The Pensions Regulator appears to have forgotten one of the fundamental laws of gravity- “what goes up, must come down”.
In consumer finance this translates into “the value of investments can fall as well as rise” and in the case of the USS, the solvency of a pension scheme can “rise as well as fall”.
Taking action based on recent results is a mugs game, past performance is no guide to the future, mean-reversion applies eventually and the USS deficit will – given time – revert to surplus.
This is because the USS pension fund is well-managed, because the Western Economy continues to grow and because the current interest rates, depressed artificially by Government policy, will eventually rise.
Why this cod-economics?
The FT have seen a letter, which they partially display, from the Pensions Regulator to the heads of the University Superannuation Scheme. The letter restates tPR’s recent mantra that a scheme is only as good as the sponsor’s covenant but then goes on to argue that the covenant is only as good as the scheme.
TPR said a “key reason” for its weaker view was the “substantial increase” in the size of the scheme’s liabilities in recent years, which had outstripped the increase in the scheme’s assets between 2014 and 2017. – Jo Cumbo;
My first article on this subject expressed my “cod view” that universities are immutable. Oxford and Cambridge have survived not just the odd economic blip but several world and European wars, plagues and industrial revolutions! A little blip in funding caused by artificially depressed interest rates is not going to threaten our university system.
USS commissioned not one covenant assessment but two, the first from PWC and the second from E&Y. Both rated the covenant as strong. TPR wish to dispute this, according to my sources because they don’t think the Univerity’s £1.5m in free cashflows sufficiently covers the debt.
“We take the view that there are issues with the sector’s ability to increase payments to the scheme, which might arise under realistic downside scenarios, to remove the deficit over an appropriate period.”
John Ralfe expresses surprise that I disagree with TPR
— John Ralfe (@JohnRalfe1) October 12, 2017
I find myself in good company.
TPR do not have a crystal ball to determine what the University’s financial position will be in years to come, the covenant assessments look at the situation today. We have to have some optimism for the future, what a dreary existence otherwise!
To suppose that the increase in liabilities that has caused the deficit is indicative of things to come is as foolish as supposing that the current bull run in UK and overseas equities is going to last. The stock market is at a record high, interest rates are at a record low, the two don’t quite cancel each other out and the USS is showing a deficit. Turn the market scenario around, the USS could have less assets but greater solvency.
The only kind of past performance that can be used to consider pension liabilities is the long-term kind, which matches the duration of people’s lives. If we look at performance in terms of the past 70 years (e.g. post-war) then we get a rather better data-set, than what’s happened over the last couple of triennial valuations (e.g. since 2010).
A welcome leak
Whoever leaked this letter to the FT is to be thanked. The discussion over the USS’ capacity to meet its pension obligations in full, is one that impacts everyone who reads this blog. It matters to universities, students, future students and most of all it matters to those in the Scheme itself.
The Universities wish to play out the discussions in private, the members are keen not just to understand the numbers , but to actively participate. At a time when the pensions industry is bewailing a lack of “engagement” , the USS has a superfluity!
Ultimately, this discussion comes down to time. Those – like John Ralfe – who think in short time horizons, want this deficit nailed immediately and would happily move the USS to a DC accrual and its assets to bonds. Those who argue on this blog (Otsuka, Leach, Keating et al.) argue that time will work the deficit out. I side with the latter group because I see no end to Universities and no reason why they should reduce the quality of benefit promise.
The Pensions Regulator appears to me to be intervening unnecessarily and unhelpfully. Its obsession with the covenant is unhelpful, its chicken and egg confusion between covenant and deficit is unhelpful and its accusation that the statement that there are “many significant risks inherent in the funding statement” – self-evident to the point of banality.
A crucial point in the charge transparency debate, was when the Investment Association over-played its hand and likened hidden charges to “Nessie”. It may be that something similar happens here. The Pensions Regulator’s case is hugely diminished by the perverse logic of this letter.
If we want no risk- let’s return to individual annuities.
The FCA want us to consider innovation in our thinking about retirement outcomes, the Pensions Regulator would have no risk in defined benefit. If we want no risk, let us have individual annuities and scrap pension freedoms; if we want innovation let us have collective pensions and the non-advised solutions on which we relied till recently.
The answer does not lie in de-risking but in risk-sharing. De-risking simply shifts risk from one party (usually a sponsor) to another (the member). Risk sharing realigns the risks taken to meet the particular circumstances of the sponsor and the needs of the member.
- In some cases, members are prepared to take 100% of the risk (the First Actuarial pension scheme is pure DC- at the moment)
- In some cases , members accept they must take more risk than previously (the CWU’s proposals for the Royal Mail are a good example)
- And in some cases, there is simply no case for changing the risk-sharing relationship.
I am not an actuary or a member – (I am a little bit a sponsor) of the USS. However, I can see with the cod eyes of a layman that the Universities represent a very strong covenant indeed and that members of the USS work for the universities because of that pension covenant.
The Pension Regulator, in this leaked letter, are intervening in a most unhelpful way, I can only sense that this aberration is because they are spooked by BHS. I hope that that the leaked letter will steel the resolve of those who take the long-term view. The USS management need all the support it can gets and the Universities need to know that they represent as good a covenant that can be offered – outside the public sector.