USS pension changes would be a disaster for universities, but they are preventable

A badly understood notion of risk has created a fake crisis in university pensions that will devastate academia, argues Dennis Leech

November 21, 2017
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The changes to the Universities Superannuation Scheme that Universities UK 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.

An 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 is 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 the Higher Education Funding Council for England withdrew it 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 mentality of 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 that 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 that 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 20 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?

Dennis Leech is emeritus professor of economics at the University of Warwick.

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