USS is being asked to consider Conditional Indexation (CI). The idea is important but misunderstood
The idea is to share the risk and rewards of investment so that members get more of the upside and employers get less of the downside of the investment return and changes in liabilities.
What happens is that members agree to not have an automatic right to increases in their pensions but agree on a formula that cuts them into any upside – by right.
The employer (UUK) likes the idea of stabilising funding rates with DB taking a step closer to a defined contribution structure. Members accept that over time, this will lead to more risk rewarded as the trustees agree to more risk with which to reward members.
The DWP has been approached to discuss whether what is on offer is a form of CDC and it would seem that risk sharing of this kind can be carried out by an occupational scheme without need for a change of legislation.
Not retrospective
Importantly, the change is not retrospective. So any benefits accrued before CI’s implementation would be guaranteed, including indexation of an existing promise,
Progress so far
The two main protagonists in recent pension disputes have expressed a willingness to find a way forward through CI
In light of the significant improvement in the funding position of the scheme, in March 2023 a joint statement confirmed that UUK and the University and College Union (UCU) agreed to develop and implement a robust and transparent mechanism for managing risk, which can provide more sustainable benefits and contributions for future valuations.
A joint working group has been established through the USS Joint Negotiating Committee to consider stability and although CI is not expected to form part of the outcome for an accelerated 2023 valuation, as it would take time to establish these arrangements if the stakeholders decided to proceed, CI could play an important role in the future sustainability of the scheme beyond 2023
A model for others?
Some experts point to the past and see CI as a return to the “best endeavours” approach used by occupational pensions before a more formal guaranteed approach was adopted.
Some will see such a return as a backward and regressive step, others will welcome it.
What we can hope for, is that CI will become an option for DB schemes looking to provide future accrual for members and intending to pay pensions – rather than outsource these payments to an insurer.
The regulatory snag
There is however a snag with regards using conditional indexation schemes as workplace pensions under auto-enrolment rules. These rules demand that indexation is guaranteed, a technicality as in all other respects, members are being guaranteed pensions well in excess of anything that could have been bought under the traditional DC formulation
As well as issues arising from the money purchase underpin, conditional indexation creates issues for sponsoring employers’ FRS102/IAS19 disclosures in their company accounts. This may make employers reluctant to “share” the benefit with Scheme Members.
The problem is that under the disclosure requirements the current service cost will reflect the anticipated future revaluations but any increase to that assumption to the accrued benefits, say reflecting those reflecting an increase in the surplus, will be shown as a past service cost and hit the current year’s Profit and Loss Account as an Administration Cost. Conversely any reduction in the revaluation rate will be treated as a actuarial gain and taken “below the line” to the Statement of Other Comprehensive Income.
This may not be applicable to University employers in the USS, but there are a number of associated employers who have to prepare accounts under the accounting standards.
It is really another weakness in the current reporting standards concerning DB pension schemes already subject to much criticism.