All entries for Wednesday 21 March 2018

March 21, 2018

Response to Urgent update from the USS trustees from member

The following response from a member was passed on to the UCU Pensions Officers discussion list by Sunil Banga


Dear USS,

Thank you for your “Urgent update from the USS trustees”, which I received on 17 March 2018, and which helped to dispel some of the rumour and disinformation that has circulated around the pensions issue. It is a great relief to learn that I am not expected to live to 147 years of age.


A number of other even more scurrilous and damaging pieces of misinformation have come to my attention, and I hope you can clear up these pieces of mischief before they inflict further damage on the reputation of USS and the higher education sector.


I have heard a vicious rumour circulated by the BBC’s education and family correspondent that the chief executive of USS, Bill Galvin, received an £82,000 pay rise this year, bringing his pay package up to £566,000 per year.[1] Only the most hardened cynic could believe this. It would, after all, mean that his pay rise alone is greater than the annual salary of many of those whose pensions the USS has proposed drastically to reduce.

What gives this rumour a particularly nasty edge is that after claiming that the running costs for the pension scheme are £125 million per year, including two staff members earning more than £1 million, the BBC correspondent quotes Mr Galvin as saying that the pension scheme is “excellent value”.

I think it would be a good idea to ask the BBC to publish a retraction, because this sort of rumour is likely to undermine the reputation not only of USS but of the higher education sector as a whole. I hope I will receive another urgent update on this matter as soon as possible.


An even more damaging piece of misinformation surrounds the results of the September 2017 survey of member institutions of USS. USS reported the survey found that 42% of employers wanted a lower level of risk.[2] This finding justified the “de-risking” exercise that increased the projected deficit in the pension fund and which ultimately gave rise to this unfortunate dispute. Could there be any greater mischief than the ugly rumour, originating with the Financial Times’s pension correspondent, that UUK “told the FT that Oxbridge colleges accounted for one third of the total wanting less risk” because Oxbridge colleges “are employers in their own right” and hence each college was counted as having an independent vote?[3] If a third of those wanting lower risk were Oxbridge colleges, this would mean that, beyond Oxford and Cambridge, the opinions of barely a quarter of the respondents to the survey justified the reduction in benefits that led to the strike.

Anyone gullible enough to believe that USS would accept this sort of gerrymandering must think that we still live in feudal times! I think it is important that USS nip this story in the bud. It is the sort of thing that might otherwise lead to the complete collapse of trust in both USS and UUK.


The thing that worries me, though: how did hackers manage to plant these stories with the BBC and the Financial Times correspondents? Could this be part of a concerted digital attack by a hostile foreign power?
As if that weren’t enough, the rumour-mongers must have hacked into Cambridge University’s response to the September 2017 survey, in which one finds the following justification for lowering the level of risk: “The University (and the other financially stronger institutions) continues to lend its balance sheet to the sector, which contains the cost of pension provision for all employers. In a competitive market for research and student places the University would be concerned if this appeared to be having an adverse effect on the University’s competitiveness (by allowing competitor universities access to investment financing or reducing their PPF costs in a way that would not be possible on a stand-alone basis).”[4]

No one could possibly believe that Cambridge University would be so selfish as to drive the whole education sector into turmoil in order to improve its relative position on the capital markets vis-à-vis other universities—or that the USS posture would collude with this sort of behaviour.


I hope you can see the urgency of correcting this bit of misinformation. The mystifying thing, though, is how someone has managed to plant the quoted statement in Cambridge’s response to the September 2017 survey, found on Cambridge’s own website. What evil force is trying to tarnish higher education in this way?
What USS must correct most urgently of all, though, is the following narrative: that in 1996, rather than build up a healthy surplus, USS permitted the employers to reduce their pension contributions from 18.55% to 14%, on the understanding that there would be no reduction in benefits; that the employers reduced their funding between 1997 and 2009, when hard times hit us all; and that when the fund was found to be in deficit, rather than ask the employers to pay a surcharge to compensate for their earlier reduction, USS instead instituted a series of reductions of benefits to the pension beneficiaries.

This story is the most damaging of all. Any child who has been immunised against profligacy by the fable of the grasshopper and the ant would recognise the impropriety in allowing the grasshopper employers to reduce their contributions in the apparently endless summer of 1997 to 2009, then requiring the employees (who, conscientious as we are, never reduced our contributions) to accept lower benefits in response to bad times. No responsible adult would let the employers get away with this, let alone an organisation like USS with fiduciary responsibilities. If we were to believe this story, we would have to believe that every time push came to shove, the independent chair of the Joint Negotiating Committee sided with the employers. That is not possible, because the very first words of the “urgent update” you just sent say that USS “has the primary duty to act in the best interests of the scheme’s beneficiaries”. No organisation would be so shameless as to allow itself to quote those words having permitted the employer to treat the beneficiaries in the way this mean-spirited story recounts.


I do hope that USS sees the urgency of dispelling the rumours that I have reported. If they continue to circulate, they will reinforce the belief that USS has acted as the servant of the most aggressive employers in the sector, who want to improve their balance sheet position even if that poisons relations between universities and their staff for a generation, destroys trust in USS and UUK, drives university employees into penury in their old age, tarnishes the reputation of the higher education sector, and thus does irremediable harm to the nation.


I look forward to your next urgent update containing apologies from all of those whose words and actions have brought USS and higher education into disgrace.


With my best wishes,


a USS beneficiary

[1] Sean Coughlan, BBC News education and family correspondent, “University Pension Boss’s £82,000 Pay Rise,” http://www.bbc.co.uk/news/education-43157711.
[2] “UUK Responds to USS’s Consultation on Funding Proposals”, https://www.uss.co.uk/how-uss-is-run/valuation/2017-valuation-updates/uuk-responds-to-usss-consultation-on-funding-proposals.
[3] https://twitter.com/JosephineCumbo/status/966205373349801985.
[4] Response to Question 3B, “University of Cambridge
Responses to Questions from the UUK Survey on the 2017 USS Valuation,” https://www.staff.admin.cam.ac.uk/general-news/uss-pension-valuation.


Why some actuaries are getting pension schemes wrong

We have been told that many of the commentators on the USS crisis are behaving like 'amateur actuaries' who don't really understand what they are talking about. We need to be put straight by real actuaries. But actuaries are not all the same. Some of the comments that have been made by actuaries fail to address the central issues in the valuation. They are unthinkingly following the conventional wisdom that is enshrined in some of the relevant regulations. But because those regulations are wrong headed, being based on flawed financial economic theories, they miss the point.

The pension regulations, as they now stand, and as they are applied, expose schemes to much more risk than is warranted by the underlying economics. Pension schemes have to deal with it at great expense. It is a large component of their so-called deficit. This is particularly true of the funding rules that require mark-to-market accounting.

The reason is that the valuation methodology deals with capital values: it requires a comparison of the value of the investment portfolio at market prices, with the liabilities, capitalised by using some hypothetical assumptions.

But the truth is that pensions are cash flows. A pension is a monthly cash payment for life. That is quite different from a capital sum. Likewise the means to pay a pension is a flow of income, which is not at all the same as the market value of the fund's investment portfolio. Stocks and flows are fundamentally different concepts, a point that is drummed into every first year economics student.

A valuation of a pension scheme should be a simple question of whether, in the future, the income will be enough to pay the pensions. But that is not the way it is done. Comparing capital assets with capitalised liabilities is a proxy valuation using very noisy variables. This approach introduces risk in a big way because asset prices are excessively volatile.

The evidence - ignored by modern finance theory - is that the prices of assets, such as equities, real estate or bonds, tend to be far more volatile than the underlying income they yield, in dividends, rent or interest. Evidence from academic studies suggests that the measure of volatility of asset prices is roughly in the region of four times what it should theoretically be. Therein lies the source of much of the risk: the use of the wrong indicators.

And this effect is huge because it leads actuaries to use risk measures (probabilities obtained from the gaussian or normal distribution) calculated using standard deviations maybe four times too large. The valuation methodology that is so close to the heart of many actuaries today is flawed and its application has harmed the provision of pensions to millions of people. The USS is the latest in a long line of schemes that have suffered.

This argument, of course, assumes that the scheme continues open indefinitely, supported by its sponsor. It is different for schemes that are expected to lose their sponsor. They will need to be self sufficient and the value of the assets will be important in that they will have to be sold in the market to pay the pensions.

It is worrying that regulation seems to focus so much on the latter case. It would surely be much better for society if it promoted the continuance of pensions schemes as open to new members in the future.

Why has this situation come about? It is due to changes in thinking in the profession prompted by government. It is also due to changes in thinking about nature of the economy, in particular the increasing belief in the benefits of marketisation. The actuarial profession was criticised for various failings in the past which led to various enquiries, most significantly that by Sir Derek Morris, which reported in 2005, one of whose criticisms was: "an insular and inward looking approach to syllabus development in the past, with too few links with other academic disciplines and developments in academic actuarial science, which led the Profession to become out of touch with the latest thinking in other disciplines e.g. stochastic modelling and financial economics".

Financial economics is an ideal field of applicaiton of actuarial skills in statistical methods since it is an axiomatic system in which every financial asset is characterised simply in terms of metrics of risk and return, enabling the use of powerful tools to make statements about risk. But it is only a theoretical model, and can be shown that its assumptions are an oversimplification of reality. But it is such a beautiful model, and which produces such clear results, that it is hard for practitioners not to forget its weak empirical foundations. It is also too easy to apply it outside its zone of applicability. It is, for example, highly questionable whether it can be applied to the kind of analysis of the USS that are being discussed, simply because the scheme is so very large, that any changes to it would have macroeconomic and market changing effects. The measures of risk and return of different portfolios surely cannot be relied upon to hold over the major changes envisaged by such as Test 1, derisking etc. that are being discussed.

Financial economics has changed the way investment is regarded by its followers. It teaches that there is no long-term premium and all investment is merely short-term speculation with more or less risk. This is empirically rejected by very many studies but it is nonetheless maintained as a belief by many of those in positions of influence over the management of pensions.

Not only actuaries but government also has adopted the financial economics way of thinking. The Pensions Act 2004 brought in strict mark-to-market valuation which has had the unintended consequence of increasing the risk of schemes and led to many closures. There needs to be a rethink.


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