Very misleading THE article comparing DB with DC pensions
An article about the USS pensions dispute in the Times Higher Education by David Voas (Let's defend pensions not defined benefits) gives a somewhat inaccurate account of the issue. It also makes a comparison between Defined Benefit and Defined Contribution pensions that is very misleading.
At the centre of the issue between the union and the employers is what kind of scheme it is. The employers want to end the guaranteed pension that is based on years of service and earnings, and replace it with a defined contribution arrangement where instead of a pension on retirement one gets a pot of money that depends only on what has been paid in and investment returns.
The article argues compares a young person aged 30 near the start of their career with someone nearing retirement, and concludes that the youngster would do a lot better under Defined Contribution. This is very misleading. For most people (almost all in fact) they would get a lot better penson in retirement from a Defined Benefit scheme.
The article actually makes a number of statements that are wide of the mark. And it is not sufficiently analytical.
For example it says, "defined benefit schemes are defunct unless underwritten by the taxpayer." That is not really true. There are schemes in the private sector that are not defunct. And there is no reason why the USS should be defunct without taxpayer support. The problem is with the way the regulations are being applied and the weakness of the employers. While it is true that most of the DB pensions schemes are in the public sector, such as the Teachers Pension Scheme that is normal in the post-92 universities, what Voas is getting at, I think, is a repetition of City group think that applies simplistic generalities.
His description of the problem, though, goes from vagueness to missing the whole point. He writes,"The problem is twofold. Employers struggle to afford the cost of guaranteeing that the benefits promised in 50 years' time will be paid ... Employees are also hit, though, because everyone ends up paying above the odds." (emphasis added) What does this mean? It sounds very bad. It is not factually true. There is no conclusive evidence that employers struggle to pay the pensions in 50 years. All that is required is that the scheme stays open until then and invests in high return assets such as company shares (equities).
The next paragraph is an explaination but is in fact a gross oversimplification to the point of being misleading, revealing that Voas has not understood the arguments: "The basic equation is simple enough: contributions plus investment income equals benefits. Contributions - and even benefits - are fairly predictable, albeit affected by changes in life expectancy. The challenge is to estimate real returns on investment over several decades."
That is not where the problem lies. There would actually be no problem if it were as Voas says. The USS investment portfolio has a high return, an average of 12 percent per year over the past five years, for example, and is expected to continue to do well into the future, since it is skewed towards equities.
The problem is that the liabilities (present value of future benefits) are being valued counterfactually. That is, NOT using the real returns on investments as described. If things were as Voas says, there would not likely be a problem. The problem is that the scheme is being told to assume very poor returns - index linked gilts have a negative return. So the problem is a result of the excessive prudence being forced on the scheme by the regulations and the weakness of the support from the employers.
In order to compare DB with DC, he contrasts two academics with the same salary, a woman aged 30 with an older man nearing retirement. They both receive a defined benefit of 1/75 of salary for a year's work. He claims that for the older man it is a windfall: "he receives substantilly more than his current contribution would support. For the 30 year old it is very poor value. She could conservatively expect her contributions to grow by 2 per cent per annum, thereby doubling her money by age 65. This fund would be worth more than the defined benefits." This is very difficult to make sense of. Why compare these two individuals in this way, by just taking a snapshot of one year. What pension would the young woman get when she retires? How would that compare with the man? Surely what is needed is to compare the pensions obtainable from DB and DC over a whole career, not just one year taken at different stages in life. It is also very superficial. We are not told if the returns are after inflation. All defined benefits are uprated for inflation by the CPI.
And so it goes on. It reads as if the article were simply intended to make the case for DC over DB. But that goes against all the evidence from academic studies and practical knowledge from actuaries. It also goes against the studies that have been done for the UCU by its actuarial advisers, which show that for the great majority of members, it is very considerably more expensive to provide a pension of a given annual amount by DC. Estimates have put this at between 40 percent and 100 percent more.
This piece is extremely poor scholarship.