The USS agreement is not a basis for a lasting settlement

USS members have been recommended to accept the deal agreed between UUK and UCU negotiators as the best that can be done in difficult circumstances with a widening deficit in the pension scheme. Some people have suggested this is only facing up to the reality that life expectancies are rising and in an economic crisis our investments are not doing very well.

The trouble is that is not a true characterisation of the situation and what is proposed is not a solution that is going to stick. It is not sustainable. In three years' time when the next valuation is due, we could well find ourselves in the same situation again, being told that the career average scheme is unaffordable and must be ended.

Remember that three years ago the changes that were imposed, notably the closure of the final salary scheme to new members, were supposed to deal with the deficit and pay for a recovery programme. We were told the problems had been sorted out. Yet now we are told that the deficit is bigger than ever.

Why did the recovery plan go wrong? There has been no real explanation of that from the USS or the UUK. They have only cited increased longevity - though their life expectancy figures are actually hardly different from those that were used in 2011 - and poor investment returns due to continued low interest rates on government bonds

But on closer inspection a lot more has gone into massaging their deficit figures than that. In the USS circular "2014 Formal Valuation: information for members", published in December in the name of the trustee board, they initially estimate the deficit at £7.6 billion in March 2014, assuming the same scheme rules as in 2011. This figure has been widely criticised for being based on assumptions that are exessively prudent and pessimistic for the scheme, and not based on evidence: such as faster increases in life expectancy than data suggests, high price inflation, and higher salary increases than recently experienced. Astonishingly the USS trustees have been willing to assume two opposite things at the same time: continued recession (manifested in low interest rates and uncertainty about the employer covenant) and economic growth (reflected in high wage and price inflation).

Then on top of that is added a further £4.4 billion in order to arrive at the figure the trustees are quoting. This is to pay for a change in the investment strategy. The plan is to forego long term return from investing in the stock market (with its associated short term risk) by switching the USS portfolio out of equities into government bonds. This, so called de-risking strategy, is turning the economics of pensions on its head, by focussing exclusively on the short term. Normally pension schemes aim to get the best return they can by investing in productive assets like company shares and holding them long-term to receive the dividends (while maintaining a suitably diversified portfolio). That has been the policy of the USS hitherto.

But now the entire focus of the USS trustees is on avoiding the risk that universities might suddenly be unable to keep up their payments at a time when the stock market is down. Hence de-risking and £4.4 billion of foregone investment income. This calculation is strongly based on assumptions the trustees are making about the employer covenant. They have decided that the scheme can rely on strong employer support for 17 years. But after that - who knows what will happen to British universities? So the prudent thing seems to be to assume they will not be able to support a decent pension scheme.

So the figure behind the agreement is a deficit of around £12.3 billion - sometimes rounded up to £13 billion. This figure is not an external fact that has to be faced up to so much as a figure chosen by the trustees through their technical assumptions and investment strategy.

But it gets worse. In their draft paper for the agreement the EPF casually threw in - almost in passing - that the latest estimate of the deficit had risen to £20 billion by January 2015 "due to market conditions". They did not state what these market conditions were that could have such a massive effect - swamping all other other influences - at a time when the stock market is strong and the economy growing.

Such volatility whereby the deficit has increased by two thirds in only ten months is not credible, especially since the whole idea of prudence and de-risking is to minimise risk and avoid volatility.

It seems clear that if the £20 billion figure is going to be believed by the trustees the USS will not last much longer as a defined benefit pension scheme and they will soon be seeking to close it to new members and/or future accrual.

Dennis Leech : 12 Mar 2015 20:04 |  Tags: Uss |  Comments (0) |  Report a problem