Is the University Superranuation Scheme suffering fantasy deficits?

fantasy deficit

First the big picture

Universities aren’t going away, nor are the people who teach in them, administrate them and provide the infrastructure that keeps them going.

Many of our universities have survived wars, plagues, great fires as well as many stock-market recessions. People have taught and been taught since the renaissance.

Now the little picture

It is being suggested, because of the financial deficit imputed to the USS pension scheme, that the foundations of our university system are under threat.

The latest financial reports from USS have made it to the front page.

Academics would have to contribute more to their retirement or have future pensions diluted, which would be strongly resisted, (John Ralfe) said. Alternatively, student fees would have to be raised, or more money would have to be diverted from teaching, he added.

John leaves us in no doubt

“The danger that USS poses to the future financial health of UK universities is hugely underestimated”

John is an expert in delivering bad news and the bare numbers give him plenty of ammunition. Using the gilt based valuation technology favoured by accountants , the deficit on the scheme has increased by £7bn in the last year to £16.5bn.

What is surprising is the next line  In the year to March 31, USS’s assets rose by 21 per cent to £60bn, but its liabilities increased by 33 per cent to £77.5bn.

What is going on?

The question I (and I hope you) are asking is how a pension scheme’s liabilities can jump 33% in a single year.

Are all those University staff living a third longer?

The answer is “no”, the nature of the liability is the same, same people with longevity increases probably flattening.

What is going on is a fiddling of the numbers about which we have heard very little. Sure interest rates have remained low and with the gilt rates – which drive accounting valuations, but I have seen no explanation why they should have driven a 33% rise in liabilities.

Bill Galvin, the USS CEO blames investment returns

 “All we’re in a position to say now is that it is likely that investment returns will be lower than they were assumed to be in 2014 and that will put up the cost of future contributions.”

I find this equally confusing. Apparently , the in-house investment team under-performed its benchmark over the period by 2% but still returned 21% growth on assets.

What kind or investment return was USS looking for? Presumably a return that could exceed the 33% increase in liabilities? In a low-inflation, low-growth environment this looks like a Herculean task?

To the ordinary reader, none of this stacks up. To assume this is leading to teachers being laid off and students paying higher fees is a big jump. People deserve a better explanation.

A better explanation.

Let’s look into the report and accounts and see what’s going on. Here is how the money in the Scheme is invested.USS1

You can see that the majority of the assets are directly managed with only around 20% invested in pooled funds. this should be good news if you have an eye for costs, but these numbers don’t give you the real reason for that 21% return. The reason for that was that the fund was invested 45% in equities, 34% in alternatives and only 15% in bonds (2015 figures).

Ironically, the under-performance was stated to be because the fund was under “invested” in index-linked gilts. I put invested in inverted commas – these gilts aren’t really an asset and their stellar performance last year is down to technical issues such as supply and demand the impact of ongoing quantitative easing.

The point to be made about the scheme, is that it appears appropriately invested for the future, a future where universities will continue to operate, teach and research. Back in 2006, when the fund was much more heavily invested in equities, John Ralfe predicted disaster. Here is what has happened (I exclude the latest returns already discussed)

2006 15.8%
2007 5.5%
2008 -37.0%
2009 26.5%
2010 15.1%
2011 2.1%
2012 16.0%
2013 32.4%
2014 13.7%
2015 1.4%
2016 11.9%

Equities have had one awful year (2008) and a number of good years. The overall impact of being invested in equities over this time will be to keep the fund invested in real assets that profit from real growth in global productivity.

We are currently working on scenarios which John would be happier with. What would have happened if USS had been more heavily invested in bonds in 2006 and what if we valued the fund relative to the actual assets it held, rather than how those assets would behave if they were gilts.

Talking of which…

Here is what has happened to the liabilities


From this, you can see that the contributions made to the scheme more or less cancelled out the accrual of new benefits (disappointing as some of those contributions were supposed to be reducing the imputed deficit.

You can also see that by far the biggest factor in the increase in the deficit was the “effect of market conditions on liabilities. This is getting to the nub of the 33% increase in liabilities. I am a simple man, nearly £8bn increase seems more than technical! What is going on?


FABI explains a lot!

FABI July 17

What First Actuarial’s FAB index does is explain that while all this “technical” stuff is going on, the real state of schemes improved from 2006 to 2017 because assets grew faster than liabilities (when you stop being technical about it).

In the real world, the USS did not increase its liabilities by 33% last year but it did increase its asset base by 21%.

The USS, unlike a lot of corporately sponsored schemes is not on a road to buy out, its members will still be teaching in 2117 and the scheme should still be operating indefinitely! We do not stop universities because of technical issues with pension scheme valuations.

The long-term future of the fund is bright so long as it takes a long-term view. The one thing that might stop that long-term view is the kind of panic measures being advocated by John Ralfe and others. We do not need to sack teachers, or increase fees – we need to see the deficit as what it is – “technical”.

This cry of pain from John Ralfe and the pedlars of gloom is crying wolf!



Here is something else.

Before I exonerate the management of USS, you might like to read this table. There haven’t been many pay-rises in the universities in the past decade, these figures make for uncomfortable reading.

The USS need to be better about messaging and explain just why the highly paid individuals working for it – are seeing such big wage-hikes.


About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in accountants, actuaries, advice gap, pensions, Public sector pensions and tagged , , , , . Bookmark the permalink.

14 Responses to Is the University Superranuation Scheme suffering fantasy deficits?

  1. John Doney says:

    Excellent article that gets to the heart of a lot of DB schemes supposed deficits. Nonsense calculations. Anyone investing now for the long term future with a reasonably balanced risk profile would be crazy to allocate so much to fixed interest/Gilts. Yet schemes such as this seem to assume it is all in Gilts. By the way if the asset managers underperformed their benchmark yet produced 21% I’d have to ask what on earth is their benchmark based on!! Do dig further into this if you can Henry – there is something rotten going on in this scheme – and its not the investment performance.

    • Nic X says:

      But hedging needs not be using the physical capital, it can be done in a capital-efficient way via derivatives overlay so that the rest of the capital can still be invested in a diversified growth portfolio. Why take the interest rate risk if you have no view on it?

      • henry tapper says:

        I think the more fundamental question – is “what risks are long-term schemes like USS actually taking?” – most of this hedging stuff assumes an end-point at which the scheme is wound up. Not a view that most members of USS would accept I think. Mind you, if future employment is made conditional on accepting DC or cash balance – as is happening elsewhere – USS members may as well forget “pensions” for future service and lock down past promises as others are doing. This is the hub of the argument – how and what you hedge is peripheral

  2. henry tapper says:

    We have hired a JCB and are digging further.

  3. Ros Altmann says:

    Excellent piece Henry. There is insufficient differentiation in this DB debate between open and closed schemes and of course the exceptional situation with respect to interest rates that currently prevails. Long-term investment for long-term liabilities is a prudent approach, as long as the investments and risks are properly understood and managed. The Bank of England’s pension scheme gives an indication of what has happened if schemes invest wholly in gilts – its pension fund fell into deficit and its contributions had to rise from around 25% to over 50% of staff salary. This is a live ‘case study’ for those who suggest DB schemes should invest only in ‘safe’ or ‘matching’ assets. Gilts do not match pension liabilities – they are an approximation. There remains a mis-match as they do not move with longevity, lpi or salary inflation and, of course, if starting from a deficit position then just ‘matching’ is not sufficient anyway. Outperformance of the liabilities is required. Diversifying sources of risk and return, which can expect to outperform ‘low-risk’ bonds is likely to offer better long-term prospects for USS. You rightly point this out and I do hope this receives plenty of ‘likes’! Well said Henry. Ros

  4. henry tapper says:

    Good of you Ros!

  5. Fascinating insight to the opaque headlines about pension scheme deficits.

    Is it correct to still measure liabilities as they are, or move on from the obsession with gilts?

  6. henry tapper says:

    RAY- Great question that captures the heart of the argument. If your pension is invested in gilts, value it with a discount rate set against gilts. I think USS uses gilts + 0.5% (correct me if I’m wrong). That seems odd when 40%+ of the fund is invested in equities. CETVs which use a measure called “best estimates” reflect the holdings in real assets but IMO, the current valuation method doesn’t. I am not an actuary and am parroting some of this, but it does seem to me that USS is tying itself in knots about this and could do with moving to a less cautious (prudent) measure for valuations. If it doesn’t, it will end up costing members their jobs and/or putting up the cost of tuition (which goodness knows is high enough already!)

  7. Dennis Leech says:

    The report does actually give a figure using best estimate. Buried away on page 104 it says that one method for valuing the liabilities is best estimate and that the figure in 2014 at the last valuation the figure was £37 bn giving a scheme surplus of £3.5bn.

  8. dearieme says:

    Ralfe was one of several people who said in 2005 or 2006 that USS was badly run and in a deteriorating condition. The management responded by (i) sturdily denying it, and then (ii) admitting it implicitly by overhauling the benefits by closing the final salary section to new members, and then (iii) later overhauling the benefits again by scrapping the final salary section to further accruals altogether, and limiting the career averaged section. The method of closing the FS section was particularly austere: your “final salary” was no longer based on, y’know, your future final salary but instead on your salary when the section was closed to new accruals. Further the scheme followed public sector pensions in reducing inflation-protection from RPI to CPI. That decision was consistent with the scheme rules (Trust deed?) but inconsistent with some of the scheme literature given over the years to the membership.

    I’d say that these rather flustered and harsh changes supported Ralfe’s original criticism. As for the question of what discount rates to use: who knows? It’s all guess work.

    It must be admitted, though, that the substantial negative real yield on ILGs must make running a DB pension scheme particularly tricky and, in particular, makes liability-matching of the sort Ralfe would presumably prefer frighteningly expensive.

    The fun will really start if universities begin to close in a disorderly way, dumping their liabilities onto the ones that survive. Closure of some might be a good idea: do we really want 40% of the age group studying fatuous degrees in Grievance Studies?

  9. Peter Walker says:

    Good discussion. Could one factor be their estimate of future increases in pensionable salaries? The table shown certainly suggests increases above CPI in higher earning staff.

    • “Could one factor be their estimate of future increases in pensionable salaries? The table shown certainly suggests increases above CPI in higher earning staff.”

      That’s a negligible factor, since the DB pension is salary-capped at £55,000 plus CPI revaluation, and it’s defined contribution above that threshold. (Incidentally, the table lists the salaries of the people who run USS, not of people employed by universities.)

  10. henry tapper says:

    To your point Peter

    Everybody knows that the dice are loaded
    Everybody rolls with their fingers crossed
    Everybody knows that the war is over
    Everybody knows that the good guys lost

    Everybody knows the fight is fixed
    The poor stay poor and the rich get rich
    That’s how it goes
    Everybody knows that the boat is sinking

    Leonard Cohen

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