USS is a major force in Britain’s delivery of pension. It has stayed open despite threats to it in the last decade and it is now thriving again. Instead of sitting back on its new found solvency it is looking forward and working out how to maximise pensions. One idea which it has been considering for some time is “conditional indexation”. It has set out a document which I have been sent for publication and I’m pleased to. Here it is

Here is the summary

Historically, USS valuation outcomes have been volatile. The cost of providing Defined Benefit (DB) pensions is set by the Trustee and has been unstable. Resulting contribution rates have varied from one valuation to the next ultimately resulting in changes to pension benefits.

This is not ideal, has damaged confidence in the scheme and has created uncertainty for members and employers.

There are a range of potential reasons for this volatility. In part this is inherent in the nature of the guaranteed benefits provided to members and the method used to value these. The impact of
valuation methodology on stability and benefits is being considered separately by the Stability Working Group which expects to report on this in due course.

Guarantees provide valuable certainty to members but come at a cost. This cost isn’t entirely known up front – meaning that things could play out better or worse than expected.

The cost of guarantees manifests in two main ways:

1. Guarantees may drive a more cautious investment strategy that prioritises certainty over returns.

2. As part of funding the scheme, the Trustee creates reserves as a buffer against risks. Building reserves costs money – the stronger the guarantee, the greater the reserve.

Broadly speaking, stronger guarantees require greater certainty resulting in higher costs and contribution requirements.

A joint working group of UCU and UCEA representatives is exploring:

• Whether by making annual increases to benefits conditional, there is the ability to better manage contribution volatility, and target better overall outcomes.
• The risks associated with such a structure and the extent to which these are fair, understandable and acceptable to all involved.

Why this is so important is that it establishes a way forward  for DB schemes wishing not just to keep running but to take on new members.

But it is an idea that could equally work for very large DC schemes such as Nest and Peoples which are used to paying benefits based on what they can afford (market values) but not as pensions and could tap the capital markets to replicate the core pension element that USS has always promised.

Indexation refers to annual cost of living increases to pensions to help protect their value from being eroded by inflation over time. Under USS’s current DB benefit structure, indexation (both before and after retirement) is guaranteed within certain limits. Under Conditional Indexation, the core benefits would continue to be DB, but indexation would be at a targeted level within certain limits. Under current governance arrangements, benefits would be set by the JNC. Whether or not indexation applied would ultimately depend on the funding position of the scheme (i.e. in simple terms whether the scheme could afford to pay it).

That final phrase is that used by Paul Todd of Nest when describing how Nest intends to pay indexation to Nest pensioners– after they have paid a core benefit. This is from April when I was reporting Nest at an IFS event.

Paul Todd of Nest has a different view.

He stresses the need for all 13m people Nest look after to have the confidence to spend an income early in retirement without worrying that their money later on. Unlike the IFS he does not suppose that a decision need be made to “fix” but he talks about collective solutions where the process of getting protection against living too long is arranged by Nest (however).

You can hear Paul speak after 40 minutes of this YouTube but to really understand Paul’s and Nest’s radical difference, listen to his answers to questions  (minute 55 onwards)

The real debate is what we can afford.

Yesterday, I was at an event organised by M&G which featured a debate about the future of DB. Toby Nangle and a number of others were asked to be polemical and succeeded in bringing questions about DB schemes into focus but I felt there was something missing from what it claimed to be “the big debate”.

I suspect that Nest and USS, from different ends of the risk and contribution spectrum, are closer to the debate we are really needing. USS are saying that members do not need the certainty of every penny guaranteed and would be better off floating a part of the pension while for Nest it is the other way round. Nest members cannot do without a core pension and need to maximise their pots to pay as much into the future as possible.

Along the way, USS is going to have to convince its unions and members that they can and should swap total certainty for market driven and certain pensions and Nest is going to have to bring some form of certainty for people who may think they are in a Government pension. It is ironic that many people in USS also think they are in a Government pension!