Students may be back at universities, but the institutions themselves continue to battle with the impact of COVID-19 on their revenue stream and must also face the burgeoning pension crisis.
Currently, the Universities Superannuation Schemes (USS), which is the UK’s largest private-sector defined benefit pension scheme, is consulting on the issues faced on the back of its estimated funding deficit increasing from £5.7 billion (as at 31 March 2019) to £12.9bn a year on.
While much has been discussed about the USS (and quite rightly so), 20-20 Trustees believe that employers and trustees should also be mindful of how USS developments could affect their own occupational defined benefit (DB) scheme, which many universities have for their non-academic staff.
Affordability
The USS has proposed to increase total contribution rates from the current 30.7% to anywhere from 40.8% – 67.9%. Even at the lower end of the spectrum, this is a phenomenal increase. Salaries account for more than half of universities’ overheads so a change to pension scheme contributions will undoubtedly have a massive impact on the cost base.
What does this mean for individual DB university schemes?
At a time when many universities are struggling with a reduced revenue stream, Trustees should consider how a potential increase in USS contributions could impact the university’s financial commitment to their university scheme. Trustees may be faced with asking some difficult questions – will this affect the university’s affordability? Will universities be looking at benefit redesign or liability management exercises to offset the burgeoning pension debt? Will Trustees need to be more creative in their approach such as exploring asset-backed funding arrangements to improve the scheme’s security?
Covenant strength
Covenant refers to the legal obligation and ability of employers to financially support the scheme now and in the future.
In the 2020 valuation, the USS has provisionally assessed universities’ covenant as ‘tending to strong’, instead of the higher rating of ‘strong’ concluded in the 2018 valuation. This would mean a total contribution of 60.3% to 67.9% compared to a ‘strong’ covenant contribution of somewhere between 40.8% and 59.7% – a significant difference. The USS has indicated a reassessment back to strong is only viable if universities agree that they cannot exit the USS without Trustee’s consent and (as considered below) they agree to a new secured debt arrangement.
What does this mean for individual DB university schemes?
Trustees should consider how USS’s reassessment affects the covenant rating on their university scheme. Should Trustees follow suit with the USS or can they objectively justify adopting a different approach? Most certainly there are some plausible grounds for a different reassessment; the USS adopts a blended covenant rate across its participating employers, whereas individual university schemes have the benefit of assessing the covenant against the specific semantics of its sponsoring university and any other sponsoring employers. If a lower covenant is deemed appropriate, Trustees will need to consider if this warrants a lower risk investment strategy from both an IRM perspective and in line with the proposed new DB funding code.
Debt monitoring
A ‘strong’ covenant in the USS will be contingent upon the successful implementation of a debt monitoring framework.
The proposed debt monitoring framework allows the USS to collect data on debt from employers and agree any mitigation measures where the USS Trustee believes there is a risk of weakening the covenant. This would also commit universities to granting pari passu security for the USS on any new secured debt.
What does this mean for individual DB university schemes?
Just as the USS wants equal ranking on new secured debt, Trustees of university schemes should consider whether equitability and security of their scheme would warrant making similar demands. Often as a competing unsecured creditor of the university, it is important that Trustees continue to ensure that sufficient protection is afforded to their members.
Expert advice and guidance is crucial
Future planning is more important than ever and 20-20 Trustees advice to Trustees of university schemes is to plan and to be prepared to act. It is important for Trustees to work collaboratively with universities to define a long-term journey plan that is both financially sustainable by the employer and provides sufficient security to protect members’ interests – sometimes a difficult balance but with the right help and advice, it can be achieved.
How we can help
There is a lot to be done and it can seem overwhelming, which is why it is more important than ever for Trustees to reach out to higher education sector experts such as those at 20-20-Trustees for advice and guidance. We are happy to work on ad-hoc projects using trustee directors with specialist knowledge who understand the challenges of the higher education sector and universities’ business model. Having our experts on your side could make all the difference when it comes to managing your pension scheme during these unprecedented times.