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March 22, 2023

USS and Capital Exhaustion

Con Keating

Shortly after it was published in early March by USS, I was asked to review their note “USS briefing: Capital funding and exhaustion risk – distribution of outcomes”. The stated reason for it was: “This briefing note provides details of analysis, requested by members of the Joint Negotiating Committee (JNC), of the risk of the scheme running out of funds before all benefits due to members have been paid.”

The study had however already been in existence for rather a long time as can be understood from this paragraph in the summary of the Valuation Technical Forum (VTF) of November 17th, which states:

Capital exhaustion

A broad overview was given on this analysis for the forum and what it was looking to consider (i.e., a metric that is looking to test what failure may actually mean as measured by the risk of running out of money to pay benefits). Within the discussion it was agreed that the analysis to date which had been prepared for and discussed with stakeholders be made available on the USS website. It was agreed this would be taken forward.”

It is interesting that there have been three and perhaps four meetings of the VTF since then but no summaries of those have been published. I am not sure if we are missing anything by that non-publication given the summary’s ability to tell us little or nothing of substance, as is illustrated below:

FMP report to 30 September 2022 (including a discussion on 30 Sept pricing modelling) It was noted that the direction of travel shown in the monitoring continued to be a positive indicator for the 2023 valuation. There was a discussion on self-sufficiency and what other measures could potentially be used to demonstrate the solvency position over time of the scheme. There was brief discussion on inflation which identified the need to understand just how impactful it would be on the valuation outcomes before engaging in a detailed discussion.”

It happens that I have difficulty believing the reported September and December asset portfolio valuations, but this leaves me none the wiser.

Though some of the VTF summary is written in a code unavailable to the uninitiated, such as: “UCU and UUK expressed their desire to have as solid a basis as possible to consider in February, in advance of the 31 March date, and there was a discussion about the art of the possible from the Trustee’s perspective including the sensitivities and book ends that could be provided to the Forum.”, it is clear that the executive’s objective is developing this model was to produce “a metric that is looking to test what failure may actually mean as measured by the risk of running out of money to pay benefits”.

Unfortunately, this modelling approach, which is based on the model developed in their NIESR papers by Miles and Sefton[i], is not fit for that purpose. The software used to produce the published results is produced by Ortec Finance. It is also a total return-based system.

The briefing note is unscientific in that it is not possible to reproduce its results from the information provided in it. This occurs so often in USS publications that one is tempted to wonder if it is deliberate policy. It is though possible to identify, by comparison, some minor anomalies and inconsistencies in the reproduced charts arising from it. One of the more egregious absences is that there is no statement of the statistical properties of the elements of the model, for example the volatilities of the asset classes comprising the portfolio. In a stochastic model, these are crucial.

This is alarming given that “The Trustee is currently considering how, alongside other risk metrics and the wider integrated risk management framework, these outputs might inform future decisions in relation to the valuation investment strategy.”

The central problem is that it deducts the projected pension payments from the stochastically generated asset portfolio as that develops over time, using the returns and volatilities of those asset categories. This can generate some rather strange results as can be illustrated in a very simple model I developed in Excel to illustrate this point. This is available on request.

Mathematically we expect the geometric return of a series of normally distributed returns to be equal to the arithmetic return of that series minus half the variance of those returns. This means that we expect the geometric return, the long run average return, to be similar, at 5.0%, for two series, one distributed N(7%,20%) and one N(5.5%, 10%) but this is not the case. In simulations, we can see the consequence of this, for the N(7,20) case we see ca 650 iterations survive and pay all pensions, the earliest failures occur around year 6 and the average survival time is around 60 years. By contrast, the N(5.5, 10) returns over 800 complete survivals, with the earliest failures occurring around year 16, and the average survival time is extended to around 71 years.

It is clear that in such models, volatility is heavily penalised. This is simply recognition that sale of some fixed amount of an asset is more onerous when that asset is depressed in price than when it is inflated, and the magnitude of those effects is directly related to the range or volatility of the asset value.

This approach to modelling will also deliver exaggerated levels of over-funding, as seen clearly in the USS briefing note charts.

In any event, such an asset only based model, where all pensions are paid by sale of assets is completely unrealistic. Pensions are paid in cash and income in critical in this context. If the dividend and investment income stream is sufficient to pay pensions, exhaustion of capital resources can only come about from the price randomness of the asset portfolio. As this is the most important point in this blog, I shall reiterate it. Crudely put, if the dividend and investment income stream is sufficient to pay pensions, then capital resources are not being touched and won't be exhausted, barring very large numbers of insolvencies, defaults and exceptional situations.

The "if" is important! It is easy to achieve in an open scheme if contributions are added to the income, harder to achieve in a closed scheme.

It should be noted that the variability of income is a fraction of that of market price – a long used heuristic is that equity prices are five times as variable as their dividends. The variability of income from bonds is lower still, indeed bond income may almost be considered deterministic, that is fixed by the terms of the security and the price paid. In addition to this, there is the cash flow from the maturing proceeds of bonds to be considered as this cash flow will also reduce the scheme’s dependence on sales of other assets to pay pensions.

The likelihood of scheme failure is far lower than suggested by these asset-based models. Indeed, they simply bear no resemblance to the observed history of DB schemes, nothing like 17.9% of schemes have exhausted all of their capital resources in the entire UK history of pension schemes. Indeed, I struggled to find any since 1921, let alone the past 60 years.

It is also interesting to note that the lower rates of exhaustion associated with the deficit repair contributions of the model are an implicit recognition of the importance of cash inflows. A 6.1% failure rate falls to 0.0% at 30 years with 10% deficit repair contributions.

Those contributions are described as 10% of the membership payrolls but I do not know how large that is, and the briefing note does not tell us[ii]. My guess would be around £9 billion, given the published higher education statistics. That contribution would represent some 35% - 40% of the pensions payable, around 1.25% in income yield terms.

It is the income aspect of the contributions for new awards which adds to the attractions and efficiency of open rather than closed schemes. Indeed, if the scheme is cash flow positive, that is investment income and new awards are greater than current pensions payable, the scheme will prefer lower prices and their higher potential returns to the high prices preferred by a closed scheme in run-off.

I will end this blog by touching on the question of leverage in schemes. As has been noted elsewhere, this can place significant demands on the liquidity of schemes, that is their cash available to pay pensions and that could have catastrophic effects, a slow-motion car crash.

It is absolutely clear that this USS model is not in any way fit for the purpose stated.

[ii]Since writing this, I have been directed to the 2020 valuation which reports active membership payroll as £8,962 million.

March 18, 2023

A critical note on USS valuation methodology

I was appointed as a UCU observer to the Valuation Technical Forum, a high level discussion group considering technical aspects of the 2023 valuation. Its membership includes representatives from UUK, UCU, USS trustees, USS executive, and their actuarial advisers.

I wrote up some comments and submitted them to the other members of the Forum. Here is the l ink.


March 10, 2023

David Miles' Response

Follow-up to Miles and Sefton on USS capital exhaustion from Dennis Leech's blog

Dear Dennis

Thanks for your comments on the various notes James Sefton and I wrote in 2021.

You make two main points: First, in our simulations we look at how the USS finances might evolve in the absence of new contributions and with liabilities (accrued pension rights) taken at some point. Second, we assume that pensions are paid out of the existing assets with a constant portfolio allocation. The evolution of that stock of assets depends on the return (investment income generated plus the capital gain or loss on the assets) net of pensions paid.

In practice the USS is still open – though in some sense its openness is declining because more new pension accruals and inflows will be significantly into a DC fund and perhaps because the rate at which younger academics join the DB scheme looks likely to be less than that of earlier cohorts.

What seems likely is that whether the scheme gets new DB members depends on the deal they are offered and that deal will be more or less attractive depending on whether there are enough assets to pay existing pension liabilities that exist as time passes. This means that to assume the scheme continues to have a steady flow of new DB members joining and that existing members can have pensions paid out of new contributions (as well as from investment income) certainly understates the extent of inter-generational risk sharing. The more existing pensions are paid out of new contributions which are in excess of what is needed to match the present value of new liabilities the worse a deal is offered to active members and the less likely that they remain active.

Our calculations ask a question about whether existing liabilities are such that they can be paid in full out of existing assets. It calculates the probability that they can and – in cases where those assets are more or less than is needed to pay existing pension promises - what is the size of the ultimate deficit or surplus. The calculated probability of running out of money before existing pension liabilities are paid is the probability that future employees or employers will have to make good the hole. If this comes from future active members it will means the present value of extra pensions they get from their contributions are lower than the money they put in. That seems likely to make new members look elsewhere. That generates a risk . Our calculations calibrate the scale of that risk.

You are right that if equities display significant mean reversion – which I think you implicitly assume – then an assumption of independent returns will exaggerate risk. This is why we did simulations with a degree of mean reversion that some studies suggest might exist.

All best


David Miles, CBE

Professor of Financial Economics

Imperial College

South Kensington Campus, London SW7 2AZ

T: +44 (0)207 594 1292

Web page:

Miles and Sefton on USS capital exhaustion

Writing about web page

Commentson the paper “How much risk is the USS taking?” by David Miles and James Sefton

The paper addresses the question posed in the title using stochastic simulations to model the likelihood of the scheme’s capital assets becoming exhausted. In this note I argue that the method they adopt, in particular their specific chosen stochastic model, is not a reliable basis for making such a judgment because it exaggerates risk.

It is crucial to understanding whether a pension scheme has “enough money”, to be clear about what that would mean in practice, what assumptions are being made about the progress of the scheme over time, and what kind of money is needed anyway. Thus any stochastic modelling that tries to answer that question should distinguish between, on the one hand, the market valueof the investment assets and, on the other, the investment incomethose investments bring in. These are not equivalent and which is more relevant depends on the framing of the question.

If the scheme is being considered for possible closure, the former view is important, since one must have regard to runoff, where assets are sold to pay pensions as the beneficiaries dwindle. But if it is being seen as possibly able to continue open indefinitely, with the support of a strong employer covenant and a steady influx of new members, then the latter perspective is required since asset sale is not the primary concern. It is important that trustees carry out analyses from both points of view, which are not equivalent.

Miles and Sefton fail to make this distinction. Instead their approach is simply to model the time path of total returns, running together investment income and capital gains/losses - whether realised or not. This means that, from the point of view of answering the question whether the scheme can remain open sustainably, their simulations overstate risk and their conclusions are overly pessimistic. Their stochastic model allows in, and bakes in, too much variation coming from excessively volatile asset markets, whether stock, bond, real estate markets.

Risk will also be overstated as a result of using percentage yields(%)instead of cash income(£)as the random element. Yield expressed as a percentage is inherently excessively volatile because market prices appear in the denominator. On the other hand, absolute investment income in money terms is driven by real economic factors and much less susceptible to this volatility.4

The paper’s basic idea is that the investment portfolio can be seen as comprising two classes of assets: ‘risky’ equities, which produce a high return on average but one that is also highly variable, and ‘safe’ bonds, with a low but fairly constant return. The question is essentially whether the equity returns, on average, are sufficiently high to outweigh the combined effects of the low bond yield and that the likelihood of the equity returns underperforming by too much.

It uses a simple model applied to actual USS data starting from the assets at the 2020 valuation, £66.5 billion. and the projected cash flow of pension payments each year up to 2102 by when all accrued benefits will have been paid.

Their conclusion is that, while on average the scheme is well enough funded that it will be able to pay all the pensions promises, there is still a significant probability that the money will run out and the scheme will be unable to pay the promised pension benefits without needing to ask the employers for further contributions. This probability is of the order of over 30 percent for a portfolio with a majority of growth assets. These findings are worrying.

The paper addresses a straightforward empirical question that turns mainly on the relative risk and return parameters of the two asset classes. However there are a number of major issues with this study that may well point to different conclusions emerging if addressed. Most importantly there is an important, basic, methodological issue unaddressed: the relation between asset prices and pensions funding for the USS, with its unique characteristics as a very large, open, immature, multi-employer scheme.

Detailed Comments

1. The methodology employed is questionable because it focuses solely on asset valuesrather than specifically on pension funding, which is likely to lead to an overstatement of risk and therefore biased findings. It examines the likelihood (as a probability estimated in a Monte-Carlo simulation) that the assets will become exhausted - not the likelihood that not all the projected pensions will be paid, without further funding. These two questions are not the same and the difference is crucially important to the stochastic modelling: the former methodology focuses on the market value of the investment portfolio where the randomness mainly comes from the stock market through prices. For the latter methodology, asset values are not of primary concern, since the scheme will only need to sell capital to pay pensions whenever there is a shortfall in income. The study should therefore model the probability of such a shortfall separately.

By ignoring this distinction Miles and Sefton are implicitly making an unreal assumption that is actually key to their results. They end up using an inappropriate risk metric for determining funding - in all circumstances whether the scheme needs to sell assets to pay pensions or not - related to the excess volatility of stock market prices. It would surely be more relevant to use a measure of variation in investment income, that is cash receipts, which is known to be much less volatile, since it is mostly independent of the animal spirits, irrational exuberance, booms and busts, etc to which the stock market is prone. When talking about risk it is necessary to study the second moments of the probability distributions but also to be clear about the metric: are we looking at randomness of capital values or investment receipts?

continue reading

December 11, 2020

USS Governance: Changes to the Articles of Associaiton of the trustee company

There is a lot of discussion just now on how the Universities Superannuation Scheme is governed. Here is a paper I wrote last year commenting on the changes then being made to the rules for appointing directors. It may be of interest but some of it could be outdated by now in light of other changes.


August 26, 2019

The USS dispute is not about cost sharing but the survival of defined benefit pensions: a rejoinder

What is at stake in the USS dispute is the survival of defined benefit pensions.

The UCU negotiators have repeatedly shown that there is no need for contribution increases or benefit cuts, that the scheme as it currently exists can continue in existence indefinitely provided it is managed in a way that seeks to make that happen. The reason is that it is a multi-employer scheme designed for a unique sector, the pre-92 universities. The pre-92 universities not only provide world class scholarship, research and education but, as a sector, can be seen as one of the UK’s most successful industries. That should be at the front and centre of all discussions about the USS: its unique nature means it has very little in common with other private sector schemes and should not therefore be compared with them.

Unfortunately the USS Employers in their latest response to the UCU have demonstrated that they are not engaging with that view and give no indication of their intention to do so. Their letter is full of innuendo and half-truth and does not deal with the arguments. It underestimates the intelligence of university staff and many will feel insulted and devalued by it.

The choice for the USS is between two possible alternative courses:

(1) that it continues to be an open ‘defined benefit’ scheme that provides guaranteed pensions based on salary and years of service, on an ongoing basis with an indefinite time horizon, open to new members, supported by a strong employer covenant that is continuously monitored; or

(2) that, in common with most private sector company schemes, it may decide that the various risks of staying open are too great, and do what they have done, close to further accrual, with consequent increases in contribution rates, as was proposed last year. New members will be offered an inferior ‘defined contribution’ plan that does not lead directly to a solid pension but uncertain benefits. Employers will take advantage of this change to cut their contributions as well as transferring all the risk.

These two alternatives require the scheme to be viewed in different ways that lead to different investment strategies and different ways of managing risk. And two different valuations. Any decision about the future of the scheme requires a comparison of both.

If the scheme is assumed to remain open, as in alternative (1), providing that there is positive cash flow available for long term investment, in a suitably diversified portfolio that includes high return assets such as equities, there will be healthy income to pay pensions in the future. The main source of investment risk - short term asset price volatility - can be managed. Since the pension payments are long in the future, it is long term investment returns that matter, and short term volatility can be ignored.

In fact in an open ongoing scheme that is cash flow positive like the USS, any downturn in the stock market is an advantage, not a threat - because it means assets can then be purchased more cheaply, reducing the cost of future service accrual.

The valuation of an open scheme ideally requires a comparison of projected income flows with projected outgo in pension payments. The UCU have repeatedly asked the USS to carry out such an analysis without one having yet been published. Our actuarial advisor First Actuarial have provided such analysis that strongly points to the scheme being sustainable. It would be good if the UUK joined us in demanding the USS carry out a similar analysis using the complete data set that they have available.

Alternative (1), of course, depends on there being a strong employer covenant. The covenant risk to the scheme is essentially the insolvency of all the pre-92 universities. The risk from insolvency of individual institutions is offset by the collective nature of the scheme, so called ‘last man standing’. The risks facing the scheme are essentially those facing the pre-92 higher education ‘market’ as a whole. That does not seem a likely prospect at the moment. If that begins to change it will be noticed in the periodic review of the scheme and in the triennial valuations. It does not seem realistic to assume it will happen suddenly without warning.

Alternative (2) is the only one that the USS employers, executive and most of the trustees seem to be willing to countenance. It denies the unique nature of the USS as a sector scheme and treats it as if it were a mature single employer scheme. It assumes the scheme matures and then the job of the trustees is to manage the ensuing runoff. The whole emphasis is on risk rather than return, making sure the invested funds can pay the pension promises with absolute certainty. Paying the pensions depends on the investments being risk-free which means investing in government bonds.

The problem - and the source of the dispute - is that government bonds are no longer a good investment. Twenty years ago they would have produced a return of perhaps 2% above inflation but today, thanks to post-crisis monetary policy and quantitative easing by the Bank of England, the rate of return after inflation is negative.

Yet the policy of the USS, supported by the UUK employers, ignoring the thinking of the Joint Expert Panel, of so-called de-risking, is to invest in assets that are guaranteed to lose money. This is regarded as a low risk strategy on the grounds that the loss is certain. This is surely an absurdity. De-risking actually increases the risk to the scheme that it cannot pay the pensions when they fall due because the loss on the gilts has to be paid for by the members and employers. This is what is driving up contributions and threatens the survival of the scheme.

It should be noted also that interest rates on government bonds are no indication of investment returns more generally. The expected long term return on equities and other forms of patient investment in the productive economy (rather than lending to the government) continues to be sufficiently high to pay the benefits.

Essentially the defined benefit scheme is being undermined by the herd mentality group think of the pensions experts in the USS executive. They are applying thinking from the past - when it was rational for pension schemes to invest in government bonds that produced a steady though modest return as part of its risk management - to today’s conditions of negative risk-free rates. It is an example of how real damage to people’s welfare can result from the continued unreflective use of an economic model when the conditions for its application do not hold or have changed.

August 18, 2016

Pension deficits: mark–to–market valuation is the elephant in the room

The chief economist of the Bank of England, Andy Haldane, has said he hasn’t a clue about pensions. It is not surprising when so many occupational schemes have a deficit that stubbornly just keeps on growing. They have agreed a recovery plan with the pensions regulator to ensure there will be enough money to pay the pensions promised when they fall due - but still the deficit grows seemingly uncontrollably.

The latest estimate for the total deficit for defined benefit schemes eligible for entry to the pension protection fund was £383.6bn at the end of June 2016, up from £294.6bn at the end of May an increase of £89bn in one month. The combined funding level has fallen to 78 per cent, close to its lowest ever level. There were 4,995 schemes in deficit and only 950 schemes in surplus.[1]

The blame for this is most often put on the fact that pensioners are living longer than expected. But that is not convincing and can be only part of the answer: deficits are changing too fast to be due to something as slow moving as longevity trends - that are anyway allowed for in the recovery plans that have been devised. The other explanation often trotted out is the catch-all ‘market conditions’ which covers a multitude of factors. This usually means low interest rates, casually and wrongly equated with poor investment returns.

No. It is the regulations governing pension scheme valuations that are mostly to blame for this unsustainable situation. They are the elephant in the room of the pension deficits story that is being ignored by most of the industry. They are not fit for purpose and urgently need to be revised. They force pension schemes to have to deal with extraneous – even spurious - risk factors which exaggerate deficits. The effect – as we have seen in recent years - is to force many schemes to close.

Deficits have grown substantially since the 1990s when minimum funding requirements were introduced. The 2004 Pensions Act set up the pension protection fund to reduce the risk of pensions failing due to the sponsoring company failing. But it also tightened up on funding rules and imposed an inappropriate market-based valuation methodology[2]. Accounting regulations based on this methodology are at variance with real-world economics. They are based on a purist belief in markets as a source of information - ignoring all evidence from academic economics, both empirical and theoretical, showing the limitations of markets as providers of information. They were intended to prevent pension schemes needing to enter the pension protection fund but in fact have had the reverse effect by making sponsor failure more likely.

It is only policy makers who can deal with this problem. They need to take an overview of the consequences of mark-to-market accounting and revise the valuation regulations in the light of experience.

... To continue reading access the full paper here or here.


The paper has been submitted as evidence to the enquiry being conducted by the House of Commons DWP Select Committee (chair Frank Field MP) and to the DB Task Force by the Pensions and Lifetime Savings Association (chair Ashok Gupta).

October 27, 2014

The pensions crisis: recommended reading

The best account I have read of the pensions crisis is this booklet: 'You're on your own'

It explains how Defined Benefit pensions (whether final salary or career average salary) are far superior to Defined Contribution pensions (building up a 'pension pot' that you cash in on retirement and use in whatever way to support yourself for the rest of your life).

It also explains how we got to the present situation with good DB pension schemes being closed in company after company. It puts the current USS crisis in perspective.


October 15, 2014

Error in Times Higher Education article on USS corrected

The Times Higher Education reporter Jack Grove has now corrected his article after I pionted out his mistake in claiming a deficit of £8 billion PER YEAR. In fact there is a surplus of £1billion per year.

The article still repeats the claim trotted out by the employers that the deficit is caused by poor investment returns.

It would be good if the magazine were to be a bit more balanced and not simply take what the employers say at face value.

September 01, 2014

USS is highly solvent – so why do the employers want to cut it?

The question USS members are asking is why, given that their pension fund is highly solvent by normal standards, they are being told by Anton Muscatelli, on behalf of the employers, that, on the contrary, it is deep in deficit.

The figures show that the USS is immensely profitable: the latest annual report and accounts show an income of £2,585.4 million and expenditure on pensions in payment of £1,462.0 million, leaving a massive net surplus to invest for meeting future needs of £1,123.4 million.

Of course these figures tell only part of the story, and one must allow for future demands resulting from demographic changes, growth in membership and so on – the job of actuaries. Nevertheless, they surely indicate that there is currently plenty of headroom, which raises the question to which members deserve an answer from Muscatelli: how does an annual surplus become a deficit? Can we please be told?

Instead of giving a clear picture of how the accounts are likely to change in the future, he just announces that there will be deficits, without explaining the basis of their derivation. He, rather disingenuously, hints at arguments but does not turn them into reasons when he says: “People’s longer life expectancies and the current global economic upheavals make these challenging times for pension funds…”

In fact, the evidence is that longer life expectancies are a significant but still relatively small factor that does not threaten the survival of the USS final salary scheme: it simply requires minor changes in the rules. “Global economic upheavals” is a term so vague it could mean anything: perhaps it is intended to make members believe that the investment returns have been unusually poor. But investment returns to the USS compare well with the rest of the industry, and the fund’s assets have grown – so that cannot be the source of his growing deficit.

Muscatelli’s figures are smoke and mirrors. His is a flawed methodology for a number of reasons. And one of the most important, which Muscatelli does not mention, is the fact that the new methodology does not count income from contributions (£1,539.6 million – enough for all the pensions in payment).

Up until now the USS, like other pension schemes, has worked perfectly sustainably as a collective fund on a money-in-money-out basis. But this principle is now to be banned for reasons that can only be described as ideological: because it is collectivist.

Dennis Leech
Professor of economics
University of Warwick

This is the text of my letter as published in the Times Higher Education on 31 July 2014 (

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