NIESR proposes alternative ‘way forward’ for the USS

The National Institute of Economic and Social Research (NIESR) has suggested giving Universities Superannuation Scheme (USS) members the option to transfer some of their pension rights to self-invested personal pensions (Sipp) to help address the scheme’s funding issues.

The report, authored by Imperial College London professors, David Miles and James Sefton, described the USS as being in a “difficult position” and argued that its proposed solution would “not create any losers”.

Strikes are due to start taking place next week at several universities over proposed changes to the scheme, which would reduce the salary cap, cap indexation and decrease members’ pension accrual rate.

The report proposed members be given the opportunity to transfer out some, but not all, of their existing pension rights at a fair rate, with those members effectively swapping a proportion of their accrued pension benefits for a cash settlement.

This cash would then be invested into a Sipp, which the authors argued would “simultaneously offer these members a better risk-adjusted return to their pension contributions, and potentially more flexibility in retirement options”.

Furthermore, this would simultaneously strengthen the covenant of the USS, according to the report, through a decline in the size of pension liabilities and a reduction of risk.

This would result in the USS and Universities UK being in a “stronger position” that could reduce the need to raise contribution rates and to cut the generosity of the pension offer for those who want to continue as members of the scheme.

The authors believe that a “significant number” of members would find it attractive to invest a proportion of their pension rights in a risker, but potentially higher return, asset.

The USS currently holds risky assets, the report noted, but it argued that risky assets are not inherently bad, just that the risk sits in the wrong place.

“The USS has to ensure (or at least come close to ensure) that they have enough assets to pay promised pensions; this is because currently the obligation to make good any asset shortfall sits largely on shoulders of universities whose ability to bear it is limited,” the report stated.

“So the USS and The Pensions Regulator cannot comfortably let the downside risk be at all significant. Thus the USS is pushed towards holding a portfolio that is appropriate for someone unable to take much risk and that means holding a lot of hedging assets of relatively low yield.

“The guarantee the USS has issued to scheme members for their past contributions is therefore very expensive. But those who 'own' the guarantee may consider the guarantee they have bought with their pension contributions a very high cost one and consider selling some of it back to the scheme at the right price.”

The report outlined an example of the sort of option that could be offered to members, detailing potential transfer amounts and outcomes.

However, the report included several complexities and caveats that need to be considered if its proposal was implemented.

For example, the report noted the difference in historic accumulated USS benefits in the defined benefit scheme and the money value.

It assumed that whatever terms the USS annuitises at in its valuations of liabilities and the transfer value offered is the same as that available to a scheme member should they purchase an annuity, which the authors acknowledged as “optimistic”.

However, it added that there could be a “very substantial benefit” not to annuitise, which would only be possible if some pension value was transferred out of the scheme.

The report also assumed that members would make well-informed decisions whereby they evaluate risk and return trade-offs, which it admitted was “not realistic” and biases outcomes in favour of transferring to much, which might call for limits on the maximum proportion that can be transferred out.

It also noted that it ignored tax issues and that suitable advice would be necessary to avoid mis-selling.

“There is a final, and in some ways fundamental, objection to the proposal,” the report continued.

“Some might argue that a transfer price that could be offered by the USS on the terms we describe in the annex (which we believe is fair to all remainers) implies that pension rights would be being sold at a price below their true value.

“We believe this claim is false; it misses the point which is central to why such a transfer can benefit both parties.

"It is true that if the USS were to sell the rights to a guaranteed pension at the present value of that stream of income discounted at the current real interest rate on entirely safe assets the transfers would be infeasible.

"This is because the USS is clearly in deficit if pensions were to be valued in this way. So they must offer terms less generous than this.

"But precisely because scheme members would not wish to invest any transfers 100 per cent in such safe assets the transfer can be of great value when offered on terms the USS can afford to offer. This is precisely what the calculations in the annex show."

Finally, it noted that the timetable suggested in the report was “very challenging”, but it would need to be to have a chance of resolving the current dispute without further strike action.

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