In eight months, the Universities Superannuation Scheme will hold its next valuation.

In recent months, we have seen signs that the funding position is moving into a more resilient place. If that continues, it could provide Universities UK and the University and College Union with the opportunity ¨C through the Joint Negotiating Committee (JNC) ¨C to consider potential improvements to the scheme and address some long-standing issues.

But how things will play out is difficult to say.

Recent events, from the pandemic to the war in Ukraine, have sent shockwaves through financial markets and some of the signals are difficult to interpret. Very different perspectives are available on how long-term structural trends for growth, returns and inflation will play out.

We conducted a ¡°deep-dive¡± review of the scheme¡¯s financial position at 31 March this year, to better understand the implications of recent events. This confirmed that the position has improved?since 31 March 2020, the date of the last actuarial valuation.

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While it is encouraging that the funding deficit had fallen from ?14.1 billion to about ?2.1 billion, it is important to understand this in context. Given the prevailing conditions at the 2020 valuation date, we set a long recovery plan and increased deficit recovery contributions by just 0.2 per cent.

More importantly, the cost of funding new benefits ¨C which accounts for the vast majority of the total contribution rate paid by members and employers ¨C was broadly the same as it was two years prior. This is notable because the ¡°future service cost¡± has consistently been rising over the past decade, in tandem with the broad decline in bond yields increasing the cost of benefits already built up.

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While recent changes to the scheme were understandably very difficult, and contested, they put the scheme on a more resilient footing. Without them, the contributions required for new benefits alone were tracking at north of 36 per cent at 31 March 2022 ¨C substantially higher than the current total contribution rate of 31.4 per cent.

At face value, the quarter to the end of June is likely to bring more good news. Although the volatility in global markets has wiped about ?15 billion off the value of the scheme¡¯s assets (down from ?93 billion at the end of November), interest rates have been rising.

The recent big swings in financial markets have reduced the reported deficit, and the adjustment to the inflation cap on future benefits has constrained the impact of higher inflation on the future service cost. It is important to emphasise that the 2.5?per cent inflation cap adjustment doesn¡¯t come into effect until 2026 ¨C so members are not yet impacted by it directly. There is time for the JNC to review it, should it wish, through the 2023 valuation.

It is, however, challenging to make judgements against a backdrop of considerable market volatility. The implications of significantly higher inflation are still working through markets and expectations ¨C so the funding position monitored at the end of June is likely to be overstated.

There may be more swings to come, and they may not fall in our favour. The International Monetary Fund has revised down its short-term global growth forecasts and raised its projections for inflation, the risks to the economic outlook are ¡°overwhelmingly tilted to the downside¡±.

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The challenge for pension fund trustees in any valuation is to try to look through short-term impacts and understand the long-term funding outlook. We spent the best part of 18 months reaching our conclusions for the 2020 valuation, given the specific challenges around that date. Ahead of the 2023 valuation, we can prepare to harness the benefits of any sustained improvement in the funding position. We hope the JNC will be able to consider lowering contributions, enhancing benefits ¨C or both. If it can agree in advance what it would do, it may be possible to implement changes more quickly than in the recent past.

We can also continue to help UUK and UCU address some important long-standing issues.

It is concerning to see significant numbers of younger university staff choosing to opt out of the benefits of USS membership ¨C nearly one in five new joiners are missing out. We are helping UUK and UCU to explore lower-cost options in recognition that needs are evolving. This is particularly important for those on lower salaries and more flexible contracts, or those who may not expect to remain in the scheme or the sector for the long term. It is also a concern to employers who want their lower-paid staff to have access to affordable benefits, against the backdrop of rising cost of living.

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We are also helping our stakeholders explore other routes to ensure that the USS is affordable and sustainable well into the future. One potential avenue is conditional indexation, whereby increases to pension benefits above statutory minimums are dependent on investment returns. This has been used to good effect in Canada, and we have facilitated early conversations with Canadian funds to understand how this might work in the UK.

We also look forward to exploring, through UUK¡¯s planned review, what improvements could be made to the scheme¡¯s governance, in line with best practice and consistent with legislation and regulatory guidance. We hope UCU feels able to engage positively with UUK¡¯s review.

These important initiatives will help the USS support the wider higher education sector it serves and maintain its position as one of the best private pension schemes in the country.

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

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