The incoherence of UUK’s attitude towards risk – Mike Otsuka

Pension risk

Low risk is intolerable when shared by 350 institutions but high risk is fine when borne by workers individually

USS’s current troubles, and UUK’s proposed solution, reflect an incoherent attitude toward risk on the part of our employers.

Their responsibility for the difficulties we now face can be traced to a consultation in February 2017. Back then, they re-affirmed a false, overly conservative assumption regarding the growth of the higher education sector. When applied to USS’s much criticized Test 1, this forces a ‘de-risking’ of the scheme towards a bond-weighted ‘self-sufficiency’ portfolio. Employers chose this even though USS suggested that they instead embrace a different, less restrictive assumption, on grounds that it was internally coherent with USS’s own assumptions regarding the growth of the sector. (See p. 22 of sec. 4.4.3.)

Had employers accepted USS’s more realistic, less restrictive assumption, this would have reduced the deficit of the September valuation from £5.1 bn to about £2 bn, reduced deficit recovery contributions from 2.1% to about 0.5%, and reduced the cost of future accrual by about 2.25%. (See p. 23 of sec. 4.4.3.) When we also incorporate the more up-to-date mortality assumptions that USS has since adopted, the upshot would have been this:

It would have been possible, after jettisoning the unpopular 1% DC match, to otherwise retain the status quo of 1/75 CRB up to £55,550, and DC above, by means of a 1% increase in the employer contribution from 18% to 19% and a 0.5% increase in the employee contribution from 8% to 8.5%.

In other words, had employers not tethered the scheme to a highly restrictive interpretation of an already ill-justified and self-defeating Test 1 ‘self-sufficiency’ measure of risk, it would have been possible to keep the current scheme afloat between this valuation and the next one, via a modest increase in contributions.

Instead, having already induced a £5.1 bn September deficit and an unaffordable increase in the cost of future accruals through their embrace of an overly restrictive and incoherent interpretation of an already ill-justified and self-defeating measure of risk, our employers made things even worse by pushing the September valuation in an even more conservative direction. This is because 42% of employers rejected even this September valuation as too risky, thereby prompting USS to speed up their ‘de-risking’ of the portfolio towards bonds and to increase deficit recovery contributions. (Please see this post entitled ‘You Break It. You Own It’ for further details.)

It appears that UUK now regrets this excess of prudence, since they recently entered into agreement with UCU to try to reduce the level and impact of the ‘de-risking’ of the scheme and to lower deficit recovery contributions. UUK might be applauded for this move, were it not the fact that they should not receive too much credit for simply trying to undo the damage caused by 42% of their own employers, whom they had previously alarmed with their own consultation document regarding the level of risk inherent in the September valuation, which has been described by people privy to it as ‘project fear’.

Having broken the valuation by making further DB accrual unaffordable on grounds that the risk is too great for them, our employers are now proposing to divert future contributions from DB into individual defined contribution (IDC) pension pots. This amounts to a gratuitously large imposition of risks on employees, since our employers have embraced IDC in preference to a collective alternative which is no more risky or costly to employers but far less risky to employees.

UUK has tried to persuade us of the merits of their IDC proposal by modelling its expected outcomes, not on the basis of a like-for-like replacement of our DB pension with an annuity, but rather on the assumption that we will engage in a highly risky form of income drawdown of our pension pot.

What they are therefore proposing is the replacement of our DB pensions with a highly risky retirement savings plan, in order to protect themselves from the cost of wastefully expensive, excessively conservative measures to reduce risk to them, which they have needlessly brought upon themselves.

In other words, low risk is intolerable when shared by 350 institutions, but high risk is fine when borne by workers individually.

In two words: sheer chutzpah.

Go to the profile of Michael Otsuka

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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10 Responses to The incoherence of UUK’s attitude towards risk – Mike Otsuka

  1. Brian Gannon says:

    This is the worry with Defined Benefits, actuaries cannot agree amongst themselves, numbers can be manipulated to demonstrate whatever point of view the employer wants to demonstrate, and trustees are never going to be sufficiently expert or influential to achieve their aim of acting in the scheme members best interests. Ultimately it is down to the will of the employer(s) and how strong their belief is in providing ongoing defined benefits accrual. Sadly it appears that for many employers they are choosing to eliminate future DB accrual. An unintended consequence of the laws brought in post-Maxwell has been the gradual deterioration in future benefits offered. A great pity.

    • Dennis Leech says:

      I though the idea was that the PPF protects pension schemes when the employer has a weak covenant. If an employer goes out of business it does not follow that the workers lose their jobs. If the line of work continues having been taken over by an other employer the pension scheme ought to carry on. It does not have to be closed, surely.

      • Dennis Leech says:

        If the university of Poppleton goes out of business the likeliest outcome would be that the buildings would become a campus of another institution and the work of teaching and research continues. So why should the USS pensions not continue to be provided also?

      • Brian Gannon says:

        Agree. It does not have to be closed. But it will be.

  2. Bob Compton says:

    Very well set out, a case of Employers cutting their noses off to spite their face. When will common sense prevail. De-risking a scheme the size and potential longevity of the USS fund will be a hugely expensive mistake. Unfortunately in the short term only the UK treasury will benefit from supressed gilt yields at the expense of all other gilt purchasers (predominately UK DB pension funds). Mike it would be worth looking at the wider National knock on consequences in the UK if the UUK persist in their current direction of travel.

  3. PeterCB says:

    I wonder whether tPR might have something to say about the integrated risk management model of the USS when the pension scheme is predominately investing in assets issued by the main funder of the employer? There is a legal duty on the Trustee to diversify.
    What will happen to USS pensions in the situation that the UK Government has to “hair cut” or renegotiate the payment terms of its bonds? It would seem likely this that would only occur after a continued period of “austerity” with all its implication for higher education funding and the capacity of USS employers to make good any resulting shortfall.
    This scenario may seem currently unlikely but within the 50+ year duration of the scheme liabilities a return to a 1973 situation would seem to be a risk that should be considered and modelled.

  4. henry tapper says:

    A very good point PeterCB

  5. sandfordc says:

    The issue about assumptions (aka actuarial valuation bases) being manipulated to demonstrate whatever point of view the employer (or authority) wants to demonstrate was first highlighted in the early ’90s by peer comparisons in asset-liability studies. Too little has changed. Employers hid profits or smoothed results.

    Mores have changed and the objective of the ‘game’ is no longer to offer the best benefits to attract & retain employees. Could the same technique be employed to escape current & future commitments. Toughen the basis – Demonstrably unaffordable! Remove diversification over time & crystallise ‘risk’ at each moment – enforce risk (of what?) assumptions that compel transition into assets that can never affordable adequate pensions.

    Maybe we should think of an alternative to ‘You Break It. You Own It’. Possibly ‘We Break It. You Own what is left of it! – Why don’t you see if you can do better with (less than) half the contributions.’ Btw, we can give you some assumptions…

  6. Jnamdoc says:

    We talk about USS ’employers’ like they are some nebulous body – they are not; employers are managed by employees & managers many of whom will have vested interests. Its not incoherent if you view this (and the demise of DB more generally) in the context of generational wealth protection. One section of the population is deciding it wants to de-risk its allocation of wealth (in pensions), at the expense of another (i.e. the young). There is a certain amount of risk in an economy, and the babyboomers think that their pensions will be safer by heaping the risk onto the next generation. It doesn’t make sense when considered in the aggregate, but for individual ’employers’ (read managers etc), they can persuade themselves they are doing the right thing, and are hoping that the young will accept the risk, and somehow also generate the economic returns and tax receipts (needed to fund gilts) to pay for babyboomers’s pensions.

  7. Martin Evans says:

    Good article Henry, your firm has done some good work on this case.

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