Equity inequities

November 21, 2013

Considerable attention has been paid to the Universities Superannuation Scheme’s ability to meet its obligations (“USS’ multibillion-pound deficit could leave staff footing the bill”, News, 31 October). These figures have been pooh-poohed by some who argue there is no problem at all, and that the deficit is a mere accounting artefact created by ideologues who do not understand how pensions work (“Pay it forward”, Letters, 7 November). But unless matters improve, the Pension Regulator will require the USS to take steps to meet the gap.

If the universities have to put more money in, where will they find it? They can hardly go cap in hand to the government and ask for an extra allocation. The government finances them on the basis of student numbers, courses studied and excellence in research: nowhere in this algorithm is there an element to cover pension fund deficits – hence the suggestion that tuition fees might have to go up. Of course, the universities could cut back on building maintenance, put off IT upgrades, buy fewer books for their libraries, or even reduce staff-to-student ratios (perhaps by laying off academics). All are the equivalent of raising fees. Students either pay more for the same or the same for less.

Why does the USS finds itself in deficit? In the past, it has pointed the finger at stock market downturns and increases in longevity for its problems. (Remember the justification for the 2011 reforms?) More recently, it has blamed quantitative easing for pushing down interest rates – it earns less on the bonds it holds and the present value of future liabilities increases. But QE has raised the price of bonds and dramatically improved share prices. This has benefited the asset side of the fund.

The USS has failed to learn that its assets should match its liabilities. Forty per cent of its obligations are to retirees or deferred pensioners. Such obligations need backing from products such as bonds: they pay out a fixed income, which is what the retirees and deferred pensioners are entitled to.

Rather than matching liabilities, the fund has invested in equities – and far more aggressively than most pension schemes. Yes, the USS’ equity allocation is lower than it was a few years ago, when the shares made up 80 per cent of its assets. However, equities still make up more than half of its portfolio (bonds constitute only a fifth and most of the rest are “alternatives”).

The universities should stop betting on things getting better, or blaming the current situation on “volatility”. Even if there were no more volatility (some hope) and even if the lower deficit claimed by the USS were the correct one, rather than the higher one the Pension Regulator is likely to use, with the equivalent of a £1,000 fee rise it would still take 15 years to plug the current deficit.

Rather than paying mega-salaries to fund managers to try to beat some index, our universities and the USS should start facing up to the reality.

Bernard H. Casey
Institute for Employment Research
University of Warwick

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Reader's comments (1)

I agree we should stop paying managers to beat the market. Iy is depressingly clear that over a 10 year period, almost no one does and worse at the start of that period and almost right until the end, no one can identify who will. Worse USS paid these huge sums to underperform. I disagree about your bond fetish. If we are in a perma slump (hello to Larry Summers) then bonds could remain negative relative to inflation for a prolonged period. IMHO the real problem is mix defined contribution now with fixed payout in 40 years. Its not possible unless you make the scheme unaffordable. If bonds pay inflation + 0.2 %, then the sums needed to pay a half salary pension are simply enormous. I'd rather we had a hybid scheme, a core pension with a similar accumulation system as now based on bonds (approx 60%) with index tracking on equities (approx 40%) but the pension limited to 20K a year index linked (only that part of your salary up to 40K considered for the scheme). For those who earn more & want an additional pension give then a % contribution on their salaries above 40K and leave them to make their own arrangement. By varying this contribution for the better paid, you could top up if needed the core pension fund. That way you provide a safe core, look after those least able to look after themselves and run a modest stable (almost management fee free scheme).

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