November 27, 2014

Warwick University:USS deficit due to "over–pessimistic assumptions and inappropriate methodology

Warwick University yesterday published its comments on the UUK consultatoin on the USS 'technical assumptions'. The report, written by a subcommittee of lay members who are not USS members, has been approved by the university's governing Council, and will go forward as part of the University's response.

It is highly technical but constitutes a powerful critique of many of the assumptions made by the trustees and effectively a rejection of their case for scheme changes. Certainly it undermines the idea that radical changes are needed to meet a yawning deficit. It also supports the alternative approach to valuation proposed by the UCU (see the appendix to the letter by Sally Hunt to the trustees on 8 September).

In carefully measured language and closely reasoned argument it delivers a damning verdict:

...the need to achieve a decisive outcome for future funding arrangements needs to be balanced against making irreversible changes to benefits which may go further than is necessary if the deficit, as we argue in this report, is based on over-pessimistic assumptions and inappropriate methodology."

It shows that using less pessmistic, more realistic assumptions and more appropriate methodology there might not even be a deficit at all.

We show that by adopting in some cases marginaly different assumptions from those used by the USS trustee but still within the bounds of acceptable prudence, the combined effect of the changes in assumptions is that the estimated deficit of £12.3bn is reduced to £1.36bn. We note that if the future service salary scale is applied for past service benefits, the estimated deficit could be turned into a surplus of £440 million."

Some other quotes from the report:

We believe that the initial discount rate is overly pessimistic."

Whilst we are not opposed to the principle of de-risking when market conditions are conducive, we feel that the proposed approach is over prudent and will only serve to “lock in” the current deficit."

We argue that the result of a questionable deficit of £12.3 billion drives some of the proposed changes in benefits that we thihk should be reconsidered. The size of the estimated deficit is also likely to result in the premature de-risking of the investment strategy. This in effect means that the estimated deficit will tend to become a reality, in other words a self-fulfilling prophecy."

We believe that a general inflation assumption for salaries of RPI plus 1% is overly

... there is now a considerable body of opinion that the improvements in longevity seen the last three decades will not continue. In any event, we believe that 1.5% is too pessimistic and that the Office for National Statistics’ projection of 1.25% is an appropriately prudent number to use."

Given current rates of inflation and the increasing concern about the possibility of deflation in a number of major western economies, we believe [the assumed rate of future RPI inflation] is too high even for long term purposes."

That the breaking of the final salary link for accrued benefits should not be pursued."

That the £50,000 threshold for the CRB section be removed if the financial impact of
doing so is acceptable to employers. Should this prove unacceptable then the CRB
threshold be increased to spine point 51."

That if the scheme’s funds’ investment performance results in a surplus that might
reasonably be expected to be maintained in the future, consideration should be given at
that point to appropriate improvements in benefits and/or reductions in contributions.

Even if not all of our proposals for changing the assumptions are accepted, the results above clearly demonstrate how highly sensitive the valuatoin methodology is to relatively small changes to the assumptions. The 2014 valuation is a transient exercise in circumstances where the assumptions as originally proposed, given the consistnetly conservative position taken, could change significantly by the time we get to the next triennial valuation in 2017. The impact on members' pensions is likely to be irreversible."

Our overall view is that collectively the assumptions are over-prudent and consequently we believe the scale of the resulting deficit to be materially pessimistic.

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