In recent weeks we have seen blogs from Professors Emeritus Michael Bromwich and Dennis Leech both addressing the travails of USS. The blogs can be read here and here respectively. Professor Bromwich’s note is a particularly good attempt at piercing the veil of USS disclosures, which once again can best be described as murky.
The irony of the pension scheme, for those leading transparent scientific endeavour and innovation, hiding behind unsubstantiated half-truths and avoiding peer review would be rather funny if the consequences were not so dire. Bromwich’s blog is worth reading on these grounds alone.
Both these blogs come down in favour of a cash-flow driven analysis of the situation, though they differ in detail. It is also clear that neither believes that the position with USS is as dire as the management of USS would have employers, employees, the Regulator, and the world believe. And when two eminent academic economists find something disturbing, it is probably wise to pause and consider.
Rather than attempting to parse the actuarial models and assumptions, a process which would surely get bogged down in the detail, I simply want to answer one question: how credible are the deficits that we are being asked to consider? I will approach this by asking: what is the required rate of return on assets held at the March 31st 2020 valuation necessary to fully discharge the projected liabilities?
USS published the technical provisions projections of the scheme at this date. In total, they amount to £137.5 billion over the coming 82 years. As these are technical provisions inputs, they will be prudently estimated, though we do not know the extent of this prudence. Scheme assets were reported at £66.5 billion. With these benefit projections and the asset portfolio valued at £66.5 billion, the required rate of return on these assets is just 3.22% pa. This is a nominal rate.
In line with avoiding peer review, we are not treated to a full description of the input parameters of these technical provisions. However, we are treated to two tables listing the gilt yield and CPI inputs. Given what we know about inflation and government bond yields, I find these bizarre. I have reproduced them below, together with their difference, as chart 1.The asset valuation above occurred close to the bottom of the pandemic panic. Asset prices have since then recovered. There have been recent comments that the asset portfolio recently had a value of £74 billion – in which case the required rate of return would now be 2.68%
These are nominal rates of return applying for the long term; the final horizon for this return is 90 years from now and the duration of liabilities is 19.8 years. The resultant question to be asked is: how do these required rates compare with USS Investment Management’s published expected returns? To present these in comparable nominal terms, I have used a CPI value of 2.0% as applied on average in the projections estimates.
These are shown as table 1.
|Index Linked Gilts||0.43%|
From this it is immediately obvious that a return of 3.22% is easily feasible within USS’s own expectations. This is particularly true if gilts and index linked gilts are only sparsely held (if at all). It is also far below the historic returns of the investment portfolio, which are substantially higher than the expected returns of Table 1. The claim that a deficit exists is therefore on extremely weak ground and this becomes even weaker in the light of recent asset price performance.
If we look to the technical provision liabilities figures published in the UUK consultation in Table 2 below, and require funding to these levels, we see the following required rates of return.
|Technical Provisions (bn.)||76.3||78.8||81.4||84.4|
|Required Return on Portfolio||2.53%||2.37%||2.22%||2.05%|
These are, quite simply, obscenely low. It is just not plausible that these low rates will persist for the next 80 years.
At these rates, it would make sense to take the money out and invest it in the universities given the economic value added of the sector!
It is immediately obvious from the projections of one year’s accruals that the scheme is growing, and growing strongly – with new accruals and £6.86 billion and pensions paid of just £2.24 billion, it is growing at 3.36% p.a. Moreover, the duration of these new liabilities is 31.8 years which compares with the scheme’s prior assessment of 19.8 years.
This scheme is not maturing – in fact, it is growing larger and longer. In this situation, it is difficult to see why there should be any meaningful focus on the various de-risking strategies of which USS management appears so enamoured.
More attention should be paid to the economic consequences of the management of USS, both to the sector and the economy. We shouldn’t allow obscurantism to let USS pursue a strategy that is decoupled from these basic realities of investment and pensions.