take more risk, so that the DB section of the scheme can be maintained indefinitely. Earlier this year, the employers and their representatives UUK, received criticism for what was perceived to be a deliberate attempt to tell the Trustee they wanted to take less risk.
This is not what happened. UUK’s response to the USS consultation did not indicate that less risk should be taken. A survey in September 2017 revealed that a majority of employers were happy with the level of risk USS was proposing – but that it was at the limit of what they would feel comfortable with. A minority wanted a less risky approach.
Following consultation with the Pensions Regulator, actuaries and employers, USS decided to lower the investment risk in the scheme (known as de-risking). This had the effect of making the projected deficit larger – because despite their reliability, the assets invested in would generate less returns.
Taking more risk is not a silver bullet for the future funding of the DB scheme. Aside from the fact there is a legal requirement to be prudent, taking more risk could result in huge financial implications for employers in the future, which would undoubtedly have an adverse effect on scheme members.
[1] A scheme where the employee is guaranteed to receive pension payments of a set value, based on salary level and years of service.