USS pension changes would be a disaster (but they are preventable) – Dennis Leech


The changes to the USS that UUK proposed on Friday will substantially alter the nature of academic employment in the Pre-92 universities and will damage higher education irrevocably. They will mean academic salaries having to rise substantially to attract the best both internationally and from other industries to maintain standards. As such, they are a very unwise, short-sighted – and unnecessary – move by the university employers.

The academic career in a leading institution is never easy. Research is fraught with hazards. However the certainty of a pension provides a safety net that facilitates risk taking. It permits a researcher, for example, to explore an avenue of enquiry, not knowing what if anything is there to be found, but always in the knowledge that if it turns out to be a blind alley – as is often the case – then at least he or she will not be personally worse off as a result. It is a good basis for intellectual risk taking on which progress in human knowledge comes.

So why are the UUK preparing to scrap the pension scheme that has worked so well and contributed to the success of British higher education? We are told it is all getting too risky and hence too expensive. But I don’t think that is true.

Without going into technicalities, two things stand out, one political, one intellectual, as having created this fallacy. The political change was the coalition government’s withdrawal from formal involvement in the management of the scheme. Originally, when it started in 1975, there were three partners with seats on the board: the employers, the members and the government. At that time universities were mainly government financed through the University Grants Committee. The scheme had a strong covenant so could ignore any short term market volatility and invest long term in high return assets. But HEFCE withdrew in 2011, since when the institutions themselves have had to stand collectively behind the scheme. That is proving increasingly difficult given the uncertainties they are currently having to face. On the other hand, many commentators regard this particular group of well respected institutions as almost certainly sure to thrive for many years to come, and wonder what the fuss is about.

The other change that has led to this crisis has been in the mental framework used for pensions accounting in recent years. Most of the actuarial profession has undergone an epic ontological conversion from having a world view based on macroeconomics to one based on financial economics. Instead of pension schemes being able to benefit long term from economic growth by investing in productive capital, the traditional approach, they are now seen as myopic speculators in financial assets. Instead of investment return being the reward for patience, it is now seen as the reward for bearing risk; the world has become a “Random Walk Down Wall Street”; all assets are assumed to have a fixed quantum of risk which automatically and always gives a commensurate return. There is no distinction between long term and short term investment; all investment is speculation.

Financial economics has been widely adopted despite the fact that it is merely a theory without a sound basis: a pseudoscience. Many of its core ideas have been debunked by leading economists. For example the efficient markets hypothesis – that markets embody all known information – has been refuted by leading economists Joseph Stiglitz and Robert Shiller on theoretical and empirical grounds respectively.

Yet much of the finance industry including many pension scheme managers ignore the evidence. It is at the heart of the USS valuation methodology which talks about market derived asset prices, yield curves and inflation expectations being “objective”. But it is nothing more than a theory based on a particular set of assumptions.

It is a truly alarming state of affairs that such a closed belief system should be governing something as important and mundane as pensions. Yet universities themselves must ultimately take the blame. For the past twenty years or so business schools have found a ready market for financial economics courses. They have been marketed as “modern finance” embodying the latest research, with the emphasis on application of techniques rather than critically reviewing evidence, and have trained many thousands of graduates applying the ideas uncritically and confidently.

We are told there is a fixed amount of risk: the USS valuation document talks about a “risk budget”. Such a thing could only exist in the world according to financial economics. Risk depends on the context. There is a lot less risk if the scheme remains open to new members than if it may have to close. The view embodied in the USS valuation is the latter and that means market volatility poses a great risk that the pensions may not be paid and that has to be covered at great expense to the institutions. But if it remains open there is no need to regard market volatility as a problem and there is much less risk. In fact the UCU actuaries, First Actuarial, have demonstrated that the scheme could continue to invest in high return equities for the long term and all would be fine. Why are the UUK not listening?

This article first appeared in  the Times Higher Education Supplement and is reproduced with the permission of Professor Dennis Leech who is Emeritus Professor of Economics at the University of Warwick.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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7 Responses to USS pension changes would be a disaster (but they are preventable) – Dennis Leech

  1. Adrian Boulding says:

    I don’t think that standard TPR/Actuarial methodology takes full account of the long timeframe that universities operate on. My old college was founded 669 years ago and will still be going strong in another 669 so a very long recovery plan and investment timeframe would be entirely appropriate. The long game is how the college manage their own investments

    From an economists point of view there is only so much money available to spend on staff salaries and pensions. The sad thing is that where an employer can take a long term view of things, a large DB pension is a very efficient way of spending the available money, from a point of view of maximising tax efficiencies and getting a fair spread of reward between members


  2. henry tapper says:

    I’m glad you wrote that Adrian – especially as I will be taking a similar line tomorrow at the TISA decumulation event! If we can’t trust universities to be around in 50 years , who can we trust!

  3. John Reynolds says:

    But, what exactly is this all about? Is it pensions? Is it funding? Is it costs? Are the people making the decisions really acting in the longer term good of the whole, or are they more focused on their own Christmas bonus? I suspect one day someone will come up with a great idea called a DB pension…

  4. henry tapper says:

    Thanks John – it’s about a wage for life IMO

  5. Bryn Davies says:

    Thank you Dennis for a great contribution to this debate. You are absolutely right. It beggars belief how those who run our universities have been persuaded to cause themselves so much self harm.

  6. Dennis Leech says:

    Thank you Bryn.

  7. Bob Compton says:

    Dennis, the PPF was set up as a safety net funded by DB pension schemes ultimately funded by those employers running DB schemes, not the Government or Taxpayers. The Act establishing the PPF had clauses in dealing with moral hazard, i.e. the perception that an Employer struggling to fund it’s DB promises would “game” the PPF and invest in “riskier” assets. To guard against these “dreadful” possibilities the Pensions Regulator was given a statutory obligation to ensure the PPF is not misused. The object in the original thinking for the legislation was that the remaining Employers with DB schemes would have to pay through the levy payment system, the costs created by these “rogue” employers. A bit like insurance claim scams being a burden not on the Insurer but on the policyholder through increased premiums.
    Now the Pensions Regulator by its very nature is risk averse, and is focused on avoiding potential claims on the PPF. It looks to see prudent levels of funding achieved within relatively short timescales, and initially ignored the impact forced funding may have on the viability of a business, and the fact their policies accelerated the demise of may struggling businesses.
    A decision to close an ongoing DB scheme to either new accrual or new entrants, is the first step in the demise of the scheme, so immediately the basis of funding has to change. So the current situation is driven by supposedly high funding costs driven by the need to ensure the PPF is not “gamed”. The government has also played its part by encouraging the purchase of Gilts by the BoE for QE, forcing up the cost of “prudency”, and creating a spiral to the insanity we have today where gilts guarantee a loss, but are still perceived as “safe”. If the UK fails to generate growth in the economy, those “safe” gilts will be at risk. GDP growth in the economy is driven by business delivering “value” (and hence profits), and hence increasing dividends for shareholders, including ongoing DB pension funds.

    It is very important that pension funds such as the USS are managed and governed efficiently, and that the benefits offered are affordable and cost effective. That means not offering early retirement deals that are not fully funded. It is also important for the UK economy that pension funds like USS are run successfully and invest for the future in real growth assets.

    If the chancellor wants to promote “patient capital” (for the reasons outlined above) schemes such as the USS must remain open to new members and accrual.

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