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April 01, 2015

Meeting between academic pensions experts and USS CEO

Following their letter to the USS trustee, signed by many of the country's leading academic experts on actuarial science, my colleagues Professors Jane Hutton Saul Jacka of the Statistics Department were invited to meet the USS chief executive, Bill Galvin.

Jane has now posted the following account of the meeting on her website.

Meeting with Bill Galvin, CEO of USS.
Saul Jacka and I were invited by Bill Galvin, CEO of USS, to meet him 'in a spirit of openness and transparency'. The meeting took place in London on Friday 27 March 2015. Jeff Rowney, the senior internal (USS) actuary, Ali Tayyebi, the scheme actuary from Mercers and Brendan Mulkern, Chief Policy and External Affairs Officer for USS were also present. Although Bill Galvin initially made his excuses, he stayed for almost an hour.

Ali Tayyebi made it clear that a major driver for the single estimate of the deficit which has been made public was the UUK's insistence that the employers' contribution could not go above 18%, as they could not afford more. However, UUK also insisted that the salary forecast should be CPI + 2%, (RPI + 1%, or they might be minded to accept RPI+0.7%), substantially above the historical position, even when the unprofessional discarding of the last three years actual salary position is used. So the UUK position is incoherent: they say they cannot afford to pay for pensions, but they can afford to assume a rate of pay increases which is know to be well in excess of what is actually paid. I reminded Ali Tayyebi what the statistical definition of bias is; the evidence is that the assumption on salaries gives a large over-estimate of the liabilities. There are other inconsistencies, and circular arguments, rehearsed again by the actuaries.

Ali Tayyebi also stated that describing uncertainty was a fundamental part of his advice. He had provided numerous different estimates of the deficit, under all the assumptions which we and Imperial College suggested, and many more, to the USS Trustee and the UUK. The USS Trustee has had open discussions with UUK. Bill Galvin said that, to his knowledge, nothing had been withheld which people have asked for. I find this strange, as both institutions (Warwick, Imperial College) and individuals have requested sight of a range of valuations.

Bill Galvin said the range of estimates of the deficit or surplus of USS will be released after the consultation. It seems to us that the USS Trustee and the UUK are withholding important information from members. We do not see how the USS Trustee can claim to be acting for the benefit of members and standing up to employers (two of their statutory duties) whilst failing to provide a range of estimates until after the consultation. In my opinion, I should not trust the USS Trustee to be open, transparent, or willing to respect beneficiaries of the USS.

I cannot find the 'openness and transparency' which was offered. Our replies to the consultation must request sight of the full set of estimates provided by Ali Tayyebi for Mercer.

Jane Hutton"

It is important to realise that it is not really the actuaries who should be engaging in these discussion since their role is to carry out formal analyses on the assumptions that are given to them by the trustee. The same actuary might give a range of answers if asked to consider a range of different assumptions. Also different actuaries might very well give different conclusions if asked to consider a wider range of methods rather than just the conventional one (as has been demonstrated by the First Actuarial report).

So it would have been better perhaps if the meeting had been with some of the trustees. It is they who are taking the decisions (no doubt with advice from Bill Galvin). And they (other than those appointed by the UCU) are paid very handsomely for it.

March 30, 2015

Very misleading statement by the USS trustee

"When I use a word,” Humpty Dumpty said in rather a scornful tone, “it means just what I choose it to mean— neither more nor less.” Lewis Caroll

"Words are a wise man's counters, they do but reckon by them; but they are the money of fools." Thomas Hobbes

The UUK consultation document Funding background from the trustee is highly misleading to say the least. It contains statements that appear superficially to have a straightforward meaning in ordinary language but are in fact technical in that they require special assumptions for them to be true. Also some statements are downright false. It also has to be said that the trustee's approach to funding raises the question as to whether the trustee is fulfilling its fiduciary duty to always act in the best interests of members. Here are some of my comments.

Valuation and Funding Methodology

The document says:

Since 2011, the deficit has increased significantly and, based on the current benefit structure (ie without taking any account of the proposed changes), the trustee anticipated that it would report a deficit of approximately £12 billion for the March 2014

There has not actually been a valuation as yet, by the way. That cannot be done until the changes to the scheme have been agreed. So there is an important element of circular reasoning here, which is rather awkward: the £12 billion deficit depends on members (via the trustee) agreeing to it.

Importantly there is selective use of evidence: the £12 billion figure assumes some changes are implemented but not others. It assumes valuing the liabilities using 'gilts plus' rather than 'best estimate minus' (discussed at length in the First Actuarial report); also 'de-risking': switching from long-term growth investments to lower-return (but less volatile) government bonds. At the same time benefits are assumed unchanged. Both sets of assumptions point in one direction making the deficit bigger and bigger. This is highly tendentious and quite biased reasoning.

Then it says:

... the most significant factor is the change to the assumption which the trustee is making for future investment returns – and the effect of a lower assumption reflecting the changed economic environment – which has added around £7.6 billion to the amount needed to pay pensions."

This does not mean what it appears to say if it is read as ordinary English. The reader might think it alludes to the financial crisis from 2008 on. But investments have recovered since then and the USS investment managers have done well. No. What the trustee means here is how the future pensions promises are valued - a highly technical matter. The USS has to find a figure to stand for a theoretical sum of money in today's terms that would be enough to pay them (assuming it lent securely to the government at low interest rates). Government interest rates - gilts - are not investment returns determined by the market but fixed by the government for reasons of macro economic policy. The term 'future investment returns' has to be understood in this very specific technical sense and is not referring to actual future investment returns that will be earned on the fund's investment portfolio.

This is the nub of the issue. The USS has a large and volatile deficit due to this valuation of liabilities - not poor investment returns. The USS trustee is using extremely low gilt rates for this calculation and not actual investment returns and calling this "the assumption ... for future investment returns".

... it expects those overall returns will be lower given the challenging future economic environment. These assumptions are ultimately judgements which all trustees must make about future anticipated investment returns. These assumptions are reflected in the valuations of scheme liabilities, and in the increased deficits of many defined benefit pension schemes."

What it means by "challenging future economic environment" is that it believes gilt rates will remain low for the indefinite future. The trustee is basing its policy on a myth that currently very low interest rates reflect the "economic environment" notwithstanding that it is being deliberately manipulated by the Bank of England as a matter of policy ("quantitative easing").

The pensions promises that need to be paid have little to do with this "economic environment". Pensions that are to be paid in the future are the same whether interest rates go up or down although they change the valuation of the liabilities a lot. That is why the valuation is inherently so volatile (hence not very meaningful).

The main reason the deficit is so large is that the liabilities valuation increases every time interest rates go down. If interest rates go low enough (and some inflation-adjusted gilt rates are already virtually zero and some actually negative) the liabilities will become infinite. The valuation methodology is fundamentally flawed because it actually breaks down when the discount rate is zero. It is mathematically equivalent to trying to divide by zero.

Life expectancy

The document contains a misleading statement about the pressures due to rising longevity:

Another factor contributing to this increase is the projected improvements to members' life expectancy. The trustee has reported that the changes to the projected life expectancy assumptions between 2011 and 2014 have added almost £1 billion to the amount needed to pay the pensions promised."

This statement appears to imply that there is factual evidence that life expectancy is increasing faster than before. In fact the evidence from the Office of National Statistics tells us that this is not so. But the trustee has decided to increase it nevertheless on the grounds that a survey of other pension schemes conducted by the pension regulator has shown that a majority are assuming a higher rate of improvement in longevity than is evidentially indicated.

So the approach of the USS trustee is to follow the herd. After all, whatever might happen to the USS, nobody could reasonably blame the trustee. They are only following John Maynard Keynes' dictum: “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

The de-risking plan versus an ongoing pension scheme: planning to fail?

The document then goes on to say:

Additionally the trustee has carried out some work to update its understanding of the potential financial strength of the sector ... concluded that the scheme's reliance on the sector is considerable and should not grow over time.

The trustee has therefore proposed ... to gradually reduce the amount of investment risk in the scheme - over a 20-year period - in order to maintain the overall levels of risk, therefore reliance, on the sponsoring employers."

This is extraordinary. It means shifting investments from return-generating equities (ie financing investment in real productive capacity by companies thereby helping economic growth) into lending to the government by buying bonds. This is estimated to increase the deficit by £4.4 billion (part of the £12 mentioned above) which is the value of investment income foregone. This decision is to increase the deficit deliberately as a matter of policy and its wisdom is highly debatable to say the least.

The fundamental, overarching risk facing any pension scheme is that there will not be enough money to pay the pensions when they fall due. This new 'de-risking' policy does not necessarily reduce the risk of that happening. Indeed it seems if anything it might increase it. By giving up £4.4 billion of investment wealth it could be seen as almost planning to fail.

The trustee is focussing only on investment risk and ignoring investment return. Yet both are equally important to addressing the fundamental hazard of running out of money. The two need to be looked at together. It could well be that increasing investment in equities and long-term return-bearing assets will improve the chances of the scheme meeting its promises. Many actuaries argue against this kind of de-risking on precisely these grounds. (For example.)

There is also the fact that - as a general principle - this approach is harmful to the economy by leading to resources being diverted out of productive investment.

Is the trustee acting in the fiduciary interest of members?

This policy by the USS trustee is not evidence-based. The thinking behind it seems to be untested financial theory intended to be applied to private companies rather than universities.

Given that they are so controversial it is highly questionable whether these decisions are in the best interests of the scheme. It is certainly not the case that there is solid evidence behind them. The question therefore arises as to whether the trustee is genuinely fulfilling its legally required fiduciary duty. Has the UCU, as the representative of members, considered this? As far as I can see there has been no discussion of the possibiity of a legal challenge on these grounds.

Are universites acting in their own best interests as universities?

The policy seems to be based on the idea that the employer covenant with the universities only has a limited period. This seems an extraordinary idea for pre-92 universities with established reputations, a unique role in society and no reason to think they should not continue. Presumably as with so much else in this dispute it derives from the new idea that universities are businesses just like any other in the private sector and therefore must copy as many of their management modalities as possible. The recent introduction of rigorous line management, with targets defined as metrics, firing academics if they faill to meet short term targets, paying vice chancellors CEO salaries, and so on, are all evidence of the zeal with which universities are embracing what they image to be how businesses behave. Applying the same logic to pensions is more of the same. This is a grave mistake because universites by their very nature are public institutions.

One wonders if the university managements have really thought deeply enough about where they are going before responding to the surveys conducted by the USS and UUK.

March 21, 2015

Suggestions for member responses to the USS consultation

Here are suggestions for USS members to consider for your response to the consultation, in the light of your own understanding of the USS valuations, and the information and mis-information which has been circulated by UUK and the USS trustees. You can then select questions/comments to contribute to the consultation.

It is in your interests - if you care about your pension rights - to respond to the consultation: many members stand to lose out quite substantially. You should also raise these questions/comments with your university management (if you are not at one of the universities such as Warwick, LSE and Imperial College, which have already challenged the assumptions behind the proposals). There is anecdotal evidence that many universities' managements have not really formed an independent view to inform their vote in the UUK but have tended to follow the conventional line. After all, pensions are complicated and difficult to understand.

The UCU head office have circulated some suggested responses. My suggestions include some in addition to those focussing mainly on specific challenges to the valuation, the way it has been implemented and the assumptions that have been made - all of which threaten the continuation of the scheme. I do not believe the scheme can survive for much longer (as a proper pension scheme - that is, a DB scheme) unless the valuation is challenged by members, both individuals and employers. We have powerful arguments: Warwick University, LSE, Imperial College, Actuarial scientists, First Actuarial.

You should also challenge the so-called de-risking strategy which means changing the scheme's investments so as to forego profitable long-term investment opportunities because they are risky in the short term. This is extremely costly and totally inappropriate given the long-term nature of universities as institutions.


The key reasons the employers say they want to make changes to the USS relate to the valuation methodology and funding requirement. UUK suggest the scheme is unaffordable, but the reasoning they have given for this so far is not based on convincing evidence. Indeed some of their reasoning is based on unduly pessimistic assumptions about the future, some of which are contradictory. They were found out exaggerating the increases in life expectancy and had to back down.

Comments members might wish to make:

Demand that UUK and the USS management and trustees respond publicly to the arguments made by the actuarial scientists Professors Jane Hutton, Saul Jacka and others in their letters to them. They should also respond in detail to the arguments put by Warwick University, LSE and Imperial.

Why does UUK ignore the actual historical performance of USS investments? USS investments have done well and can be expected to continue to do so (in line with the growth of the economy). Yet USS trustees assume poor investment performance when calculating the liabilities: they calculate the liabilities using a return on government bonds (gilts) rather than the actual investment portfolio which is a properly diversified holding that includes a wide range of assets. They are not required to do this by the Regulator so why do they insist on it?

Why does UUK ignore the actual historical performance of salaries? The trustees' forecast of salary growth is hence much higher than it currently is. This - arbitrary - assumption makes final salary pensions seem too expensive.

Why have the UUK decided that the sector only has a horizon of 17 years? Why do you not accept the Ernst & Young assessment of robust financial health for at least 20 years?

What is the impact on the estimated actuarial deficit and valuation of varying the length of the recovery period to 20 years (and beyond)?

What is the impact on the estimated actuarial deficit and valuation of using an 'ongoing' valuation instead of a 'solvency' or 'self-sufficiency' valuation? The First Actuarial report indicates that this could make a large - even fundamental - difference.

Why was a self-sufficiency valuation used?

Proposals: New scheme and benefits

Closing the final salary scheme is a betrayal. Members have planned their careers on the belief they would receive a pension and lump sum related to their years of service and final salary when they retire, as promised by the USS and employers. It is unacceptable to replace that retrospectively by a link with their salary in 2016. While the Hutton report argued that CRB pensions were fairer than FS, and recommended that pension schemes make the switch, it did not say that serving members should be moved from FS to CRB. It also recommended that in CRB pensions should be indexed to earnings (so that pensioners would benefit from economic growth) not prices (which is what the USS is proposing, linking pensions to the inferior CPI not even the RPI).

What happens to the death-in-service benefit?

What is the current cost of administering the system?

What is the cost of implementing the USS proposals?

What is the cost of DC: 4% is mentioned in the USS modeller, but it is not clear what the denominator is. If employers contribute 12% and employees 8%, a total of 20%, does 4% of salary go on cost of DC?

How will the £55K cap be applied to part-time workers?

How will the £55K cap be applied to casual workers?

Governance and related issues

What are the risks that the new computer system in USS will not be ready by 1 April 2016?

What approach will be taken if the new computer system in USS is not ready by 1 April 2016?

The proposals involve introducing a DC element for salaries over the £55k threshold and cutting back on DB accordingly. Clearly a DC system moves risk to individuals because there is no guanteed pension or 'pot'. Why have trustees supported moving risk from the collective USS fund to individual members? DC schemes are not really proper pension schemes because they do not lead to a pension in the ordinary sense of the word: they produce an uncertain 'pot' at retirement that can be worth little depending on the vagaries of the stock market. Although such pension schemes are being introduced in the private sector they are nontheless unfair. USS as the largest funded pension scheme in the UK is in a unique position to oppose this trend, not join it.

How much of the trustees' time is taken up by the work? We note the Trustees’ payments are in the annual report, pp96-7. [The highest paid in 2013/4 is Carter (£78k), then Harris (the chairman) £70k, Bull (£70k), Holmes (£55k). The UCU trustees donate their fees to charity and do not benefit financially, under union rule.]

You might ask the trustees if they allowed false information on life expectancy provided by the USS group of the Employers' Pension Forum (EPF) to go unchallenged?

Ask your university management: Did you, as a part of [your university name] senior management, allow false information on life expectancy provided by EPF to go unchallenged?

Can [fill in your university name] University accounting systems manage with the requirements of a DC system?

How many of [fill in your university name] senior staff have opted out of USS as their pensions are too large to get tax benefits?

Complaint form

If you as a member wishes to make a formal enquiry about the errors or assumptions, you might find this form useful. Guidance is here.

March 12, 2015

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.

February 12, 2015

USS Doublethink

What is alarming about the deal that has just been agreed between the UUK and the UCU negotiators is the doublethink it requires of anyone who believes it offers a solution. It is intended to reduce risk – by making so called technical assumptions on the most prudent basis possible so as to avoid the risk of the money running out for whatever reason. Yet the resulting figure for the so-called deficit that this gives is extremely volatile.

Thus for example we have been told that the deficit was around £12 billion in March but had increased to an estimated £20 billion by December. Normally pensions accounting is very boring with changes taking place gradually over many decades. Yet here we are expected to believe that the deficit has varied by two thirds in only nine months! And no reason is given except vague market conditions. (And we have not had a stock market crash.)

Why did nobody say to the chief executive and the trustees: “Steady on – this can’t be right. There must be something wrong with your model. You have supposedly eliminated risk by using your new methodology, very prudential assumptions and all, yet there appears to be an awful lot more risk/volatility than there was ever before.”

The problem is of course caused by the fact that the methodology is based on purely theoretical financial models with no empirical evidence behind them. In other words blind faith.

The deal does nothing to solve a funding problem but instead makes it worse. The same theories that contributed to the banking crisis in 2007/8 are at work here. We have learned nothing from that experience. And we are told this is ‘economic orthodoxy’ so cannot question it.

October 06, 2014

USS employers shown to have falsified life expectancy figures

One of the chief reasons given by university employers for the changes to USS that they want is that we are all living longer in retirement, life expectancy has increased.

But my colleague Jane Hutton, professor of statistics at Warwick university, has shown that they have been overstating their case and posted false figures on their website.

The Employers Pensions Forum (EPF) Q&A webpage originally stated (Q9): "Current longevity patterns are significantly different to those when the scheme was set up in 1974. Then it was expected that a USS pensioner retiring at age 65 would live for 6 to 8 years in retirement so the cost of the scheme and the contribution rates were set on this basis. By 2014 the anticipated length of retirement is around 30 years, ..."

In other words, in 1974, 'our' life expectancy was half (49%) that of the general public, but by 2014 it had risen to 1.4 to 1.6 times greater! The Office of National Statistics has an increase of 1.3 to 2.3 years for each decade; the EPF has an increase of 5.8 years for each decade.

Jane wrote to the EPF pointing out that these figures are hardly credible since they would require us to believe not only that life expectancy was grossly underestimated when USS was set up in 1974 but also that rapidly increasing life expectancy had been ignored subsequently.

She did not receive so much as an acknowledgment of her email. But when a colleague looked at the same webpage he could not find the numbers because they were no longer there. Fortunately, Jane had printed the original version of the webpage as it had been (see Q9). The new page with the offending figures for life expectancy removed is here, but with no indication it has been edited and the same date as before.

November 11, 2013

Scare stories about USS pension scheme are overblown

There is an excellent article by Ros Altmann, the well known pensions expert, in the Financial Times today.

She says that the concerns about the USS deficit that have been expressed by John Ralfe (on BBC Newsnight and in the FT) are overblown.

Hers is a similar argument that Con Keating and myself put forward in somewhat less measured language last week.

November 05, 2013

Fantasy world of pension deficits

Last Monday the Financial Times ran an article, by independent pensions consultant, John Ralfe. that alleged that there was a massive 'black hole' in the Universities Superannuation Scheme, the USS, the second-largest private pension scheme in the UK. This repeats the sensational and irresponsible allegations he made on Newsnight the previous week.

Here is the reply by Con Keating and myself published in today's Financial Times pointing out that this is Alice in Wonderland economics.

John Ralfe famously, when he was finance director of Boots in 2000 and 2001, moved the investments of the pension scheme from a balanced portfolio to 100% bonds based on new theories from financial economics and against conventional actuarial practice.

About the same time actuaries were being told (by Ralfe and others, for example Exley, Mehta and Smith) that markets are efficient and market prices contain all the information there is. Therefore market prices of financial assets like shares and bonds must be objective, scientific values. This led to the development and enactment of supposedly objective accounting rules meaning that actuaries and accountants need do little more than calculate market values for assets and liabilities in order to value pensions. But the idea that markets are efficient in this fundamentalist manner has been questioned by many economists following the financial crisis where many market values turned out to be illusory.The evidence against the efficient markets hypothesis is surely by now overwhelming and it is shocking to find somebody still advocating it in the face of that.

Ralfe is saying is that pension schemes must always be fully funded - that is, they must have enough assets to cover their liabilities at all times. And any that do not - because they rely on payments from future service and new members - or because the calculation of the liabilities figure is unrealistic - are in deficit and must find the money to fill it. This is insisting on suddenly changing the model - a bit like telling all householders they are in deficit because they have a mortgage and have to pay it off - a model that is known to work well is replaced by one that does not - for what are essentially ideological reasons.

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