All entries for Saturday 25 April 2015

April 25, 2015

Misleading picture of USS pension changes in UUK 'heat map'

Universities UK (representing employers) have just (on 20 April) published comparisons of the pensions members can expect under the USS employers' proposals and under existing rules. This so-called 'heat map' is meant to show the impact of the proposed changes to benefits for members of both the final salary and CRB sections of the USS scheme, modelled according to income and to the number of years before normal retirement age. It has been circulated to members (via employers) as new information in the middle of the consultation period.

Surprisingly, it suggests that almost all members, of both the final salary and the career revalued benefits sections, will get better pensions if they agree to the changes! Only those on very high salaries and close to retirement will lose out. This is a totally unexpected story in view of the dire warnings we have been given up to now about the need to address a large and growing deficit.

The figures are actually very misleading and disingenuous because they use over-optimistic assumptions and selective evidence.

Final Salary Section

The comparisons for members of the final salary section are extremely disingenuous. They are for future accrual only. But the main thing that members are worried about is the treatment of past accrual - that is, what their years of service up until the change over will be worth. But that has been completely ignored. Under the proposals past service will give a pension based only on salary in 2016 - rather than at retirement as expected. If salaries are expected to rise by RPI to retirement while inflation adjustment of the 2016 pension is by CPI - which is what the document assumes - this is going to be quite a big difference for most people in the middle of their career.

What members need is a comparison of the whole pension they can expect to receive that takes account of the number of years they have already contributed.

Also the calculation of the defined contribution pension (for salaries above £55,000) is wildly optimistic - see below.

And of course contributions rise from 7.5% to 8%, an increase in costs not mentioned in the comparisons.

CRB Section

The comparison for the CRB section is not surprising given the increase in the accrual rate from 1/80 per year to 1/75 below the salary cap at £55000. That guarantees higher pensions for all but the highest paid. But this ignores the big increase in contributions for this group from 6.5 to 8 percent of salary. It would give a more honest picture to model both changes together.

Also the calculation of the defined contribution pension (for salaries above £55,000) is wildly optimistic - see below.

The new defined contribution section for salaries over £55k

Tha assumptions underpinning the calculations in respect of the new defined contribution pensions (DC) element seem to be very dodgy. The growth rates assumed seem to be wildly optimistic. Apparenltly (according to the 'heat map' document) they have been agreed by both sides - UUK representing employers and the UCU representing members.

There are two issues: assumed growth rates of the DC fund and annuity rates for converting the DC 'pot' into pension - both are higher than seems reasonable or sensible.

For their predictions UUK assume a range of three growth rates: 4.5%, 5.5%, 6.5%. These are very healthy rates of growth and much better than the rates usually used currently in the pension industry for such comparisons: -0.5%, 2.5% and 5%.

Why have these rates been used? It looks like pension misselling on a grand scale. And why have the UCU negotiators apparently (according to UUK) agreed to them? This is surely not in members' interests.

Then there are annuity rates used to convert the pension 'pots' - on the DC element for salaries over £55k - into pensions.

The 'heat map' document assumes the following rates of conversion of DC pot to annuity:

"Joint life annuity rate (long term market conditions) 23.0 (CPI increases, 5 year guarantee)"
"Single life annuity rate (long term market conditions) 21.5 (CPI increases, 5 year guarantee)"

These rates of conversion of DC pot to annuity are more generous than what the USS modeller assumes. They also seem to be better than what one can purchase on the open market.

DC pensions are risky

What this document fails to mention is that the main objection to DC pensions is they transfer all the risk from employers to members. A DC pensions does not deliver a predictable pension on retirement but an uncertain 'pot' of money depending on investment returns in the stock market and so on, which a member is then meant to live on for the rest of their life. A DC pension is not really a pension in the dictionary sense of the word - which is an income for life - but is really a kind of subsidised saving plan to which both the employer and employee contribute.If there is some kind of financial crisis theen members can lose a substantial part of their pension. (For example, what would happen to a DC pension pot if Greece leaves the Euro?)

For most members the DC component is quite small at the moment because it accrues only on salary above £55k. But the expectation is that it will grow in the future especially if - as many expect - we are told there are further funding problems with the defined benefits CRB at the next revaluation in three years' time.

The spectre of future funding shortfalls

The main threat to the DB pension scheme is from funding. If that is deemed to be inadequate at the next valuation then the rules are likely to change yet again and the DC section will expand or replace DB altogether. Many of us (including some of the UCU negotiators) believe the methodolgy used to value pension schemes and work out funding adequacy levels is deeply flawed and does not provide a good guide when gilt interest rates are as low as they are now. This is bad economic thinking by some pension trustees and actuaries and is leading to socially harmful results.

Sense about the deficit by Simon Wren–Lewis

In his latest blog, Mediamacro myth 4: The immediate necessity of belt tightening ,Simon Wren-Lewis demonstrates the folly of governments trying to cut the deficit in a recession when interest rates are as low as they currently are.

We must always remember that a country is an economy not a company or a single household. Attempting to cut the government deficit in a recession only succeeds in making things worse.

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