Woon Wong’s letter to TPR on USS’ deficit

Woon Wong

At a recent pension conference, Woon Wong mentioned a letter sent to David Fairs which would be posted on my blog. This is the letter and I am proud to openly publish it.

At the conference were a number of USS members including Woon, Sam Marsh (who spoke), Michael Bromwich, Deepa Driver and Jackie Grant. Also present were David Fairs and USS Trustee Chair Dame Kate Barker as well as representatives from the DWP policy team.

Let’s hope that this letter and its contents adds to the rich debate on how we treat our open DB schemes. This letter is of more than academic interest to the million people still accruing DB benefits in the private sector , to members of LGPS and to all deferred and actual pensioners of occupational DB pensions and the PPF.

Thank you Woon.


Mr David Fairs

Executive Director for Regulatory Policy, Analysis and Advice

The Pensions Regulator


8 December 2021

Dear David

Re: USS’s deficits and truly open schemes


Accrued benefits are more secured in schemes open to strong flows of new entrants than in self-sufficient closed schemes. Also, cash contributions in the former provide a more cost-effective way of guaranteeing inflation-protected accrued benefits than index-linked gilts. Such evidence implies

  • rather than in purely financial terms, the nature of employers’ business activities and the likelihood of employers to simply continue such activities in future could occupy a more important role in determining the strength of covenant, and
  • fixating on self-sufficiency at negative interest rates is counter to economic rationales and thus detrimental to scheme beneficiaries’ best interests.

The Universities Superannuation Scheme’s past and current deficits are due to valuation methodologies that use irrelevant risk measures as a result of ignoring the strength of truly open schemes. A correct perspective of risk would appreciate self-sufficiency is feasible via Long-Term Objectives of higher funding ratio through investing in productive assets.

This letter is organised as follow. Section 1 introduces a key extract of your blog dated 8 December 2021 regarding truly open schemes. Section 2 investigates the security of accrued benefits in such open schemes. Section 3 considers possible Long-Term Objectives on funding and investment strategies available for USS. Section 4 and 5 discuss the deficits of USS.

  1. Your blog on open DB schemes

Many claim that closures of DB pensions are due to regulations. So, I am encouraged by your blog (8 December 2020), which for example reads

Truly open schemes with a strong flow of new entrants may always be immature. In those circumstances, as I have set out above, we recognised that schemes might invest in more illiquid and volatile assets in the expectation of a higher return. They might anticipate that higher return in their discount rate and consequently set lower technical provisions. The rationale being that there is sufficient time for the scheme to ride out that volatility.

As a consequence, their LTO may be some way off. And if they continue to remain open and in a ‘steady state’, they will continue to ‘stand still’ and not progress towards it.

This is an economically rational approach to valuation of DB schemes, underpinned by evidence that risk from investing in high return assets can be mitigated by immature open schemes, and thus lower technical provisions are required.

However, there are signs that suggest the intent of your blog and related regulatory guidelines have not been implemented in practice, thereby causing the Universities Superannuation Scheme (USS) valuation ignores these economic rationales and errs in its funding towards excessive prudence to the detriment of members’ best interests.

  1. Security of accrued benefits in truly open DB schemes

Based on the economic rationale in (1), my recently completed working paper (henceforth Research Paper) studies the security of accrued benefits offered by a truly open, steady state DB scheme which has similar defined benefits and cash flow as that of USS.[1] Table 1 below provides the risk of underfunding (asset less than liability) and risk to accrued benefits (failure to pay pensions in full) of the DB scheme.

The figures in the table are obtained based on 10,000 stochastic simulations. The studied DB scheme has similar funding ratio and investment return (CPI+3.03%) as that of USS in March 2020. Its investment returns are assumed normally distributed with 10% standard deviation. Risk statistics are provided for durations up to 800 years into the future, simply for the fact that both Oxford and Cambridge universities have been around for over eight centuries.

For example, when the contribution rate is 26% of payroll, the risk of underfunding and risk to accrued benefits in the next 80 years are 4% and 0.3% respectively. Regarding the remark in your blog that

open schemes and closed schemes should provide the same level of security for members’ accrued benefits,

the former provides better security (with 0.3% risk) for members’ accrued benefits than the latter that has attained self-sufficiency (with 5% risk, as regarded by industry), for all currently promised pensions would have been paid within 80 years. In short, Table 1 shows that the USS’s accrued benefits would be much more secured if the scheme remains open.

Note that at 26% of payroll contribution, the small risk (0.3%) of failing to pay pensions in full is consistent with the cash flow funding analysis for USS carried out by First Actuarial, which concludes at the same contribution rate “[t]he USS’s needs for income with which to meet benefit outgo are met with a considerable margin of safety.”

The studied open DB scheme is not pay-as-you-go pensions because it is funded, and as Table 1 shows, the risk of underfunding declines over time. On the other hand, risk to accrued benefits accumulates over time. In the long run, both risks converge to the same probability. This is because, given a fixed contribution rate, the scheme will either run out of money (underfunded and outgo not paid) or be massively overfunded with outgo paid fully.

Cost of guarantee

What is the highest contribution rate required if it were allowed to vary so that members’ accrued benefits can be paid even in the most extreme scenarios? If index-linked gilts were used as guarantee, the real yield on 31 March 2021 would imply 58.6% of payroll is required. The Research Paper shows, however, the cost of guarantee can be met by 34.7% of payroll contributions. At this rate of contribution, no sale of assets is required to pay for outgo and by virtue of time diversification of risk, the scheme will be overfunded with certainty in the long run. To appreciate how contributions in open DB schemes help secure members’ accrued benefits, observe that both risks (underfunding and failure to pay for outgo) converge to as low as 0.1% over time when the contribution rate rises from 26% to 30.7% of payroll.

It is noteworthy that the current USS’s contribution rate stands at 30.7% of payroll.

Implication for covenant

While immature scheme can take more risk, your blog points out a strong enough covenant is required

to provide the support a scheme would need to get back on track over time should things not turn out as hoped.

The stochastic analysis in Table 1 considers 10,000 scenarios, many of which include economic events either as bad as or worse than the 1918 Spanish flu pandemic, the Great Depression, the two World Wars, multiple revolutions, 1970s stagflation, the burst of Japanese asset bubble in 1990s and dot-com bubble in 2000, the Great Recession, and the current Covid-19 pandemic. At 30.7% of payroll, which is the current contribution rate of USS, there is zero case of failure to pay pensions in full for all the scenarios. This illustrates for truly open schemes such as USS, rather than in purely financial terms, the nature of employers’ business activities and the likelihood of employers to simply continue such activities in future could occupy a more important role in determining the strength of covenant. First Actuarial provided similar conclusion for USS:

Being an open scheme brings significant investment advantages, which can be exploited to the benefit of the employers and members. The investment time horizon is infinitely long. An open scheme pays its benefits from contribution and asset income without any need to sell investments. If the asset income is sufficient, fluctuations of their market value is relatively unimportant.

USS reduced the discount rate in 2020 valuation due to the belief that its financially measured covenant has weakened to tending-to-strong from strong. However, no evidence was provided to explain why a tending-to-strong covenant of a truly open scheme (that may always be immature) should warrant a discount rate that is significantly lower than the return the scheme assets can achieve. Indeed, the ‘truly open’ and ‘always be immature’ nature of USS renders a financially measured tending-to-strong covenant into an overall strong covenant for valuation purposes.

  1. Higher funding ratio as Long-Term Objectives (LTO)

Your blog says it is beneficial for all schemes to set “a low dependency LTO as a good long-term planning tool irrespective of their maturity.” Notwithstanding that “LTO may be some way off” (see Section 1 above) for USS, we now consider LTO based on higher funding ratio of asset over liability, which provides the alternate means for low dependency. The Research Paper shows that a higher funding ratio provides more security for accrued benefits.

Table 2 below shows how investment strategy leads to different contribution rate, accrual rate and funding ratio in 20 years’ time. At year 0, the studied DB scheme starts with 26% of payroll contribution, 1/75 accrual rate and 136% funding ratio (same as USS in March 2020). Consistent with Modern Portfolio Theory, given the negative real interest rate, a de-risked portfolio (10% equity) leads to higher contribution rates, lower accrual rates and funding ratio, and critically increases the risk of the scheme defaulting and failing to meet its Long-Term Objective. On the other hand, when equity holding is at 60% (similar to that of USS), funding ratio is projected to rise to 176%. Should more prudence be required, higher funding ratio can be achieved by setting contribution rate to be at least 26% and accrual rate not more than 1/75.

The figures in the table are obtained based on 10,000 stochastic simulations. The scheme portfolio comprises of equity and gilts only. Portfolio returns are assumed to be normally distributed. For 60% equity portfolio, the expected return and volatility are CPI+2.18% and 10% respectively. The expected return CPI+2.18% is lower than USS’s expected return CPI+3.03% as of March 2020.

USS views 26% of payroll contribution as insufficient to support the current benefit structure and hence rejects the LTO of higher funding ratio without de-risking or being close to self-sufficiency. I shall not provide lengthy counter arguments to USS’s view here, but simply point out that (a) as demonstrated in Section 2, an open scheme provides better security for accrued benefits than a self-sufficient closed scheme; and (b) contributions and accrual rate can be dynamically adjusted so that funding ratio would remain high enough for realistic recovery should extreme adverse scenarios arise.

Regarding de-risking, it helps if we have a correct perspective on risk. Equity is risky asset, but we would not describe economy as risky. For a sufficiently diversified portfolio of world equities, the longer the holding horizon the closer the portfolio return is to the world economic growth; see my earlier paper for some discussions and related literature. For a truly open DB scheme such as USS, investing in equities is equivalent to investing in the economy. Therefore, it is perfectly reasonable for a truly open DB scheme to never de-risk. Since USS is sufficiently funded, its funding ratio will rise just like the GDP level of world economy.

The above analysis is consistent with what First Actuarial wrote in response to call for evidence by the Joint Expert Panel:

Given that the USS is on an improving trend, any funding target is achievable simply by waiting. The longer we wait, the higher the funding level which can be achieved from growth in the assets and 26%.

Indeed, Table 3 below shows that USS’s funding ratio is on a rising trend since 2017.

Table 3

Year 2017 2018 2020 2021*
Funding ratio 1.319 1.420 1.363 1.472
The funding ratio is obtained by dividing USS’s asset by its liability. The liability is calculated using expected portfolio return as discount rate. 2021 funding ratio is calculated using estimated outgo.


  1. Has USS’s drive to self-sufficiency become economic absurdity?

Self-sufficiency has driven both past and current valuations of USS as if it were a scheme that needs to be closed and shifted to a gilts-based portfolio. In 2017 valuation, discount rate is lowered by Test 1 which forces USS to move overtime towards a scheme that can be self-sufficiently funded and closed if desired.[2]

The constraint on discount rate becomes more sophisticated in 2020 valuation, which requires for risk management purposes both scheme assets and technical provisions to be close to self-sufficiency liability. This risk management approach was opposed by stakeholders in the Valuation Methodology Discussion Forum before the 2020 valuation, on the ground that

“[m]aking self-sufficiency the centrepiece of the Trustee’s risk metrics fraught with difficulties. …other methods – that are more directly linked to cash contributions – are more effective to measure risk.”

In its consultation for 2020 valuation, USS rejected the stakeholders’ view by placing more emphasis on their primary objective of protecting accrued benefits than their secondary objective of keeping the scheme sustainable and affordable. While USS’s position may sound reasonable, as explained in a report written after release of consultation by Aon (the employers’ actuary), the approach repeats the ills of Test 1 since it is

highly sensitive to the input parameters much in the same way as blighted Test 1.

The various problems of 2020 valuation may be summed up by the fact that USS fails to recognize the strength of a truly open scheme as described by your blog and is using risk measures that are more suitable for a closed scheme. This is evidenced from the same report written by Aon:

For an open scheme with a long-term investment strategy, the valuation results will be very volatile from one valuation to the next – because the assets are mismatched. It is only by chance that the scheme will be anywhere near its “expected” funding level at the next valuation. We are therefore concerned that the risk framework is more appropriate for a closed scheme, with a much better hedged investment strategy.

Aon is not alone in its view. First Actuarial, members’ actuary, has questioned in the 2017 valuation whether the sensitive nature of USS’s methodology befits that of a truly open scheme

An actuarial model of a continuing scheme which displays vulnerability to market value fluctuation can be questioned as to whether it is representative.

Although Test 1 is no longer used in USS’s 2020 valuation, self-sufficiency is unnecessarily causing issues of affordability and volatile contribution rate for both members and employers, as pointed out below in a recent report by First Actuarial.

What is not reasonable in an open scheme is for issues of self-sufficiency to override other issues such as affordability for the employers and active members and the need for stability in the contribution rate. Self-sufficiency can become overriding after closure. Before closure it is not overriding.

Fixating on self-sufficiency to protect accrued benefits but ignoring other evidence produces valuation outcomes that are inconsistent with economic principles. Since gilt-plus discount rate overestimates DB scheme’s liability in falling interest rates, it is thus shocking to find out that a gilt-plus discount rate would reduce USS’s 2017 deficit from £7.5bn to £3.4bn.[3]

Repeated over-estimation of liability in past valuations turns inconsistency into economic absurdity in 2020 valuation. As of March 2020, the accrued benefits of USS amount to £84.4bn in real terms, which is less that the current scheme assets of about £90bn. This means that the scheme can pay the pensions in full without making any real return on its assets for the next 80 years. Despite this, USS wants to carry out benefit cuts by approximately a third, which includes imposing an inflation hard cap of 2.5%.[4]

  1. Evidence and economic rationales are key for beneficiaries’ best interests

It is Trustee’s fiduciary duty to always act in the best interests of scheme beneficiaries, one of which is security of accrued benefits. USS mentions in its 2020 valuation consultation eleven times the “legal duty” to pay pensions in full. “Best interests” is only mentioned once in the foreword of the consultation to justify the conduct of 2020 valuation during the worst market condition due to the COVID-19 pandemic. UCU, the union representing scheme beneficiaries, does not agree with USS. Since USS adopts a methodology that is not consistent with a truly open scheme and hence vulnerable to market short term fluctuations, legal proceedings have been launched by members against the insistence of valuation during stock market crash. Indeed, as stochastic analysis of Table 1 shows, should cash contributions be considered, there is zero or little risk to members’ accrued benefit even amid a pandemic.

Security of accrued benefit is ONE interest; affordability and sustainability are OTHER interests. Indeed, ensuring that the scheme remains open, affordable and sustainable increases the security of accrued benefits. When evidence and economic rationales show all these interests can be achieved, insisting on only one interest to the detriment of others due to an inappropriate methodology is, I believe, neither the intent of your blog nor that of UK Pensions Acts or UK pensions regulation.

On differences of view and the need for evidence and economic rationales

USS attributes the outcome of 2020 valuation to differences of view between Trustee and stakeholders. However, no evidence has been provided to justify its view on the use of self-sufficiency liability for risk management and the high level of prudence for discount rate. If evidence were provided, many of these differences could be resolved. However, as pointed out by employers’ actuary, USS struggled to provide any economic rationale for the decision to lower discount rate of 2020 valuation:

the explanation for moving from Gilts+3% to Gilts+2.5% p.a. is that the trustee took time to refine and finalise its position – meeting nine times and considering a significant amount of additional analysis, and taking “proportionate account” of input from TPR. However, we are concerned that we are hearing about process, rather than why decisions have been made. If no rationale can be articulated, then this also casts doubt on how the assumptions will be set at future dates.


Have trustees been ill-advised and misinformed by irrelevant risk measures?

Regarding your blog, a senior consultant of LCP reckons

“[a]t the very least, TPR believes that its intentions may have been misunderstood and that it always planned a more flexible approach for fully open schemes with a flow of new members.”

Has USS Trustee “misunderstood” the intentions of TPR? Note the USS 2020 Technical Provisions consultation was released before your blog on open DB schemes.

When irrelevant factors or risk measures are used, risk aversion is unduly raised, and discount rate lowered. In 2017 valuation, as pointed out by the Joint Expert Panel,

… the way in which the employers’ risk appetite has been applied through Test 1 has contributed to the adoption of strong risk aversion.

In the same way, an interpretation of risk that is more fitting to a closed scheme would misinform USS’s Trustee, giving rise to investment and funding strategies that ironically weaken the security of accrued benefits and cause unnecessarily affordability issue.


Yours sincerely

Woon Wong

Reader in Finance

Cardiff University

PS: I am a UCU alternate negotiator of USS. But this letter is written in my capacity as a member of USS and a UK government taxpayer.

Cc:         Dame Kate Barker

Chair of USS Trustee

Bill Galvin

Chief Executive of USS

Alistair Jarvis

Chief Executive of UUK

Jo Grady

General Secretary of UCU

Judith Fish

Chair of Joint Negotiation Committee

[1] The benefits of the studied DB scheme are career average inflation-protected at accrual rate of 1/75 with lumpsum payoff. Like USS, the scheme starts with contributions larger than outgo and reaches a steady state when the contributions and pension outgo remain the same in real terms from year to year.

[2] See Sam Marsh’s “Understanding ‘Test 1’: a submission to the USS Joint Expert Panel”, July 2018.

[3] See my letter to TPR dated 2 March 2019.

[4] The benefit cuts are (i) impose an inflation hard cap at 2.5%, (ii) lower the guaranteed benefit from c. £60,000 to £40,000, and (iii) lower accrual rate from 1/75 to 1/85.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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6 Responses to Woon Wong’s letter to TPR on USS’ deficit

  1. con Keating says:

    It is as well that the response to the DB Funding Code consultation gas been delayed.
    It is clear that many of the Regulator’s tests and ambitions are economically and financially illiterate – a simple example: “open schemes and closed schemes should provide the same level of security for members’ accrued benefits,”

  2. Martin T says:

    It is generally accepted that a reasonably well funded DB pension is better than DC and this is officially recognised in the regulations over DB->DC transfers.

    Consider a scheme which is currently open and taking some investment risk above low-dependency with either a credible short recovery plan to achieve full funding or the scheme is already fully funded on this basis. The sponsor is happy to keep the scheme open and underwrite a reasonable investment rate of return but can/will not fund to self-sufficiency/buy-out level and will close the scheme to future accrual if that is the long-term plan.
    Might not the members quite rationally prefer it to remain open even if there is some slight increase to the risk that past accrued benefits are not paid in full? Might not the Trustees agree that is in the members best interests, or at least the non-deferred members?

    If the choice is between A) near certainty of past DB accrued benefits plus significantly greater uncertainty of future DC ones, and B) less certainty for past benefits but continuing DB accrual, why are TPR rigidly encouraging scheme closure with their funding regime with valuations based on (so called) low-risk gilts? Surely Trustees should have the ability to balance a risk to past DB accrual against the alternative of future DC provision and aim for outcomes in the members best interests?

    I think tPR is too focussed on protecting past DB benefits, and the PPF, to the detriment of members overall outcomes. If only tPR had an extra aim of facilitating improved retirees total incomes, not just one component’s certainty. That could enable consideration of the risk balancing between past DB and future DB/DC in much the same way that tPR will consider it reasonable to balance a DB scheme’s funding and the affordability of the sponsor’s contributions.

    It seems to me that a rational solution for the USS would be to convert future provision to a multi-employer CDC scheme aiming for, but not guaranteed to deliver, the current DB benefits. Perhaps the creation of a multi-employer CDC scheme will be triggered by this dispute just as a single employer CDC has been triggered by the Royal Mail dispute.

    • henry tapper says:

      Martin , I very much like your thinking. I suspect that the mood music in Brighton may be moving your way. I’d add an additional issue we’ve had from de-risking

      One of the problems created by de-risking is artificial transfer values that reflect the lack of returns achieved on risk-free assets. The BSPS fiasco was in part a product or discount rates falling as the scheme moved from growth to defensve assets making the CETV’s “advisable” and ushering in many factory-gating ne’er do wells to Port Talbot and Scunthorpe.

  3. Bob Compton says:

    Woon, as promised, I have read your letter to David Fairs and his recent blog. It is good to see that David is acknowledging that fully open schemes like USS if remaining open for ever will never reach maturity, however USS must be treated as an exception. Your research paper confirms what should be blindingly obvious, Investing in real assets that have the prospect of keeping pace with future GDP growth are a better long term investment, than investing in Gilts (actually debt) locking in negative real returns.
    I have two comments to make:
    I. No pension fund trustee with a fund generating income through dividends and/or contributions should be “investing” in negative real yielding gilts. Those trustees with gilt portfolio’s if they are not considering an imminent buy out, with inflation on the rise should consider cashing in on the current gilt pricing as the capital value of gilts will tumble as inflation takes off.
    2. The DB funding code as presently set up and confirmed by David’s blog will benchmark Bespoke valuations against the Fast Track metrics of “gilt yield +”X.X%””. If the TPR benchmark is gilt based, Trustees and their actuarial advisers will naturally tend to be over cautious even when bespoke is the basis followed. I.E. Trustees will be less willing to move to a funding strategy that is real asset based, and as your paper has set out, will lead to increasing the long term cost of running DB schemes, and ultimately speed up their extinction. This of course may be TPR’s stated aim as if there are no DB schemes around they have met one of their primary objectives in ensuring the solvency of the PPF (which actually does not need that protection!).

    The debate will no doubt roll on.

  4. henry tapper says:

    There is a strong argument for putting all schemes with the aim of self-suffeciency and/or buy out in the hands of the pension protection fund who can look after them till they achieve their aim – or fall into the PPF.

    The Pension Regulator could then deal with the truly open schemes with the care and attention they need.

    I’m not sure how some of the great funded schemes like LBG would feel being regulated by a body dedicated to running off pension liabilities but the PPF have all the expertise to become a world class regulator of the DB funding code.

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