Help USS avoid the ‘de-risking’ trap: a plea to the Joint Expert Panel
This is a USSbrief, published on 16 July 2019, that belongs to the OpenUPP (Open USS Pension Panel) series. It has been submitted to the UCU-UUK JEP (Joint Expert Panel) by the author on 14 June 2019. The author makes this submission as an ordinary member of USS, not on behalf of UCU or his employer.
For me, the fundamental question to be addressed in this phase of your work as the Joint Expert Panel, from which all matters relating to the valuation of USS flow, is what the scheme is trying to achieve and how. There appears to be broad consensus among scheme members and the sponsoring employers around four principles. These are that USS must:
- Remain a Defined Benefit [DB] scheme.
- Provide a decent pension in retirement for its members (broadly, one which is comparable to that provided by Teachers’ Pensions Scheme [TPS]).
- Remain open to new accrual and to new members (which is critical if inter-generational equity is to be maintained).
- Be cost efficient.
Fulfilment of principle 4 requires that USS invest the funds that it manages in return-seeking assets. Any investment is risky, and it is likely that prudent risk management will result in a mix of higher and lower yielding assets being held. Important factors here are scale and time. USS has significant economies of scale, allowing it to spread risk at any one time. USS also has a long time horizon: the scheme is a long way from maturity, has positive cash flow for as far ahead as can reasonably be modelled, and a strong employers’ covenant. These factors mean that short-term risks and those arising from cyclical phases of economic growth and decline can be managed successfully, as USS has done in the past.
Yet instead of choosing to manage risk, and to remain cost-effective (thereby upholding principle 4) by emphasising investment in return-seeking assets, USS has a settled policy of what it calls ‘de-risking’. This involves moving from higher- to lower-yielding investments, in the belief that the latter are less risky than the former. This is mistaken on two counts. First, it assumes that low yielding investments are low risk. There is now considerable evidence, e.g. arising from analysis of the 2008 global financial crisis and the Eurozone crisis, that this cannot be assumed to be the case. Moreover, such a belief carries with it a significant risk of asset-price inflation. Investors seeking to ‘de-risk’ by buying low yielding assets create a demand, which drives up the price of those assets and further depresses their returns. This can create a vicious circle, whereby increased holdings are then required in order to generate the required overall return. Such behaviour increases risk, as prices and returns move further out of kilter. It also fatally undermines principle 4, the cost-efficiency of the scheme.
Secondly, and relatedly, the term ‘de-risking’ is a misnomer. Undermining the cost-efficiency of the scheme by selling higher-yielding assets and buying lower-yielding ones does not reduce risk: it crystallises it. De-risking is not a rational response to long-term risk for USS. It simply turns a theoretical risk, that the scheme might not in future have sufficient assets to cover all its pension liabilities, into a certainty that it will not have sufficient assets to cover all its pension liabilities.
Given the agreed purpose and the particular characteristics of USS (principles 1–4), USS’s decision to de-risk makes little sense. Instead, it seems calculated to undermine principle 4, and thereby to change the purpose of the scheme — against the wishes of both its members and sponsoring employers (with the exception of one or two that are very small and very rich) — by hastening the closure of the DB section to new accruals. Thus, USS also appears to be acting in direct violation of principles 1, 2 and 3. It is hard to resist the conclusion that USS management wishes to shift all investment risk from itself onto its sponsoring employers and scheme members.
I would therefore be grateful if the JEP could, from a starting point of upholding the four principles enumerated above, bring its expertise to bear on demonstrating to the USS trustees that a suitable investment strategy, which does not require any further ‘de-risking’ of scheme assets, is the best means of sustaining the financial viability of the scheme and upholding the four principles on which it should rest.
This is a USSbrief, published on 16 July 2019, that belongs to the OpenUPP (Open USS Pension Panel) series. It has been submitted to the UCU-UUK JEP (Joint Expert Panel) by the author on 14 June 2019. The author makes this submission as an ordinary member of USS, not on behalf of UCU or his employer. This paper represents the views of the author only. The author believes all information to be reliable and accurate; if any errors are found please contact us so that we can correct them. We welcome discussion of the points raised and suggest that discussants use Twitter with the hashtags #USSbriefs73 and #OpenUPP2018; the author will try to respond as appropriate. This work is licensed under a Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International License.