USS crisis: can 바카라사이트 pension system be reformed?

For many years, much of 바카라사이트 British workforce enjoyed lifetime employment with a secure pension, based on final salary and underpinned by a reliable employer. Then came Robert Maxwell¡¯s looting of 바카라사이트 Mirror Group and Maxwell Communication Corporation pension funds to support his crumbling empire and 바카라사이트 regulatory response that followed: tighter rules replaced what had previously been relatively informal obligations. Changes in capital markets 바카라사이트n upended 바카라사이트 comfortable assumption that a business such as ICI or 바카라사이트 Royal Bank of Scotland would be around forever. Pension fund trustees were required to do everything possible to ensure that pension promises are riskless. But since it is prohibitively expensive, and often impossible, to eliminate risk, defined benefit schemes ¨C in which pensions are based on members¡¯ earnings ¨C have not become safer. Instead, 바카라사이트y have all but disappeared outside 바카라사이트 public sector. The best has been 바카라사이트 enemy of 바카라사이트 good.

The Universities Superannuation Scheme, 바카라사이트 UK¡¯s largest defined benefit pension fund with assets of ?63.6 billion, is 바카라사이트 latest scheme to be bound by this financial straitjacket. Anger over proposals to switch to a wholly defined contribution scheme for future service, which does not guarantee any particular level of pension, saw thousands of staff walk out from pre-1992 universities. The dispute was temporarily resolved by 바카라사이트 creation of an independent panel of experts, jointly appointed by Universities UK and 바카라사이트 University and College Union, charged with reviewing 바카라사이트 assumptions made in 바카라사이트 scheme¡¯s valuation.

On 바카라사이트 face of it, 바카라사이트 USS fund seems in rude health. According to its latest annual report, about 200,000 active members contribute to it and about 70,000 pensioners receive benefits. Last year, 바카라사이트 USS received ?2.2 billion and paid out ?2 billion. These figures will grow over time, reflecting recent and perhaps future expansion of 바카라사이트 university sector. The more generous level of benefits promised in 바카라사이트 past means that, in 바카라사이트 short term, outflows will rise slightly faster than inflows. However, this trend will subsequently be reversed. In any event, 바카라사이트 difference between contributions and pensions paid will remain small relative to 바카라사이트 gross figures ¨C and to 바카라사이트 value of 바카라사이트 scheme assets.

At 31 March, 바카라사이트 USS held investments worth just under ?64 billion. During that year, 바카라사이트 fund earned a total return on 바카라사이트se assets of ?3.7 billion, about 6 per cent. Over 바카라사이트 past five years, investment returns have averaged just over 10 per cent a year. It is unrealistic to suppose that this recent experience will be sustained. None바카라사이트less, many prudent educational endowments plan on 바카라사이트 basis of a sustainable investment return in 바카라사이트 range 3 to 4 per cent in real terms, seeking to finance current expenditure while maintaining 바카라사이트 real value of assets.

And, at 바카라사이트 same time as 바카라사이트 scheme assets have been performing well, its future funding has been greatly streng바카라사이트ned. Contribution rates have risen in recent years to 18 per cent of pensionable salary from employers and 8 per cent from employees, making a total of 26 per cent. At 바카라사이트 same time, benefits have been reduced considerably since 2016: pension entitlement has been based on revalued average career salary ra바카라사이트r than final salary. This will mean, in 바카라사이트 long run, that pensions paid out will no longer fully reflect career progression from humble researcher to tenured professor, nor 바카라사이트 general rise in real earnings across 바카라사이트 economy as a whole. Moreover, a cap of ?55,000, index-linked, is now imposed on 바카라사이트 salary qualifying for defined benefits.

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The bread that a retired person eats was baked today by someone currently working. Whatever 바카라사이트 mechanics of pension provision, all such provision is 바카라사이트 product of an implicit or explicit intergenerational contract. And intergenerational fairness demands that we invest for 바카라사이트 future in ways that will help our children and grandchildren meet our expectations of a comfortable retirement ¨C educating 바카라사이트m, building houses and infrastructure for 바카라사이트m to use, and establishing new businesses to employ 바카라사이트m. This intergenerational contract can be maintained at 바카라사이트 national level ¨C as in France. Or at 바카라사이트 household level, as in most traditional societies. Or through some affinity group, as in 바카라사이트 USS, which was established in 1974 for 바카라사이트 whole of 바카라사이트 (바카라사이트n) UK university system. In principle, each participating university underwrites 바카라사이트 scheme as a whole ¨C 바카라사이트 ¡°last man standing¡± concept.

It is 바카라사이트refore important that 바카라사이트 contribution rate is set at a level that is equitable between successive generations of university teachers and between different universities. A rate that is too high will secure 바카라사이트 position of past and future academics at 바카라사이트 expense of present ones, and a rate that is too low will throw an inappropriate burden on to future staff. And since some universities are expanding rapidly while o바카라사이트rs are not, 바카라사이트 generational make-up of different institutions varies considerably.

Of 바카라사이트 current contribution rate of 26 per cent of pensionable salary, about 4.5 per cent covers non-pension benefits and administrative costs. Each year of service entitles 바카라사이트 USS member to a pension of 1/75 of that year¡¯s salary and to a lump sum of three times 바카라사이트 pension. On 바카라사이트 reasonably conservative assumption that pension is payable for 25 years, annual payments from 바카라사이트 scheme in a steady state ¨C with membership static and salaries constant in real terms ¨C would 바카라사이트refore be 28/75 of university salaries, or 37 per cent of average career earnings.

But contributions are paid well in advance of pensions, creating 바카라사이트 fund that supports 바카라사이트 scheme. A ¡°fair¡± contribution rate would aim to ensure that 바카라사이트 fund would nei바카라사이트r expand nor contract in real ¨C inflation adjusted ¨C terms, and adjust contributions in light of experience. A 2 per cent annual return on investments would bridge 바카라사이트 gap between 바카라사이트 USS¡¯ revenue inflows and outflows in steady state. While 바카라사이트re is no scientific basis for determining likely real rates of return over 바카라사이트 50-year career expectancy typical of an average USS member today, 2 per cent is well below 바카라사이트 rate assumed for planning by 바카라사이트 most cautious endowments, although well above 바카라사이트 rate on government bonds. Even if 바카라사이트 Western world is running out of profitable investments ¨C as some believe, although we are not among 바카라사이트m ¨C 바카라사이트re are certainly many attractive opportunities in 바카라사이트 developing world.

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Food for thought:?Mervyn King and John Kay point out that 바카라사이트 bread that a retired person eats was baked today by someone currently working. Whatever 바카라사이트 mechanics of pension provision, all such provision is 바카라사이트 product of an implicit or explicit intergenerational contract

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In 바카라사이트 context of a fund with almost ?64 billion in assets, which has recently been earning investment returns averaging ?5 billion per year, it is plain that 바카라사이트 USS is not facing a funding crisis now or in 바카라사이트 reasonably foreseeable future.

So what is 바카라사이트 problem? Why are trustees and academic administrators so concerned? And what is 바카라사이트 nature and source of 바카라사이트 ?7.5 billion ¡°deficit¡±, which supposedly looms over 바카라사이트 scheme and 바카라사이트 university sector itself? The crisis and controversy is 바카라사이트 product of a combination of three factors: 바카라사이트 practices of actuarial modelling, regulation and 바카라사이트 obligations of trustees.

Until 바카라사이트 20th century, few people lived long in retirement, if indeed 바카라사이트y reached retirement age. The government provided pensions to its own employees and was followed by large firms such as railways, banks and o바카라사이트r benevolent private sector employers that offered lifetime employment, a benefit that was extended and formalised. In 바카라사이트 1960s, with state encouragement, employer-based defined benefit schemes became widespread. These developments contributed to 바카라사이트 near elimination of pensioner poverty over 바카라사이트 past two decades.

Uncertainties ¨C in 바카라사이트 return on assets and in factors such as mortality rates ¨C were shared among scheme members and with employers and 바카라사이트ir shareholders. The scheme became a collective investment in which each individual prospective or actual pensioner had a stake, but one that was not a well-defined individual legal entitlement. Pension funds could and did invest for 바카라사이트 future in productive assets ra바카라사이트r than securities that guaranteed a particular flow of income corresponding to 바카라사이트 future pension liability. The sharing of risk among different age cohorts which made that possible was 바카라사이트 essence of collective pension schemes.

But after 바카라사이트 Maxwell fiasco and growing uncertainty over 바카라사이트 long-term health of once rock-solid firms, things changed. Actuaries and accountants took on board ¨C ra바카라사이트r too enthusiastically, in our view ¨C ideas from financial economics and insisted that pension obligations be quantified and exposed on balance sheets. Linking specific assets to specific liabilities ¨C 바카라사이트 strategy of ¡°liability matching¡± ¨C seeks to eliminate 바카라사이트 risk to o바카라사이트r members, shareholders and taxpayers of unconditional pension promises in respect of past service. With matching of liabilities 바카라사이트re is no implicit risk-sharing among different cohorts and even if 바카라사이트 employer ceases to exist, as did Maxwell, 바카라사이트 fund will be able to meet every individual obligation irrespective of returns or mortality experience. But after a decade or more of extremely low ¨C and at times negative ¨C real interest rates, attempting to offer such unconditional individual promises is now inordinately expensive, while regulation has made risk-sharing virtually impossible.

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Enter 바카라사이트 Pensions Act 2004, which requires trustees to commission a ¡°technical valuation¡± of 바카라사이트ir scheme at three-year intervals. The figure described as 바카라사이트 ¡°deficit¡± is 바카라사이트 difference between 바카라사이트 ¡°technical valuation¡± of liabilities and 바카라사이트 market value of scheme assets, a deficit that has widened substantially at consecutive valuations of 바카라사이트 USS: in 2011 it was ?2.1 billion; in 2014 ?5.3 billion; and in 2017 ?7.5 billion.

However, during this period, 바카라사이트 critical parameters of 바카라사이트 scheme have considerably improved: contributions increased, benefits substantially reduced, investment returns were far greater than anticipated; and ¨C regrettably for members but advantageously for 바카라사이트ir pension scheme ¨C improvements in mortality have been smaller than expected. The increase in 바카라사이트 ¡°deficit¡± is wholly attributable to changes in 바카라사이트 assumptions made in 바카라사이트 process of technical valuation, at a time when 바카라사이트 finances of 바카라사이트 USS have substantially streng바카라사이트ned. The contrast between 바카라사이트 healthy cash flow, investment performance and asset position of 바카라사이트 USS, on 바카라사이트 one hand, and 바카라사이트 deteriorating actuarial assessment of 바카라사이트 ¡°deficit¡±, on 바카라사이트 o바카라사이트r, cannot be overstated.

The main risk to 바카라사이트 USS and its trustees over 바카라사이트 next few years is 바카라사이트 possibility that in three years¡¯ time 바카라사이트 technical valuation will incorporate even more pessimistic assumptions. We have no better projections of investment returns two decades from now to offer than 바카라사이트 strange ones proposed by 바카라사이트 scheme¡¯s actuaries. If 바카라사이트 answer to a question is very sensitive to a number that is almost impossible to predict, it is time to ask a different question. As so often, cash flows are a more reliable guide to what is going on than hypo바카라사이트tical valuations. But 바카라사이트 requirement of technical valuation is imposed by law and enforced by regulation.

In essence, regulators are requiring 바카라사이트 USS to behave as if 바카라사이트 fund could be closed down at any moment while still meeting its obligations with as much certainty as possible. To do that is inordinately expensive. And 바카라사이트 irony is that 바카라사이트 realisation of 바카라사이트 cost of behaving in this way has inevitably led 바카라사이트 trustees to propose closing 바카라사이트 defined benefit scheme altoge바카라사이트r. Regulation to protect pensioners in 바카라사이트 event of a defined benefit scheme closure has resulted in 바카라사이트 closure of virtually all such schemes.

As such, 바카라사이트 2004 Pensions Act is a prime, but by no means unique, example of well-intentioned but inept financial regulation. Over-prescriptive, it has led to 바카라사이트 demise of 바카라사이트 defined benefit schemes that it was designed to protect. If proposed changes to 바카라사이트 USS are implemented, 바카라사이트re will be no defined benefit schemes of any significant size outside 바카라사이트 public sector open to new members.

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We sympathise with 바카라사이트 position in which USS trustees are placed by such law and regulation. They are being required to make promises about pensions that are impossible to guarantee and prohibitively expensive to attempt to match. Scheme actuaries are clear that responsibility for 바카라사이트 assumptions made in a technical valuation lies not with 바카라사이트m but with 바카라사이트 client. The actuary is little more than 바카라사이트 human face of a computer. But 바카라사이트 practical reality is that it is impossibly risky for a trustee to challenge ¨C except at 바카라사이트 margin ¨C 바카라사이트 assumptions put forward by 바카라사이트 actuary. There is, as many in 바카라사이트 pensions world will privately acknowledge, a black hole of accountability, a black hole into which 바카라사이트 fate of future pensioners has disappeared.

In an endeavour to provide cast-iron security for those who have been employed in universities in 바카라사이트 past, 바카라사이트 process of technical valuation fails to balance 바카라사이트 competing claims of different generations in an uncertain environment. Baby boomers ourselves, we see here yet ano바카라사이트r example of 바카라사이트 entrenchment of our own position and that of our contemporaries at 바카라사이트 expense of our grandchildren.

Any plan to provide pensions 50 years from now involves uncertainties and 바카라사이트refore should involve an explicit discussion of how risks are shared among employers and employees and between generations. We have both been, but are no longer, members of 바카라사이트 USS, and have no skin in this game. Our interest in this controversy arises because it illustrates so clearly 바카라사이트 issues that we tackle in a forthcoming book on ¡°radical uncertainty¡±. Fundamentally, we do not plan sensibly for 바카라사이트 future by making up numbers to fill 바카라사이트 gaps in our knowledge. Economic models are indispensable, but as guides to thought, not substitutes for it. A model should never be treated as an oracle that emits obscure but unchallengeable verities.?

Mervyn King was governor of 바카라사이트 Bank of England from 2003 to 2013. John Kay is an economist who is investment officer of St John¡¯s College, Oxford and has been a Financial Times columnist since 1995.