September 15, 2017

USS valuation: don't believe all you read in the press. USS is in good shape

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The reports that have appeared in the press that the USS is in deficit of so many billions of pounds (Times Higher, Financial Times) are very one-sded and misleading - not least because the precise figure seems to change massively each time it is quoted. The latest valuation - actually dated 31 March 2017 - is in progress. The scheme's trustees are currently consulting the university employers about the approach they are following.

The document laying out the assumptions and the questions the universities are being asked has been made available to members if they request it. Members should ask their employer. It has also been published on its website by Sheffield University, and can be downloaded from here.

The calculations that have led to the conclusions reported in the press are based on a very particular view and approach the USS executive want to follow. This is the belief - handed down by generations of actuaries - that pension schemes should invest their funds primarily in government bonds (aka gilts), on the principle that such investments are totally safe, whereas equities are somewhat risky.

The problem with following this maxim in today's economic conditions is that - as a result of our government's policy of very low interest rates - is that it gives a very poor return, one that is currently below inflation.

In other words following their own orthodoxy is irrational: the principle of investing in low risk gilts is a guarantee of losing money in real terms!!! Yet despite their best efforts the UCU has been unable to get them to question their professional norms, and to consider other assumptions, even if it means the pension scheme having to close to defined benefits as a result.

The document's reference to poor investment returns largely reflects this assumption. Yet returns to investing in growth assets are not too low. For example equities continue to give a dividend yield sufficient to meet the anticipated pension obligations.

At the core of the valuation problem is the so called Test 1 which is somewhat technical but requires university employers to make up for the loss by extra payments. But their capacity to make such additional payments is limited. Hence the threat to the affordability of the scheme. But Test 1 is a very specific methodology whose evidential base is open to question. It assumes the only investments are loss making gilts. It would be good to know how the test would work on the assumption the scheme is invested in the actual assets it has. It is puzzling why this is not done.

The draft valuation assumes implicitly that the scheme must be seen as about to close to new members and always remain invested in low-yielding but secure gilts. But the scheme is open to new members, and serves a sector with strong employers - the pre-92 universities (in other words not the former polytechnics but the older, more famous and well established institutons from Oxbridge via the Red Brick Civics to the New Universities founded in the Sixties) - and therefore can invest for the long term. Because it has done this over many years, the USS has an investment portfolio that is mainly concentrated in growth assets such as equities and few gilts - so the assumptions of the executive are not relevant anyway. These investments do well and make a return sufficient to pay the pensions - as long as the scheme remains open.

The UCU's actuary First Actuarial has just published their response to the USS valuation. This assumes the scheme remains open, continuing indefinitely with the profitable investment portfolio it actually has (rather than loss making gilts). The bottom line is that there is no need to cut pensions benefits or raise contributions:

"We conclude from the cash flow analysis later in this report, that the current contribution rate from the 2014 valuation remains a prudent contribution rate, given the current benefit design of the USS. In a scenario of “best estimate” pay rises, the benefits of the USS can very nearly be paid from contributions, without reliance on the assets. There is no need to change either the contribution rate or the benefits to have a prudent funding plan. The strong likelihood is that the USS can be invested to outperform the return required to safely deliver the benefits. Given time, the outperformance will increase the funding level to any desired target. Any formulation of the sign off of the valuation which maintains the current contribution rate and the current benefits is acceptable."

All USS members interested in what is happening - or likely to happen - to their pension rights ought to read this document.


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