Pure DC at your university? Mike Otsuka speaks out

Mike is now a regular writer on this blog; he’s an LSE philosopher, a member of the USS pension scheme and an expert in pensions (not a “pensions expert”).

Mike Otsuka

Mike – back in the day

 


Southampton has come out in favour of closing USS’s defined benefit (DB) pension to future accrual and moving to a purely defined contribution (DC) scheme. Their VC, Sir Christopher Snowden, has issued a statement in defence of this decision. As a recent past President of Universities UK, Sir Christopher is a leader among senior managers in the higher education sector. Given his prominence in UUK, it is alarming that his statement harbours so many myths, misconceptions, and misunderstandings (to borrow a phrase from UUK’s Employers Pensions Forum).

Sir Christopher (i) refers to “the growing deficit”, (ii) claims that the “current USS scheme is heavily in deficit”, and (iii) speaks of an “increase in deficit payments”.

(i) The scheme’s deficit is not growing. It is lower in absolute terms than the deficit recorded at the last valuation — £5.1 bn for March 2017 versus £5.3 bn for March 2014. More significantly, when one places this billion pounds shortfall in the proper context of the enormous size of the scheme and looks at the funding level of assets as a percentage of prudently valued liabilities, we see that the funding level of the scheme has improved from 89% in March 2014 to 92% in March 2017.

(ii) A scheme that is 92% funded is not “heavily in deficit”.

(iii) There is no proposed increase in deficit recovery contributions. The proposal is for DRC to remain unchanged at 2.1%.

Speaking of deficit recovery payments, there is the following howler in Sir Christopher’s statement:

“the University along with all other institutions who participate in this scheme are making substantial payments to address the huge deficit in addition to the pension contributions, currently of 18% of salary, together with 8% from employees in the scheme.” (emphasis in original)

It’s simply false to maintain that the 2.1% deficit recovery contributions are in addition to the 18% employer pension contributions. These are, rather, included as a part of the 18% contributions. (Protip: Don’t draw attention to your errors with italics.)

I save the biggest howler for last:

“…after careful consideration [Southampton] has supported the proposal for a defined contribution (DC) scheme for future benefits because it would provide greater certainty in terms of benefits…”

It is precisely the opposite of the truth to claim that DC gives greater certainty in terms of benefits. Unlike DB, which provides a great deal of certainty in terms of the pension benefits one will receive in retirement for one’s contributions, DC provides no such certainty whatsoever. It all depends on investment returns during one’s working life and annuity rates at retirement. That’s why it’s called ‘defined contribution’ rather than ‘defined benefit’.

“…after careful consideration…”

This one needs no further comment.

About henry tapper

Founder of the Pension PlayPen, Director of First Actuarial, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in accountants, actuaries, pensions and tagged , , , . Bookmark the permalink.

5 Responses to Pure DC at your university? Mike Otsuka speaks out

  1. Thank, Henry, for re-posting this. Any of your readers who has got as far as this comment might also be interested in my recent open letter to USS University Employers:

    View story at Medium.com

    Liked by 1 person

  2. henry tapper says:

    Another excellent piece

    Like

  3. Richard Bryan says:

    Eventually there will come a point when a DC scheme will very likely produce a better pension than a DB scheme with the required contributions increasing as threatened. The FTSE dividend yield is about 3.5%, the current CB scheme offers 1/75 for a 24% total contribution, i.e. effectively a yield of 5.55% uprated by CPI. Invest in a FTSE tracker, reinvest the dividends for, say, 20 years, about the average time between contributions and payment, which will double the capital (in real terms, if company profits keep pace with inflation) and then taking the dividends as income will give a better income than the CB, and that’s without touching the capital. No need to worry about annuity rates or ‘lifestyling’ into bonds, either. There is of course more ‘risk’, but something seriously wrong will have happened to the western economy if this doesn’t work out on average over several decades.
    An increase in the contribution rate to 32% will swing this argument even more.
    Btw, new article in the FT this evening, regarding a letter from the Pensions Regulator to the USS – they are no convinced by the covenant!! Ooops!

    Liked by 1 person

  4. henry tapper says:

    Richard, I agree with your conclusions. There is of course another way, CDC- which might be an eventual answer for employers with weak covenants and a workforce which believes in the western economy! I have read the piece in the FT, the letter beggars belief.

    Like

    • Richard Bryan says:

      Thanks, Henry. Yes, of course an investment strategy which works for an individual would work even better if pooled in a risk-sharing scheme like CDC.

      Like

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