October 27, 2018

Pensions regulation based on mark–to–market valuation lacks transparency and overstates risk


Pensions regulation based on mark-to-market valuation lacks transparency and overstates risk*

(* This is a revised version of a presentation given at the CSFI Roundtable “Pension funding – more than an academic question” 27 September 2018, Wax Chandlers Hall, London.)

Although it is the largest in terms of assets and number of members, the University Superannuation Scheme (USS) is only the latest in a long line of private sector defined benefit pension schemes to be threatened with closure under the current system of regulation. USS members, of whom there are over 200,000 actively contributing[1], have seen through this and taken industrial action to challenge the valuation. They, being mainly academics, and, as such, disinclined to accept anything on trust, and to think things through from first principles for themselves, have questioned the methodology that would lead to this apparently well funded scheme being suddenly closed to DB accrual. The result of the industrial action has been the setting up of a high level enquiry under a panel of experts appointed jointly by the employers’ body, the UUK, and the members’ union, the UCU.

The Joint Expert Panel published its first report on 13 September 2018 commenting on the USS valuation dated at March 2017, which is the focus of the dispute and has not yet been completed. It is quite critical of some of the actions of the employers, the scheme management and also the regulator. The panel is due to continue its work into a second stage to look more fundamentally at the regulatory methodology, particularly as it applies to the university sector[2].

I am not going to discuss the USS dispute or the JEP report here in detail[3]. That would be a good subject for another CSFI round table which I hope can be organized soon.

I will argue instead more generally that our poorly designed regulation system[4] is a policy mistake on a grand scale. Specifically by prioritising the statutory funding objective, which is supposed to ensure every scheme has enough assets to cover its technical provisions, it fails to give a clear picture of the health of an open pension scheme, and is problematic in two ways. First it is not transparent, because it focuses on a poor indicator. Second, and worse, it greatly exaggerates risk, that has to be dealt with at great cost. I will argue against this monistic approach and for economic pluralism in the monitoring of pension schemes, looking at them in the round, using a range of criteria, not simply balance sheet valuations of assets and liabilities on a mark-to-market basis at a moment in time.

I will also argue that an effect of the regulatory system is to allow circular reasoning where the assumptions that are made in valuing liabilities are self-fulfilling. Pessimistic assumptions lead to negative outcomes. Schemes end up being forced to close as a result of over-prudent assumptions.

A third important line of criticism of the current regulatory regime, that is often ignored, is that, besides limiting pensions provision for millions of people, with consequent erosion of the social fabric due to poor support for the elderly, it is also doing substantial macroeconomic damage, hampering economic growth. I will show that this is the result of the adoption of false economic theories over empirical evidence.

Full paper here






[1] The scheme also has approximately 70,000 retired, and 150.000 deferred members.

[2] It is important to understand that the USS is the pension scheme covering only the so-called pre-92 universities and associated institutions, including Oxbridge, the Scottish ancient universities, the London colleges, the Civics and the 1960s generation of New Universities. In the main they all have a substantial commitment to research as well as teaching at both undergraduate and postgraduate levels, and many are among the leading universities worldwide. The new universities that have been created by the Thatcher government and subsequently are not USS institutions. Since historically most of them were formerly polytechnics or other kinds of colleges in the local government sector, their staff are members of the Teachers Pension Scheme, which is an unfunded government scheme. It has been remarked that if the proposed changes to USS go through, and it closes to DB accrual, pension benefits will be better at Oxford Brookes than Oxford, Anglia Ruskin than Cambridge, Teesside than Durham.

[3] The terms of reference and the first Report of the Joint Expert Panel can be downloaded from http://www.ussjep.org.uk

[4] Dating largely from the Pensions Act 2004 that created the Pensions Regulator and Pension Protection Fund, and regulations subsequently applied by the regulator.


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