May 31, 2015

USS assumptions out of line with other pension schemes

We know that the viability and sustainability of the universities pension scheme, the USS, depends crucially on what is believed about the unknowable future in terms of what are known as the 'technical provisions'. Members have been told by the trustee and the employers that - while the scheme may be very profitable at the moment (and increasing its portfolio of investments rapidly) - at some point in the future that is going to change and it will start to run out of money. Just when that happens - and indeed whether it is factually true that it happens at all - depends on precisely what is assumed about the key parameters like future life expectancy, inflation, salary growth, and so on.

We have been assured that the assumptions the trustee is making are conventional within the pensions industry - the USS is merely following good practice that applies to all defined benefit schemes. Members have been told not to worry too much about them because they are 'economic orthodoxy' and some have been convinced by this argument. Well, I believe we should never take anything on trust and should question everything - especially if it is something whose meaning and context are not immediately obvious to us.

It is therefore interesting to compare the USS trustee's assumptions, laid out in its consultation document and annual report, with the findings of a recent survey of pension schemes by KPMG, which reported on 270 companies with defined benefit pension schemes. This shows that some of the key USS-trustee assumptions in fact appear to be out of line with the industry norms. This seems to be the case particularly for life expectancy and mortality, salary growth and inflation.

On life expectancy, the USS trustee assumes that members who retire today at age 65 will live a further 23.7 years for males (25.6 for females). This seems very high in comparison: the survey median for males is 22.5 years (no figure for females). For those currently aged 45 the assumption is that they will live for a futher 25.5 years after retiring at 65 (males; 27.6 years for females) which compares with a survey median of 24.2.

The USS trustee not only assumes USS members to have high life expectancy but in addition that it will continue to improve at a much higher rate than for other workers, which seems surprising. The USS-trustee assumption is that life expectancy will improve at a rate of 1.5% per annum whereas the KPMG survey median is 1.25%. The survey found that 72%* of companies assumed a rate of improvement less than 1.5%. Perhaps we would expect other groups of workers to catch up with relatively long-lived university staff long term. This assumption of a very high rate of improvement in an already very large life expectancy has a significant effect on the viability of the scheme.

On salary growth, the USS trustee's assumption is again out of line with the industry norm. The KPMG survey median assumption is for salaries to grow at RPI (Retail Price Index) plus 0.5% per year. Only 12% of companies assume a rate above RPI+1%, which is what the USS trustee assumes. There is no explanation as to why this very high rate of salary growth is being assumed. Its effect is very large and it appears a very arbitrary assumption which makes the pension scheme seem very expensive.

On inflation, the USS figure is again out of line with the rest of the pensions industry. The USS trustee assumes RPI inflation will continue at 3.6% per annum while the KPMG median is 3.4% (and only 24% of schemes are assuming more than 3.5%). This seems surprising that there should be so much disagreement about inflation.

On all three it seems the USS trustee is making assumptions about the future trends in these figures that have the effect of making it more likely that the scheme will be seen as unsustainable because they have a very large effect on the calculation of the deficit.

Members might be justified in asking why it is necessary to be so much more conservative than the rest of the pensions industry, when it is known that many schemes are already very prudent.


*Thanks to Susan Cooper for pointing out the error in this figure in the earlier version posted.

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