On de-risking and self-sufficiency in relation to USS

Number 49: #USSbriefs49

Woon Wong, Cardiff Business School

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This is a USSbrief, published on 24 August 2018, that belongs to the OpenUPP (Open USS Pension Panel) series. The contents were submitted to the UCU-UUK JEP (Joint Expert Panel) by the author on 15 August 2018.

This is Woon Wong’s second submission to the JEP. His first submission is #USSbriefs34, ‘Industry debate and USS’s phantom deficit’.


Here, in my second submission to the JEP (see also USSbriefs34 ‘Industry debate and the phantom USS deficit’), I would like to point out the problem with de-risking. I have constructed a computer model of a Career Average Revalued Earnings (CARE) DB (defined benefit) scheme that is similar to that of USS. The X-axis of the figure below refers to the weight of bond in the pension portfolio and the Y-axis indicates the probability of a CARE DB scheme going bankrupt in a 40-year horizon. The portfolio comprises only bond (UK gilt) and equity (as represented by the Morgan Stanley Capital International world equity index). Note that the blue line corresponds to the current 28% combined contribution rate of USS, whereas the orange and grey lines correspond to lower contribution rates of 25% and 20% respectively. Obviously, the lower the contribution rate, the higher the chance of fund’s bankruptcy in 40 years’ time. More importantly, the increase in holding of gilt raises the bankruptcy risk. There are two reasons for this outcome: (1) the current low gilt yield fails to meet the inflation cost; and (2) risk of equity can be diversified away in long horizon investment. It must be emphasised here that it is the failure in grasping the financial economics of these two points that is causing many DB schemes to be wrongfully regarded as being in deficit and closed.

The figure also sheds light on a closely related issue — self-sufficiency. By definition, a self-sufficient portfolio employs an investment strategy such that there is a low probability (5% over 20 years’ time) of ever requiring additional employer contributions to fund benefits earned to date. For the current contribution rate of 28% (blue line), the USS’s reference portfolio (with 65% equity) or current actual portfolio (with 50% to 60% equity) has less than 5% of bankruptcy in 40 years’ horizon. Since bankruptcy and requiring additional contributions are not quite the same thing, the yellow line (with the same 28% contribution) is also shown in the figure, indicating the chance of bankruptcy in 20 years’ time. Clearly, as long as there are not less than 50% of equities in the portfolio, the chance of bankruptcy is close to zero. Finally, the 25% orange line does suggest we can reduce our contribution rate and still remain self-sufficient (this information should be attractive to many vice chancellors).

Hope you find the above useful.

Yours sincerely
Woon Wong
Cardiff Business School
15 August 2018

P.S. 1. The rate of equity return is based on my recently completed working paper, ‘The Phantom Deficits of USS Pension’. 2. The above will form part of my forthcoming working paper, possibly called ‘Yes, the British young can afford a defined benefit pension’.


This is a USSbrief, published on 24 August 2018, that belongs to the OpenUPP (Open USS Pension Panel) series. The contents were submitted to the UCU-UUK JEP (Joint Expert Panel) by the author on 15 August 2018. 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 #USSbriefs49 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.