January 28, 2021

Pension scheme valuation versus pension funding and the cost of prudence (with reference to USS)

My argument in this latest draft of my paper on pensions valuation and funding (pensionsvaluation5.pdf) is relevant to all defined benefit schemes, of which there are still over 5300. It is aimed primarily at the regulator, who is faced with a siituaton of worsening deficits, and secondly at the actuarial profession. It is also directed at all who are involved in the valuation of the University Superannuation Scheme, whether executive, directors or the stakeholders UCU or UUK.

According to the latest Purple Book published by the Pension Protection Fund, total combine deficits of all DB pension schemes as at March 2020, have reached £90.7 billion last year compared with £12.7 billion the year before. This is before the effects of covid-19 have been felt and more and more schemes have to depend on the PPF.

The pensions crisis, that has been getting worse for a number of years, and has led to many schemes closing to new accrual, is exacerbated by a regulatory system requiring market price valuations, combined with very low gilt rates (due to government monetary policy/ quantitative easing) used to calculate liabilities. But this is not the only methodology that can be used: it is aimed at ensuring schemes with weak employer support have enough assets they can liquidate to pay the pensions should they have to close. But for an open scheme with a strong employer covenant it is very misleading and leads to cost increases that undermine it. For an open scheme it is better to make a direct analysis of funding needs comparing projected investment earnings with benefit outgo (something that actuaries did in the past).

Where there is a very large and significant difference between the se two methodologies is in the risk metric that determines the cost of prudence. The mark-to-market methodology must use a very much greater risk allowance - due to the much greater volatility of asset market prices as compared with investment earnings. This means that the regulatory system we are using artificially inflates the cost of prudence. It contains a serious bias that makes schemes appear much more expensive, and deficits much bigger, than would be the case if they were valued as open schemes.

This is a serious issue for the USS which has so far stuck religiously with the mark-to-market methodology despite it being an open scheme with a strong multi-employer covenant. Stakeholders should demand a re-appraisal using the traditional actuarial methodology before reaching any conclusions about the future of the scheme.

December 11, 2020

USS Governance: Changes to the Articles of Associaiton of the trustee company

There is a lot of discussion just now on how the Universities Superannuation Scheme is governed. Here is a paper I wrote last year commenting on the changes then being made to the rules for appointing directors. It may be of interest but some of it could be outdated by now in light of other changes.


August 26, 2019

The USS dispute is not about cost sharing but the survival of defined benefit pensions: a rejoinder

What is at stake in the USS dispute is the survival of defined benefit pensions.

The UCU negotiators have repeatedly shown that there is no need for contribution increases or benefit cuts, that the scheme as it currently exists can continue in existence indefinitely provided it is managed in a way that seeks to make that happen. The reason is that it is a multi-employer scheme designed for a unique sector, the pre-92 universities. The pre-92 universities not only provide world class scholarship, research and education but, as a sector, can be seen as one of the UK’s most successful industries. That should be at the front and centre of all discussions about the USS: its unique nature means it has very little in common with other private sector schemes and should not therefore be compared with them.

Unfortunately the USS Employers in their latest response to the UCU have demonstrated that they are not engaging with that view and give no indication of their intention to do so. Their letter is full of innuendo and half-truth and does not deal with the arguments. It underestimates the intelligence of university staff and many will feel insulted and devalued by it.

The choice for the USS is between two possible alternative courses:

(1) that it continues to be an open ‘defined benefit’ scheme that provides guaranteed pensions based on salary and years of service, on an ongoing basis with an indefinite time horizon, open to new members, supported by a strong employer covenant that is continuously monitored; or

(2) that, in common with most private sector company schemes, it may decide that the various risks of staying open are too great, and do what they have done, close to further accrual, with consequent increases in contribution rates, as was proposed last year. New members will be offered an inferior ‘defined contribution’ plan that does not lead directly to a solid pension but uncertain benefits. Employers will take advantage of this change to cut their contributions as well as transferring all the risk.

These two alternatives require the scheme to be viewed in different ways that lead to different investment strategies and different ways of managing risk. And two different valuations. Any decision about the future of the scheme requires a comparison of both.

If the scheme is assumed to remain open, as in alternative (1), providing that there is positive cash flow available for long term investment, in a suitably diversified portfolio that includes high return assets such as equities, there will be healthy income to pay pensions in the future. The main source of investment risk - short term asset price volatility - can be managed. Since the pension payments are long in the future, it is long term investment returns that matter, and short term volatility can be ignored.

In fact in an open ongoing scheme that is cash flow positive like the USS, any downturn in the stock market is an advantage, not a threat - because it means assets can then be purchased more cheaply, reducing the cost of future service accrual.

The valuation of an open scheme ideally requires a comparison of projected income flows with projected outgo in pension payments. The UCU have repeatedly asked the USS to carry out such an analysis without one having yet been published. Our actuarial advisor First Actuarial have provided such analysis that strongly points to the scheme being sustainable. It would be good if the UUK joined us in demanding the USS carry out a similar analysis using the complete data set that they have available.

Alternative (1), of course, depends on there being a strong employer covenant. The covenant risk to the scheme is essentially the insolvency of all the pre-92 universities. The risk from insolvency of individual institutions is offset by the collective nature of the scheme, so called ‘last man standing’. The risks facing the scheme are essentially those facing the pre-92 higher education ‘market’ as a whole. That does not seem a likely prospect at the moment. If that begins to change it will be noticed in the periodic review of the scheme and in the triennial valuations. It does not seem realistic to assume it will happen suddenly without warning.

Alternative (2) is the only one that the USS employers, executive and most of the trustees seem to be willing to countenance. It denies the unique nature of the USS as a sector scheme and treats it as if it were a mature single employer scheme. It assumes the scheme matures and then the job of the trustees is to manage the ensuing runoff. The whole emphasis is on risk rather than return, making sure the invested funds can pay the pension promises with absolute certainty. Paying the pensions depends on the investments being risk-free which means investing in government bonds.

The problem - and the source of the dispute - is that government bonds are no longer a good investment. Twenty years ago they would have produced a return of perhaps 2% above inflation but today, thanks to post-crisis monetary policy and quantitative easing by the Bank of England, the rate of return after inflation is negative.

Yet the policy of the USS, supported by the UUK employers, ignoring the thinking of the Joint Expert Panel, of so-called de-risking, is to invest in assets that are guaranteed to lose money. This is regarded as a low risk strategy on the grounds that the loss is certain. This is surely an absurdity. De-risking actually increases the risk to the scheme that it cannot pay the pensions when they fall due because the loss on the gilts has to be paid for by the members and employers. This is what is driving up contributions and threatens the survival of the scheme.

It should be noted also that interest rates on government bonds are no indication of investment returns more generally. The expected long term return on equities and other forms of patient investment in the productive economy (rather than lending to the government) continues to be sufficiently high to pay the benefits.

Essentially the defined benefit scheme is being undermined by the herd mentality group think of the pensions experts in the USS executive. They are applying thinking from the past - when it was rational for pension schemes to invest in government bonds that produced a steady though modest return as part of its risk management - to today’s conditions of negative risk-free rates. It is an example of how real damage to people’s welfare can result from the continued unreflective use of an economic model when the conditions for its application do not hold or have changed.

December 17, 2018

USS Institutions Meeting very disappointing

Last week was the annual USS Institutions Meeting, an opportunity for employers to be updated about the state of the pension scheme.

I attended as an elected member-nominated rep on the Advisory Committee (part of the formal USS governance structure). Attendees were invited to submit a question. I was disappointed that mine was not addressed but instead a heavily edited version substituted - and even that was not fully answered. My question was addressed to the chief executive, Bill Galvin, but the substitute question was answered by the actuary.

At bottom the issue facing the USS and the focus of the dispute is intellectual: a matter of methodology. A pension scheme must have sufficient funding to cover its liabilities when they fail due to be paid. That is obvious but there are different ways of assessing a scheme's ability to fund its pension payments over the years. However the law only requires the trustees to report on one of them, the Statutory Funding Objective, which requires the assets must be at least equal to the actuarial valuation of the liabilities known as the technical provisions, otherwise there is a deficit that must be filled by a recovery plan.

The actuarial profession is not united that this method - valuation - is necessarily the right approach and that it may be problematic. Many actuaries instead advocate projecting the flow of income - from both contributions and investments - to see if it will cover the flow of future benefits. I wanted to cite an important reference critiquing the valuation method: the paper by Simon Carne, which shows that the projection method is perfectly rigorous.

I wanted to show that it makes perfect sense to use both methods to get a rounded view. And Bill Galvin had previously accepted the point when I had asked a similar question two years ago. But it was evident that the the USS executive and the board are committed to one and only one valuation.

Here is my question:

The USS seems to be wedded to a single approach to funding via valuation, using ideas from financial economics. But that is not the only one. Another, equally valid method is available: the budgeting approach traditionally used by actuaries based on projected income and outgo. Simon Carne, in his seminal paper “Being Actuarial with the Truth”, showed this method to be perfectly rigorous and most of the claims of financial economists against it to be false. For a scheme with a strong covenant like the USS it has the advantage of avoiding the use of volatile asset prices and problematic discount rates.

It answers the question: by how much is the pension fund in surplus or deficit on the premise that the existing investment strategy is maintained, with all future reinvestment following the current investment strategy? It would be useful for the USS to know the answer to that question, in addition to the valuation. This method - which does not depend on discount rates driven down by the artificialities of the government’s quantitative easing policy, nor the market risk introduced by excessive asset price volatility - has been advocated by First Actuarial and applied to many schemes, including USS, showing only small deficits or surpluses.

At this meeting two years ago I asked if you would use this approach as a supplement to the statutory valuation. Bill Galvin replied: “Triangulation of different approaches is very much part of our first principles approach, with the use of a number of different lenses rather than a single lens; then we are very open to that as well.”

Can I please ask that you report the results of using this approach to determine the level of funding?”

Here is the question that was put to the scheme actuary, who was easily able to dismiss the suggestion of an alternative approach. It did not seem from his answer that he had seen the original question.

Here is the edited version

This illustrates a great weakness of the current management of the USS: that it fails to engage with the intellectual arguments surrounding pensions. Since the USS is the pension scheme for universities, it might be expected that the trustees, most of whom are academics, would be keenly interested in the arguments about actuarial practice and financial economics that have been going on for over twenty years, in order to try to get a better understanding. But no, they seem to want to manage the scheme as if there is nothing to question about the methodology, and their job consists in little more than unthinkingly applying the rules designed essentially for small commercial companies. It is unfortunate that academics and others who are thinking about these crucial methodological questions are not being taken seriously by the management. It is hard to avoid the conclusion that the USS has become a scheme FOR universities rather than a true university scheme.

November 29, 2018

A question for the USS executive

I have put down the following question for the USS Institutions Meeting on 6 December.

"The USS seems to be wedded to a single approach to funding via valuation, using ideas from financial economics. But that is not the only one. Another, equally valid method is available: the budgeting approach traditionally used by actuaries based on projected income and outgo. Simon Carne, in his seminal paper “Being Actuarial with the Truth”, showed this method to be perfectly rigorous and most of the claims of financial economists against it to be false. For a scheme with a strong covenant like the USS it has the advantage of avoiding the use of volatile asset prices and problematic discount rates.

It answers the question: by how much is the pension fund in surplus or deficit on the premise that the existing investment strategy is maintained, with all future reinvestment following the current investment strategy? It would be useful for the USS to know the answer to that question, in addition to the valuation. This method - which does not depend on discount rates driven down by the artificialities of the government’s quantitative easing policy, nor the market risk introduced by excessive asset price volatility - has been advocated by First Actuarial and applied to many schemes, including USS, showing only small deficits or surpluses.

At this meeting two years ago I asked if you would use this approach as a supplement to the statutory valuation. Bill Galvin replied: “Triangulation of different approaches is very much part of our first principles approach, with the use of a number of different lenses rather than a single lens; then we are very open to that as well.”

Can I please ask that you report the results of using this approach to determine the level of funding?”

October 27, 2018

Pensions regulation based on mark–to–market valuation lacks transparency and overstates risk

Pensions regulation based on mark-to-market valuation lacks transparency and overstates risk*

(* This is a revised version of a presentation given at the CSFI Roundtable “Pension funding – more than an academic question” 27 September 2018, Wax Chandlers Hall, London.)

Although it is the largest in terms of assets and number of members, the University Superannuation Scheme (USS) is only the latest in a long line of private sector defined benefit pension schemes to be threatened with closure under the current system of regulation. USS members, of whom there are over 200,000 actively contributing[1], have seen through this and taken industrial action to challenge the valuation. They, being mainly academics, and, as such, disinclined to accept anything on trust, and to think things through from first principles for themselves, have questioned the methodology that would lead to this apparently well funded scheme being suddenly closed to DB accrual. The result of the industrial action has been the setting up of a high level enquiry under a panel of experts appointed jointly by the employers’ body, the UUK, and the members’ union, the UCU.

The Joint Expert Panel published its first report on 13 September 2018 commenting on the USS valuation dated at March 2017, which is the focus of the dispute and has not yet been completed. It is quite critical of some of the actions of the employers, the scheme management and also the regulator. The panel is due to continue its work into a second stage to look more fundamentally at the regulatory methodology, particularly as it applies to the university sector[2].

I am not going to discuss the USS dispute or the JEP report here in detail[3]. That would be a good subject for another CSFI round table which I hope can be organized soon.

I will argue instead more generally that our poorly designed regulation system[4] is a policy mistake on a grand scale. Specifically by prioritising the statutory funding objective, which is supposed to ensure every scheme has enough assets to cover its technical provisions, it fails to give a clear picture of the health of an open pension scheme, and is problematic in two ways. First it is not transparent, because it focuses on a poor indicator. Second, and worse, it greatly exaggerates risk, that has to be dealt with at great cost. I will argue against this monistic approach and for economic pluralism in the monitoring of pension schemes, looking at them in the round, using a range of criteria, not simply balance sheet valuations of assets and liabilities on a mark-to-market basis at a moment in time.

I will also argue that an effect of the regulatory system is to allow circular reasoning where the assumptions that are made in valuing liabilities are self-fulfilling. Pessimistic assumptions lead to negative outcomes. Schemes end up being forced to close as a result of over-prudent assumptions.

A third important line of criticism of the current regulatory regime, that is often ignored, is that, besides limiting pensions provision for millions of people, with consequent erosion of the social fabric due to poor support for the elderly, it is also doing substantial macroeconomic damage, hampering economic growth. I will show that this is the result of the adoption of false economic theories over empirical evidence.

Full paper here

[1] The scheme also has approximately 70,000 retired, and 150.000 deferred members.

[2] It is important to understand that the USS is the pension scheme covering only the so-called pre-92 universities and associated institutions, including Oxbridge, the Scottish ancient universities, the London colleges, the Civics and the 1960s generation of New Universities. In the main they all have a substantial commitment to research as well as teaching at both undergraduate and postgraduate levels, and many are among the leading universities worldwide. The new universities that have been created by the Thatcher government and subsequently are not USS institutions. Since historically most of them were formerly polytechnics or other kinds of colleges in the local government sector, their staff are members of the Teachers Pension Scheme, which is an unfunded government scheme. It has been remarked that if the proposed changes to USS go through, and it closes to DB accrual, pension benefits will be better at Oxford Brookes than Oxford, Anglia Ruskin than Cambridge, Teesside than Durham.

[3] The terms of reference and the first Report of the Joint Expert Panel can be downloaded from http://www.ussjep.org.uk

[4] Dating largely from the Pensions Act 2004 that created the Pensions Regulator and Pension Protection Fund, and regulations subsequently applied by the regulator.

August 17, 2018

The USS analysis of reliance is seriously flawed and biased against the scheme

Evidence to the Joint Expert Panel


Dennis Leech, Emeritus Professor of Economics, University of Warwick, 15 August 2018

The assessment of reliance on the employers’ covenant is fundamental to the valuation and funding of the scheme. If the likelihood of the employers being asked to make additional payments above the maximum they can afford is too high, then that spells too much reliance and there will have to be benefit cuts. The details of their approach to this calculation are set out in various USS documents, including the Draft 2017 Actuarial Valuation, 1 September 2017, and Proposed approach to the methodology for the 2017 actuarial valuation: response to the Valuation Discussion Forum, 22 November 2016, and formalized in their various Tests.

The reliance measure is the difference between the scheme’s assets and what is termed the ‘self sufficiency’ liability. Self sufficiency is the level of assets that would be required for a low-risk investment strategy with a low probability of ever needing further contributions to provide benefits. The self sufficiency liability is described by USS as a ‘safe haven’ because it could be covered by investing in government bonds that are completely safe. Self sufficiency liability is calculated using a ‘gilts plus’ discount rate (gilts plus 0.5 or 0.75%) regardless of the actual investment strategy of the scheme. Because current gilt rates are so very low due to government monetary policy, this gives an extremely large figure of £82.4 billion for the liabilities. The conclusion reached by the USS from this is that the reliance is near the maximum that the employers can support.

There are however, serious problems with this approach to reliance. The methodology is flawed in two important ways.

  1. Essentially what is at issue is a choice between two statistical hypotheses that have far reaching consequences that are very different: on the one hand, the scheme remains open indefinitely, and on the other, there is a high likelihood of it having to close at some stage in the not-too-distant future. An even-handed treatment that tested the two hypotheses fairly would use the method of scientific testing of statistical hypotheses. This has not been done and instead the USS approach has, in effect, been biased in favour of supporting the second hypothesis.

  2. The treatment of risk by the USS is not consistent. In particular no allowance has been made for the fact that risk is not an absolute factor like it would be in a gambling situation, but is conditioned by circumstances. It is different for each of the two hypothesis under consideration. Two types of risk need to be considered: that which depends on the particular hypothesis being tested and that which is independent of it. We can call these respectively endogenous and exogenous risk.
Mistaken testing methodology

The USS tests of the reliance of the scheme on the covenant amount to essentially testing two hypotheses against one another using statistical reasoning. Either the scheme remains open indefinitely, and continues as it has been until now, or it eventually changes fundamentally and makes the journey to self sufficiency or closure. However, in their analysis, the USS have not treated both hypotheses in the same way, as a truly scientific approach would warrant. The hypothesis that the scheme remains open without undue reliance has not been thoroughly investigated and has been rejected nonetheless.

The scientific approach to testing a statistical hypothesis proceeds by first deriving the probability distribution of the relevant test statistic on the assumption that the hypothesis is true. The decision about whether to accept or reject the hypothesis is made by partitioning the theoretically possible values of the test statistic into two sets, the acceptance region and the rejection region. The test statistic is then computed and a decision made depending on where its value falls.

The test statistic in this application is the liability and the decision rule used is to compare the liability with the assets plus the amount of reliance that the institutions can afford. The affordable maximum reliance has been fixed at around 7 percent of payroll over 40 years.

The key point that the USS has ignored is that the liability depends on the particular hypothesis being assumed true and tested. If the scheme is regarded as continuing indefinitely then it can invest in high volatility assets to gain the higher returns that such assets will bring. High volatility is not a source of risk in this case. And if the scheme is cash positive, as the USS is and is forecast to continue to be indefinitely (see the paper by Salt and Benstead) it need not match the risk of the assets held with the liabilities. As Salt and Benstead put it:

“Being an open scheme brings significant investment advantages, which can be exploited to the benefit of the employers and members. The investment time horizon is infinitely long. An open scheme pays its benefits from contribution and asset income without any need to sell investments. If the asset income is sufficient, fluctuations of their market value is relatively unimportant.”(p8)

It follows that the liability for an open scheme will be appropriately calculated using a – higher - discount rate reflecting the expected return on the assets held in the investment portfolio. That will give a low figure for the liability.

On the other hand, if the scheme is seen as being in danger of closure, the volatility of the asset prices assumes central importance, and becomes risk. Under this ‘weak covenant’ hypothesis there is a danger that the scheme will have to sell off assets to pay benefits at some time in the future when prices are low and will be unable to pay the benefits in full. Therefore on this hypothesis the scheme needs to invest in – low volatility - assets that match the liabilities in terms of risk and return. The appropriate discount rate is therefore the - low – bond rate. The USS ‘self sufficiency’ portfolio is calculated on this basis.

The proper assessment of reliance therefore requires two different calculations of the liability: one assuming a strong covenant, that uses a liability based on best estimate returns from an income-seeking investment portfolio (such as the current one); and one for a weak covenant, that uses the self-sufficiency gilts-plus approach, assuming a low risk portfolio. Both calculations should be done. If they both give a reliance figure that is probably above 7 percent of salary, then the result is clear that the employers are unable to continue to support the scheme.[1]

It seems likely however that if the two approaches are applied correctly by the USS they will give different results. The assets on the valuation date of 31 March 2017 were £59.9 billion and the best-estimate liability figure was £51.7 billion, giving a surplus of £8.2 billion, and therefore no further reliance on the employers is indicated.[2] On the other hand, the self-sufficiency-gilts-plus liability was £82.6 billion, a reliance of £22.6 billion, larger than the target reliance of £10 billion.

The conclusion is that the result of the tests depends on what is assumed. On the hypothesis that the scheme remains open the inference is that it does not place particularly great reliance on the employers, and therefore we should accept the hypothesis and keep the scheme open. On the other hand, on the hypothesis that the scheme does not remain open indefinitely, there is likely to be high reliance on the employers.

Keeping the scheme open indefinitely would seem to be a perfectly reasonable and prudent course of action that would require neither increases in contributions nor cuts in benefits.

Inconsistent idea of risk

When valuing pension schemes it is important to separate the risks they face into two types: those that exist independently of the valuation, exogenous risks; and those which are consequent on it, what might be called endogenous risks.

A scheme in deficit is threatened by an existential risk due to the deficit itself, whatever other risks there may be. The need for the employer sponsor to make additional payments into the scheme threatens the company’s solvency and weakens the covenant. Many schemes have closed as a result of the actuarial valuation showing a deficit requiring deficit repair contributions over and above the employer’s regular contributions.

A scheme in surplus does not face that risk but is still subject to exogenous risks from other sources. A company, or association of employers such as the USS, can become insolvent for reasons unconnected with its pension scheme. For example large numbers of students might start deciding that a university degree is not worth the cost and refuse to incur the level of debt required leading to universities becoming insolvent.

The assessment of the reliance on employers should separate out these two types of risk and treat them fundamentally differently in the analysis. The exogenous risks can be allowed for by adjusting discount rates for prudence according to the usual actuarial principles.

However the endogenous risks require recognition of the simultaneity between the liability valuation and the covenant. If the covenant is strong the scheme can remain open and invest in high return assets and ignore the short term volatility in their prices. Therefore the risk of not being able to pay the benefits is low. But if the covenant is regarded as weak there is a non-negligible risk of not being able to pay the benefits.

The reliance calculation that has been done by the USS is deeply flawed because it ignores this endogeneity of the liability with respect to the strength of the covenant. It uses a liability value calculation based on a low-risk investment portfolio, with a low – gilts-plus - discount rate, appropriate to a situation of weak covenant. This leads to a greatly exaggerated idea of the scale of risk and therefore biases the analysis against finding that employers can afford the scheme - provided it remains open indefinitely. The USS is in effect assuming what it is setting out to test: by using the ‘safe haven’ valuation for the self-sufficiency liability it is assuming the existence of risk that is a consequence of an assumption of a weak covenant, and then claiming it shows there is too much reliance. It is circular reasoning.

The calculation by the USS is incoherent because it fails to recognize that the liability depends on the assumed strength of the covenant. The self-sufficiency-as-safe-haven definition is appropriate for an assumption of a weak covenant where prudence requires the lowest risk investment strategy. But if the covenant is assumed strong, so that short run market volatility does not pose a serious threat, the scheme can remain open to new joiners indefinitely and implement an investment strategy accordingly. It can invest in assets like equities that have high expected returns since their greater price volatility does not pose risk to its survival.

The analysis of reliance by the USS does not establish what is being claimed for it.


Salt, Hilary and Derek Benstead, Progressing the valuation of the USS, Report for UCU, First Actuarial, 8 August 2017

USS, Proposed approach to the methodology for the 2017 actuarial valuation: response to the Valuation Discussion Forum, 22 November 2016.

USS, Draft 2017 Actuarial Valuation, 1 September 2017.

[1] Strictly the two hypotheses are non-nested with respect to each other. Neither is a special case of the other. The result of the tests may be indeterminate in that both are accepted or both rejected.(See for example https://core.ac.uk/download/pdf/7092823.pdf)

[2] This figure includes no allowance for prudence as required. However it is hard to believe it would not still be very large after such allowance was made.

June 25, 2018

Pensions: A sustainable social contract

Pension schemes are often described disparagingly – without evidence – as being unsustainable or unfair between generations, or even according to some people, a kind of fraud, a form of Ponzi scheme. That is because they are fundamentally intergenerational, in that pensions require the working generation to supply goods and services to the retired. That is inescapable and therefore all pensions are essentially pay-as-you-go in this sense.

This paper pensionssocialcontract.pdfcalculates the investment returns required for pension schemes on various assumptions and finds that if they are properly designed they are perfectly sustainable given the typical investment returns that are currently achievable.

It is important to note that the rate of interest on government bonds, ‘gilts’ – which are presently very low due to government policy known as ‘quantitative easing’ and such – is not the same as the rate of return on investments. Investment returns on equities and property are determined in the market and not related to government-policy driven interest rates.

The USS chief executive Bill Galvin has recently issued yet another statement in which he argues the opposite. He says that the cost of future accrual in the scheme is as much as 37.4 percent of salary. It is hard to accept such a high figure without a proper explanation. It would be good to know what lies behind it.

June 20, 2018

Too much money: It’s time to push back on DB deficits

Writing about web page https://secure.mallowstreet.com/Article/b33077

Here is the article that I linked to on twitter. It is behind a paywall which means most people could not read it, so I am posting it here. I have included the comments as well because they add something to the argument.

It is interesting in calling for reform of the way pension schemes are managed, especially regarding things like derisking. It is also calling for the DWP to take the matter on board and to act. The author, Robin Ellison, is a very much respected authority on pensions and what he says carries a lot of weight.

Too much money: It’s time to push back on DB deficits by Robin Ellison

For reasons which are probably obvious on the inside but seem impenetrable on the outside, the Pension Protection Fund continues to publish monthly stats on the collective deficits of UK defined benefit plans.

These numbers can fluctuate around £50bn in a month, which suggests that over 60 years any worries about collective UK private sector DB deficits are so volatile as to make publication of the numbers somewhat meaningless.

This over-statisticalisation of the system seems even less useful when looking at other studies which have been published in recent weeks. First Actuarial publish a frequent survey called FAB (First Actuarial Best Estimate Index), which suggests that at the end of April 2018, there was a collective surplus of £308bn and a funding ratio of around 125% on a best estimate basis.

The PPF itself, using a system in the course of refinement, suggests that schemes are collectively funded to around 95% on a s179 basis.

LCP coincidentally published their annual Accounting for Pensions survey in April, which showed that the FTSE 100 companies had a collective surplus (on an IAS 19 basis).

And even the defensive and increasingly aggressive Pensions Regulator has several times argued that the national funding issues for DB schemes were nothing to worry about – saying the system is in good shape.

Return to surpluses is possible

Of course, not much of this gets reported. But UK companies have been pumping funds into schemes over the past 10 years, and as interest rates stutteringly begin to firm, there emerges a non-remote possibility of a return to surpluses.

The question then will be posed by regulators, select committees and financial commentators as to what on earth we were doing to allow such a waste of capital to develop.

These counter-productive funding rules have impacted on British industry.

But not only has it resulted in over-provision; it has been coupled with a destructive ‘defensive investment’ strategy, investing through fixed income – especially index-linked and ordinary gilts – which will inevitably take a hit.

This policy has deprived many members of schemes from enjoying their expected pensions, and shareholders of their proper returns – all because of self-interested and counter-productive regulation and policy.

Time for the IFoA and PLSA to act

It is not too late. We now need to explain rather more forcefully than we have done so far, just what a fantastic job pension scheme trustees and their sponsors have done, despite the regulatory headwinds.

And it is time for (1) the Institute and Faculty of Actuaries to rethink just what is meant by derisking and (2) the PLSA to push back against TPR investment nostrums to try and live in what remains of the 21st century.

Because if we don’t, once the government has found post-Brexit time in its legislative timetable, we might regret not pushing back against the overzealous demands of the white paper as amended by the DWP select committee.

Pauline Armitage19 June 2018 at 13:08
Excellent. No one listened last century so I doubt they'll heed the message now...but then there are 88 years to go so maybe.
Peter Woolsey19 June 2018 at 13:35
At last someone with lengthy experience, and who knows probably more about the issues than anyone else, has bravely come out to challenge the establishment view and TPR on both deficits and funding principles. DB schemes last for generations (if allowed to do so!) and so funding and investment strategies must be based accordingly. De-risking merely demands more and more contributions from sponsors that quite possibly will not be required in the long term. There is potentially the danger that members' prospects of benefits at retirement will actually be harmed because of this. In the past, when investment was mainly in equity type vehicles, surpluses built up which would have served to guard against bad times; but Government got worried about the cost in tax relief and put a ceiling on funding levels. It's not surprising we got to the current position following this because all the good work in the past was undone by poor Government decision-making. It should be remembered that valuations are just a snapshot of a situation at a particular point in time.
Martin Veasey19 June 2018 at 15:04
Unless the covenant is in peril and there is a clear TP deficit, then it isn't a problem that a scheme is underfunded on a risk-free (or close to) basis - the liabilities aren't due today so why should one expect to have all the corresponding assets today? Yes, we should use this as a basis for longer term planning / aspiration but it's not a general emergency for the industry.Media reporting seems to promote the view that this is an immediate solvency metric and a general measure of health in the DB marketplace, both of which thoughts I disagree.

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