All entries for Thursday 28 January 2021

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.


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