{"id":1614,"date":"2019-08-21T13:14:58","date_gmt":"2019-08-21T12:14:58","guid":{"rendered":"http:\/\/blogs.cardiff.ac.uk\/business-school\/?p=1614"},"modified":"2019-08-21T13:45:06","modified_gmt":"2019-08-21T12:45:06","slug":"now-you-see-it-now-you-dont-is-the-university-pension-fund-really-in-deficit","status":"publish","type":"post","link":"https:\/\/blogs.cardiff.ac.uk\/business-school\/now-you-see-it-now-you-dont-is-the-university-pension-fund-really-in-deficit\/","title":{"rendered":"\u2018Now you see it, now you don\u2019t\u2019 \u2014 Is the university pension fund really in deficit?"},"content":{"rendered":"\n
\"\"<\/figure>\n\n\n\n

In our latest blog post, Dr Woon Wong argues that the discount rate currently used to value the liabilities of the Universities\u2019 Superannuation Scheme is too low, and that the largest higher education strike in British history followed by the forming of the Joint Expert Panel<\/a> help to reveal that the claim of a deficit is fallacious.<\/h3>\n\n\n\n

It has long been suspected that falling gilt yields overstate\nthe liability of defined benefit (DB) schemes. It is thus surprising to find\nthat, based on projected benefit payments data available from the University Superannuation\nScheme (USS), \u2018gilt-plus\u2019 (gilt yields plus a fixed margin) discount rates actually\nreduce the reported 2017 deficit of the USS from \u00a37.5bn to \u00a33.4bn. <\/p>\n\n\n\n

This finding makes the reason behind the 2017 deficit ever more\npuzzling since the valuation assumed that gilt yields would revert back to\ntheir higher (2014) level in ten years\u2019 time (thereby implying a deficit\nlower even than that obtained by a gilt-plus method). Regulatory guidelines\nrequire assumptions be evidence-based. <\/p>\n\n\n\n

\u201cIf evidence-based discount rates are used, the scheme is found to be in a surplus that can be as large as \u00a37.5bn.\u201d<\/p><\/blockquote>\n\n\n\n

Debating the discount rate<\/h3>\n\n\n\n

The problem with the USS\u2019s valuations is related to the discount rate debate that was published by the Pensions Regulator (tPR) in the 2017 Annual Funding Statement for<\/a><\/em> <\/a>Defined Benefit Schemes<\/a><\/em>. <\/p>\n\n\n\n

In that debate, proponents of gilt-plus valuations argued\nthat low gilt yields mean low returns on other asset classes. Recent research, however,\nshows that gilt yields are driven by inflation whereas returns on equities (the\nmost important asset class for pension funds) are determined by firms\u2019\nproductivity in the real economy. <\/p>\n\n\n\n

\u201cThe fall in gilt yields since the 1970s are the result of successful monetary policy to target inflation in order to ensure optimal economic growth, which in turn makes businesses profitable and hence healthy returns on equities.\u201d<\/p><\/blockquote>\n\n\n\n

Furthermore, Lord Paul Myners CBE (the UK\u2019s financial services secretary during the 2008 financial crisis) questions the wisdom of discounting pension liabilities at the current low-interest rates, which have been manipulated through quantitative easing<\/a>. Such a view is shared by economists who regard long term interest rates as inappropriate discount rates after they have been used as monetary policy tools.<\/p>\n\n\n\n

Also, gilt yields may have been depressed relative to\neconomic fundamentals by the Pensions Act 2004, since this requires pension\nmanagers to purchase gilts regardless of price. An\ninvestment bank estimates the potential demand for index-linked gilts as five\ntimes the size of the current market.<\/a><\/p>\n\n\n\n

The need for transparency<\/h3>\n\n\n\n

The USS has refused repeated requests by scheme members for\ninformation such as the projected benefit payments data. It is only after a\nmember of the Joint Negotiation Committee (representing University and College\nUnion) obtained the required information from USS that the findings\nreported in this article are made possible. <\/p>\n\n\n\n

It turns out that the reported discount rates are actually investment returns, not discount rates in the usual sense. Since the 2017 reported discount rates (investment returns) begin and remain at a very low level for ten years, the resulting actual discount rates are significantly lower; as shown in Figure 1.<\/p>\n\n\n\n

\"\"<\/figure>\n\n\n\n

The above revelation raises the issue of frankness in the\ngovernance of USS. Letters\nhave been written in the past<\/a> pointing out to USS that the scheme\u2019s\ndeficits\nare the outcome of falling gilt yields rather than any true funding shortfall. <\/p>\n\n\n\n

\u201cWhile the USS denies the use of gilt-plus methods in the\n2017 valuation, it fails to mention that the new approach actually produces a\ndeficit\nthat is higher than that obtained by gilt-plus discount rates.\u201d <\/p>\n\n\n\n

As Figure 1 illustrates, the 2017 reported discount rates\nbeing deceptively close to those of 2014 does not help convince its scheme\nmembers that USS is acting openly (in\nspite of the fiduciary\nduty of trustees to act honestly<\/a>).<\/p>\n\n\n\n

Evidence-free assumptions<\/h3>\n\n\n\n

The USS attributes the initial low investment returns to high asset prices buoyed by low-interest rates and a possible market down rating. However, the first ten years of investment returns average only 0.93 per cent, which is significantly lower than the gilt yield of 1.727 per cent as at the valuation date. A simulation study can show that the low return assumption is equivalent to using a rate with a less than 10 per cent probability to value a DB scheme.<\/p>\n\n\n\n

Also, the 2017 discount rates and inflation\nforecasts have varied like a rollercoaster for 50 years. It turns out that the\ndiscount rates are required to fall from year 11 to less than 2.8 per cent at\nyear 34 in order to ensure the\nfailure of Test 1 in the 2017 valuation<\/a>. <\/p>\n\n\n\n

\u201cNeedless to say, the rollercoaster variation of discount rates and inflation forecasts is inconsistent with the inflation targeting policy of the Bank of England.\u201d<\/p><\/blockquote>\n\n\n\n

Finally, both gilt yields and US interest rates were at similar\nlevels at the time of 2014 valuation. Since Brexit, the spread of US interest\nrates over gilt yields has widened to around 1.3 per cent, which further confirms\nthe assertion that gilt-plus valuation inflates pension costs. <\/p>\n\n\n\n

This is because (a) the assets of USS are internationally diversified,\nand hence (b) if the level of interest rates were to determine returns on other\nasset classes, it would be the US interest rate that calls the shots.<\/p>\n\n\n\n

Role of academics<\/h3>\n\n\n\n

Earlier research has shown that managers have been known\nopportunistically to use downward-biased discount rates to inflate\npension costs in order to obtain labour concessions. <\/p>\n\n\n\n

What happened to USS is worse: opaque valuation method based\non un-evidenced assumptions provided the 2017 deficit which led to a decision to close the\nUSS DB scheme? \u2014 an outcome that only the largest strike in British higher education\nhistory has been able to prevent. <\/p>\n\n\n\n

Note that as a result of continuing closure of DB schemes in\nthe UK, the\npension industry<\/a> is anticipating an estimated additional\n\u00a31 trillion annuities business in the next 20 years.<\/p>\n\n\n\n

The economic truth is that DB schemes enjoy intergenerational\nrisk-sharing and time-diversification of risk that no other pension designs can match.\nMoreover, regulations require trustees to always act in the best interests of\nscheme beneficiaries,\nwhich means implementing the regulatory guidelines of evidenced-based\nassumptions for valuation. <\/p>\n\n\n\n

While the report of Joint Experts Panel (JEP)<\/a> has vindicated the industrial action, the recommendations of JEP remain merely advisory. Therefore, it is vital for economists (and other academics) to scrutinize the assumptions that underpin the valuations of USS.<\/p>\n\n\n\n

Dr\nWoon Wong<\/strong><\/a> is a Reader in Financial Economics at\nCardiff Business School.<\/strong><\/p>\n\n\n\n

This article originally appeared in the Royal Economic Society<\/a> Newsletter (April 2019).<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"In our latest blog post, Dr Woon Wong argues that the discount rate currently used to value the liabilities of the Universities\u2019 Superannuation Scheme is too low, and that the […]","protected":false},"author":1538,"featured_media":1621,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_jetpack_newsletter_access":"","_jetpack_dont_email_post_to_subs":false,"_jetpack_newsletter_tier_id":0,"_jetpack_memberships_contains_paywalled_content":false,"_jetpack_feature_clip_id":0,"_jetpack_memberships_contains_paid_content":false,"footnotes":"","jetpack_post_was_ever_published":false},"categories":[1062],"tags":[1055,1060,1056,1057,167,28,100,1047,1050,442,563,1049,308,1054,411,1046,1059,366,1043,1042,1052,1058,1051,95,580,16,1061,1044,1048,1053],"class_list":["post-1614","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-pensions","tag-bank","tag-bank-of-england","tag-banking","tag-banks","tag-brexit","tag-cardiff-business-school","tag-cardiff-university","tag-defined-benefits","tag-discount","tag-financial-crisis","tag-financial-services","tag-gilt-plus","tag-higher-education","tag-inflation","tag-investment","tag-joint-expert-panel","tag-joint-negotiation-committee","tag-labour","tag-liability","tag-pension","tag-pensions","tag-pensions-act-2004","tag-pensions-regulator","tag-policy","tag-regulations","tag-research","tag-royal-economic-society","tag-university","tag-university-superannuation-scheme","tag-valuations"],"jetpack_sharing_enabled":true,"jetpack_shortlink":"https:\/\/wp.me\/paOfaS-q2","meta_box":[],"jetpack_featured_media_url":"https:\/\/blogs.cardiff.ac.uk\/business-school\/wp-content\/uploads\/sites\/620\/2019\/08\/Business-man-as-magician.jpg","_links":{"self":[{"href":"https:\/\/blogs.cardiff.ac.uk\/business-school\/wp-json\/wp\/v2\/posts\/1614","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.cardiff.ac.uk\/business-school\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.cardiff.ac.uk\/business-school\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.cardiff.ac.uk\/business-school\/wp-json\/wp\/v2\/users\/1538"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.cardiff.ac.uk\/business-school\/wp-json\/wp\/v2\/comments?post=1614"}],"version-history":[{"count":4,"href":"https:\/\/blogs.cardiff.ac.uk\/business-school\/wp-json\/wp\/v2\/posts\/1614\/revisions"}],"predecessor-version":[{"id":1629,"href":"https:\/\/blogs.cardiff.ac.uk\/business-school\/wp-json\/wp\/v2\/posts\/1614\/revisions\/1629"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/blogs.cardiff.ac.uk\/business-school\/wp-json\/wp\/v2\/media\/1621"}],"wp:attachment":[{"href":"https:\/\/blogs.cardiff.ac.uk\/business-school\/wp-json\/wp\/v2\/media?parent=1614"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.cardiff.ac.uk\/business-school\/wp-json\/wp\/v2\/categories?post=1614"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.cardiff.ac.uk\/business-school\/wp-json\/wp\/v2\/tags?post=1614"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}