All entries for Saturday 24 March 2018
March 24, 2018
I have serious concerns about the latest proposal agreed between the UCU and UUK to set up an expert panel and agree to whatever they come up with. The panel is to be made up of both actuaries and academics with an ‘independent’ chair.
The UCU general secretary Sally Hunt has written to members recommending it but I find her approach worrying. She is approaching the issue of the pension scheme valuation as if it is a wage negotiation where two sides present their positions and there is a compromise; it is simply a matter of more or less money. This way of looking at the issue is worrying since it concedes too much and ignores the main point.
The issue is about the methodology that is being applied. It is also about language. It is hard to see how there can be much compromise when two sides use the same words to mean different things.
The fact is that the scheme is – literally – not in deficit. It is in large cash surplus year after year. That is a matter of plain fact. There can be no argument about it. It is not putting an optimistic gloss on assumptions or theories about the future. It is to merely to use the words to describe the state of the scheme in their ordinary meaning. Deficit: “The total amount by which money spent is more than money received”.
By contrast the employers use the word ‘deficit’ as a technical term which belongs to a particular theoretical approach. It measures the difference between capitalised values of assets and projected benefits calculated on very strong assumptions.
We should insist that the starting point of the discussions is that the scheme is in surplus and we should not appoint any experts who do not also start from that position.
The difference between the two sides is one that is familiar in Keynesian economics, between uncertainty and risk, a distinction due originally to Frank Knight. In any decision situation the future is, naturally, unkown. If that lack of knowledge is fundamental to the socio-economic conditions that will prevail and events that will happen that cannot be forecast, then it is a case of radical or Knightian uncertainty. Examples would be the possibility of a war, a recession or market crash.
The other situation, referred to as risk, is where the future can be defined in terms of a phenomenon that is subject to the laws of chance. That would be where probabilities can be defined and calculated on the basis of regular patterns of behaviour that can be observed. Examples might be natural phenomena such as weather events, or the tides. An important application in pensions and insurance is to mortality rates, the unique domain of actuaries. Risk requires well defined probabilities to define the relevant laws of chance. While the future outcome is unkown, it is possible to make precise probability statements about the likelihood of it being in certain ranges.
The difference between the two sides in the debate about the future valuation of the USS is between those who believe it is a matter of uncertainty and those who think it is all a matter of risk and that the probabilities can be found from market data. My view is that the stochastic behaviour of market assets like equities, bonds and real estate cannot be characterised by stable probability distributions. The belief of the risk analysts is that the return on every asset has given expected value and risk. Moreover, the return on every pair of assets has a well defined covariance that can be relied upon to remain constant throughout every eventuality. These extremely strong assumptions are at the heart of the methodology that we are challenging. Yet many highly respected financial experts and actuaries accept and use them with insufficient scepticism. They have often proved wanting because human affairs drive markets not natural phenomena. They should be regarded as situations of uncertainty not risk.
Coming back to the main issue, of how the panel of experts is to conduct itself, the question that has to be determined is what happens in the future. Will that surplus continue indefinitely or will it eventually turn into a deficit. When will that happen? If it goes into deficit, how large will that be and can it be covered by the sale of the investments or not?
To answer these questions will require the help and cooperation of the USS staff who have the necessary data. The UCU’s actuary, First Actuarial, tried to do this analysis for us some months ago, but they were unable to do more than provide indicative figures due to the lack of help from them. They were nevertheless encouraging and suggested the scheme would not run into a funding crisis. The union should insist on this approach rather than leaving it a panel of experts with ill-defined terms of reference.
Whoever the union appoints as expert members of this panel must understand this and not simply go along with the conventional industry approach based on the use of pretty feable probability measures. It will be difficult for the panel to operate because it will be confrontational: ‘our’ experts will have to win over ‘their’ experts. It is not simply a matter of looking at the data to see the truth. Nor is it a matter of finding a negotiating space within which to reach a bargain.
I don’t frankly understand why it is necessary to have a panel of experts at all. The UCU should insist on the USS providing the figures that will permit a rounded picture of the likely evolution of the fund into the future. And there should be no detrimental changes to the contributions and benefits unless the necessity is clear from this picture.