UK university pensions suffer from misplaced caution


UK universities face a new wave of pension strikes. This was the indication of relationships warning that students who have recently returned to university could suffer further disruption from striking academics. It’s easy to condemn them, but I’m not. They are victims of unduly risk-averse decisions under the University Retirement Scheme, under the influence of incorrect regulation.

The USS is a large funded scheme, with 476,000 members and £ 82.2 billion in assets. Universities are also more or less immortal institutions. If they can’t afford the benefits promised in their scheme, no one can, except perhaps the government.

Given the impossibility of total security, how “safe” would a prudent person want long-term promises to be? Two recent documents illuminate this question.

Raghavendra Rau of Cambridge analyzes a weighted portfolio of 55 per cent in global equities, 20 per cent in global bonds, 20 per cent in British bonds and 5 per cent in British bonds from the year 1900. Compare the “yield assumption” prudent “of the USS of zero real yield over 30 years with the worst realized return on such a portfolio in the past 120 years, spanning two world wars and the great depression. It turns out that the conservative hypothesis of the USS is far worse than even these disasters.

The USS is making extraordinarily pessimistic assumptions about long-term returns.  Chart showing the value of an investment of £ 1 in 1900, no withdrawals, real terms (logscale) projected to 2050. Note: Historical real returns in the UK for a 55% weighted portfolio of global equities, 20% bonds global, 20% UK bonds and 5% UK bills (with annual rebalancing) year 1900

Is this prudence or extreme pessimism? The first, he argues David Miles and James Sefton of Imperial College. They estimate the risk in terms of a standard probability distribution and conclude that “a substantial investment in riskier assets (shares) makes the average result one in which the system is comfortably able to pay the accrued benefits. But the risk of having far fewer funds than necessary to pay existing pension promises is significant and the chances of large deficits are very substantial. “

So even though the returns on equity are returning to average, there is a 23% chance that the USS will run out of money by 2100. If this is to be avoided, something has to change, they insist.

This raises two big questions. The first concerns the likelihood of such disastrous results. The second concerns the possibility of insuring a pension fund against such disasters.

Corresponding to me, Miles argues that “there is a great risk of champion selection bias: the United States and the United Kingdom have not lost wars, they have not had hyperinflation, they have not been invaded, they have not had a political collapse. . Returns on Argentine, German assets (the bonds were canceled in the middle of the century) etc. they look very different and are vastly more volatile. ”It is easy to imagine catastrophic developments – thermonuclear warfare, communist revolutions, collapse of the state, and so on – that would wipe out any equity portfolio.

However, it challenges the belief that a higher contribution rate and more prudent investment strategies protect wealth from such catastrophes. These are not insurable, certainly for a large number of people. If the UK and US were hit by 1,000 nuclear warheads, capitalism collapsed or governments went bankrupt and taxed most of the wealth, no investment fund would survive. The destruction of wealth on this scale today cannot be avoided with a little caution. This gives an illusion of security, but not reality.

Forget this notion. What makes sense is to have a sensibly invested fund (i.e. one predominantly in equities) that is structured to limit the downside risk for both members and sponsors in the event of a problem, on a relatively manageable scale. What would therefore be necessary is an adjustment of the benefits and contributions. This flexibility is what all pension funds need, not to protect themselves from extreme disasters, but against the disadvantages of actual performance in the real world.

In sensible management collective defined contribution pattern, it would have happened. Since USS sponsors don’t have infinitely deep pockets, it makes sense to limit the responsibilities they bear. As Miles also writes: “The question is whether the USS with its strange structure (a large number of different institutions, many with limited capacity to insert more) is able to make promises that guarantee fixed pension payments. We need to spread the risk better “.

Does this make sense. But the answer is to consider that very structure. It is not for the USS to try to insure against the end of our world. The end of the world is not insurable. No sensitive fund should attempt such a thing. In the ordinary course of events, the USS is more than adequately funded, whatever the regulations say.

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