The economic crisis brought about by Covid-19 poses one of the most significant challenges in living memory for the UK¡¯s higher education sector.

Institutions and individuals are facing uncertainty and profoundly difficult choices.

As the principal pension scheme for academics and support staff across 340 higher education institutions, the Universities Superannuation Scheme has an important role to play in ensuring the long-term success of the sector. The pensions promised to our 440,000 members help our sponsoring institutions attract and retain world-class talent.

The current crisis has made the value of a defined benefit pension more obvious than ever before. Those who are promised an index-linked income for life, regardless of future circumstances, are in possession of an increasingly rare and valuable asset.

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The increased cost of buying future income to cover pension promises can be seen clearly in the markets. For example, to buy ?1 of future annuity payments on the open market costs 24 per cent more than it did five years ago, and 48 per cent more than 10 years ago. The cost of generating the cash flows needed to pay for new pensions has gone up inexorably.

Our monthly monitoring reports reveal just how much recent events have affected USS. In March, we reported that ¨C on our current assumptions ¨C a ?12 billion gap had developed between our assets and the cost of the pensions already promised to our members. At the end of May, this gap had grown to ?19 billion. At the last valuation a little over two years ago, it was ¡°only¡± ?3.6 billion.

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The impact of current market conditions means that the estimated contribution cost of our members¡¯ benefits has also risen sharply since the last valuation ¨C from 28.7 per cent of salary to 39.2 per cent at the end of May.

Of course, these figures are snapshots of financial measures that are inherently volatile. But it is undeniable that events have not moved in our favour, and in very material ways. Historically low interest rates have compounded the long-term challenges presented by increased life expectancy and volatile financial markets.

The figures illustrate the scale of the challenge facing us and our stakeholders at the University and College Union and Universities UK as we push ahead with the 2020 valuation to establish whether the scheme has enough money to pay the pensions already promised and the cost of making new promises. The unavoidable truth is that defined benefit pensions were expensive before Covid-19; the depth of the present economic shock has exacerbated these issues.

So what can we do to mitigate the impact of today¡¯s challenges? We can explore taking on more investment risk in an attempt to secure higher returns and offset some of the additional costs facing employers and members.

But we start from a difficult place. Not just in our view ¨C the formal feedback from the Pensions Regulator since 2014 has been that the scheme is at the limits of risk, creating a significant constraint. ?

The 2018 valuation reflected the willingness of our sponsors to accept moderately more risk. And we have been examining strategies that assume higher levels of risk and return over the long term compared to the current assumed trajectory. We will seek confirmation of employer support for them in a consultation with UUK that we expect to launch next month.

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However, given the lower expected returns across all asset classes, these moves will not be sufficient to keep contributions close to those paid in the past.

We have been asked to look at ¡°smoothing¡± contributions over several years, anticipating that the scheme will become less expensive. Recovering the deficit over a longer period has also been considered.

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Both these measures dip into the same well ¨C depending on tomorrow¡¯s investment returns to fund today¡¯s and yesterday¡¯s promises, and on institutions generating operating surpluses to underpin those returns. This is possible, but there is a bottom to that well.

Employers will wish to ensure future commitments are manageable, and the USS, as the trustee, must be confident that promises to members made by employers can be delivered in almost all future circumstances. We are happy to examine again employer willingness to underwrite short-term arrangements, and we will explore again the Pensions Regulator¡¯s position on these issues. In 2018, employers suggested that they wished to have less exposure to the risk that scheme costs don¡¯t fall as anticipated in the future, but a recent consultation suggests sentiment may have shifted.

In summary, we have taken the following action to address the deep challenges facing the scheme: ?

• We have asked employers to sign up to a long-term commitment to the scheme that will allow us to rely on their collective strength for the next 30 years. This will help us take on more risk in search of reward.
• We have revised our methodology.
• We will consult with UUK in August and September on our approach to the 2020 valuation, including the assumptions we are making about the future and the willingness of employers to underpin them.
• We are engaging closely with the Pensions Regulator to ensure it understands our views on the strength of employer backing and our ability to take a long-term approach to funding the scheme.

However, we cannot change the fundamentals of the equation. Unless employers are prepared to underpin a very big dependency on volatile asset returns, and unless they can convince us that they are able and willing to do so through tangible commitments, then contributions will have to rise sharply. It looks likely that they will need to rise even higher than anticipated at the 2018 valuation.

It is never pleasant to be the bearer of difficult news that will require difficult decisions. But what matters most to USS, as the trustee, is the long-term security of the benefits promised to its members by their employers. That is our primary concern for the 2020 valuation.

Bill Galvin is group chief executive of the Universities Superannuation Scheme.

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