USS Pension Reform: On Prudence, Fairness and Trust

By David Owen, Professor of Social and Political Philosophy at University of Southampton (@rdavidowen, You can find more posts by David here.

Recently proposals have been advanced for reform of the USS Pension which will have very considerable effects on both those who has been in the Final Salary Scheme and those who only been in the Career-Average Defined Benefits Scheme. Claims and counter-claims have flown about so it worth stepping back to review the position by recalling principles for guiding pension reform and looking at the current dispute in the light of these principles. There are three main kinds of principles involved here:

  1. Principle of prudence in guiding the evaluation of the assets and deficit of a pension fund, where this judgment will be informed by the kind of fund in question (for example, a one-firm fund or a fund supported by multiple corporations).
  2. Principles of prudent fairness in proposing reforms to the fund, where issues of fairness pertain particularly to the legitimate expectation of fund members and to the distribution of risks and benefits.
  3. Principle of trust in the communication of the fund evaluation and the rationale for, and consequences, of proposed reforms.

Let us take each in turn.

Prudence and the calculation of assets and deficit.

Guidance from the Pensions Regulator suggests that valuations should not be based on only worst-case assumptions in every issue as “an appropriate overall level of prudence in the technical provisions should be the paramount objective” of a valuation. But this is precisely what appears to have been done on calculating the USS fund deficit as a recent letter to the THE points out:

False assumptions of the USS

23 OCTOBER 2014

Last week, the Employers Pension Forum published “Proposed Changes to USS – Myths, Misconceptions and Misunderstandings”. The document contains misinformation and a mistake. We focus on the section “M7: The assumptions used to value the fund have been chosen to artificially create a large deficit”.

Having reviewed the assumptions given in the 2013 annual report, we believe, as statisticians and financial mathematicians, that each assumption is inadequately justified and that cumulatively they are unreasonably pessimistic and incoherent. The predicted salary increases assume a buoyant economy while investment returns assume a recession.

For example, the average annual rate of return on assets achieved by the Universities Superannuation Scheme over the past 10 years was about 7 per cent and over the past five years about 11 per cent. It is therefore difficult to understand the EPF’s assertion that “since 2011…the continuing global economic challenges…have had a detrimental impact on the value of USS’ assets”.

Meanwhile, members’ wages are assumed to grow by the retail price index plus 1 per cent (taken to be 4.4 per cent) plus incremental increases. Over the past 20 years the actual rate was about 2.7 per cent, with similar growth over the past 10 years. Post-2008 rates show negative real-pay growth. The age-related assumption is wage growth (1 per cent to 4 per cent) by progress up the salary scale: anecdotally this assumption leads to higher pay growth rates than the majority of academics have experienced over the past 10 or 20 years. As the fund’s actual experience was used to give a mean retirement age of 62 years at the last valuation, it seems odd that salary assumptions do not also reflect actual experience.

The assumptions on mortality appear to be unchanged from the 2011 valuation, yet the EPF archly advances the statement that “members of the USS are living longer so the pension scheme has to pay pensions in retirement for longer than planned” as a reason for deterioration in the fund’s position since 2011.

A reasonable change in any one of these assumptions would give a lower estimated deficit. The EPF states that although changing the assumptions in this instance could affect the size of the deficit, “it cannot change a deficit into a surplus”. It takes little mathematical knowledge to recognise that this statement is wrong.

In other words, the valuation is performed on the basis of various assumptions about likely future experience and each assumption is inadequately justified and that cumulatively they are unreasonably pessimistic.

This letter provides strong prima facie grounds for believing that the calculations involved do not respect the principle of prudence. This is reinforced by a much earlier pre-emptive counter to such reforms of the USS scheme by the pensions expert and LSE governor Ros Altman makes a number of additional points where the headlines are:

  • Universities Pension Scheme scaremongering is overdone.
  • Classic example of damage to pensions from QE
  • USS is not a closed scheme, so it is unfair to compare it with most other UK schemes
  • Its funding position is being well managed and it should not be panicked by exceptional interest rate environment.

Prudent fairness and proposals for reform

Consider the claim invoked in the current proposals is that combined (employer plus employee) contribution rates are projected to rise from 23.5% after the 2011 valuation to around 35% and this, USS claims, is “unaffordable”. It has long been a principle of actuarial valuations of pension funds that valuations should ensure gentle changes in funding rates. This large increase would represent a failure by the fund or its actuaries to observe that principle. There is a reason for the principle of gentle increases, namely, ensuring that the legitimate expectations of members of the pension scheme are not radically breached and this informs the more general principle of prudent fairness that is central here. Professor Mike Otsuka at the LSE has drawn my attention to a related case in which the salient principle is exhibited:

How to close a final salary scheme properly. It’s very simple:

“For all scheme members, any benefits built up in the final salary scheme [up until the date of closure] will be protected and remain in that scheme. When benefits are calculated at retirement, they will be linked to the member’s most recent pensionable earnings (but using the final salary scheme rules).”

That’s what the Teachers Pension Scheme did when they moved everyone in the post-92 higher education sector over from final salary to career average salary defined benefits.

Why did they do that? Because an Independent Commission said that the “Government must honour in full the pension promises that have been accrued by scheme members: their accrued rights. In doing so, the Commission recommends maintaining the final salary link for past service for current members.”

The principle of prudent fairness does not, however, simply concern the transition to a new scheme but also the character of the new scheme. Thus it is proposed that the new scheme would combine a Defined Benefit (DB) element and a Defined Contribution (DC) element with the switch from one to another happening at a given salary level. Yet, as a large scale Canadian study has comprehensively demonstrated (, DC schemes are much more inefficient than DB schemes and off-load greater levels of risk onto individuals. Dennis Leech at the University of Warwick has also stressed this point here ( Prudent fairness supports maintaining an efficient collective scheme in which risks and benefits are shared fairly among members – such as a Career-Average Defined Benefits Scheme.

Trust in the communication of the fund evaluation and the rationale for, and consequences, of proposed reforms

The final principle concerns how communication is carried out concerning the evaluation and the proposed changes. It is important that whose involved in the process need to be able to trust the communications that they receive if these communications purport to provide neutral and impartial information. On the evaluation side, it is apposite here to note an earlier letter to the THE by Professor Jane Hutton (also one of the signatories of the THE letter cited above):

The Employers Pension Forum published a Q&A purporting to explain the reasons for the proposed changes in the Universities Superannuation Scheme with the date 11 August 2014. I read it in early September, and realised that the life expectancies given under question nine were completely implausible. I did not know whether this was incompetence or an attempt to mislead.

I wrote to the EPF on 9 September, raising questions about this. I have not received a reply. However, when accessed on 2 October, the Q&A had been changed to omit the incorrect life expectancies, but still bore the date 11 August 2014. There was no indication that the change had been made, and the conclusions drawn remained.

As the EPF Q&A claims to provide information, with the implication that the advice is impartial, it is more than disingenuous not to alert readers to the change. The balance of my opinion as to whether the inaccuracy arose from incompetence or dishonesty has altered.

If we turn to consider the issue of the rationale for the reforms, the most obvious concern is that no information is provided on what alternative possible reforms have been considered and why they have been rejected. This is a central element of the response by Oxford University to the consultation and their response is worth reading in full. Oxford’s response also draws attention to the limited timeframe that has been made available for this consultation – a point that is also salient to the issue of trust.

It appears then that members of the USS scheme have prima facie reasons to be mistrustful of the good faith in which the necessity of just these reforms is represented to them. To restore trust requires that the issues raised here are fully and properly addressed.

The University as a Civic Community

By David Owen, Professor of Social and Political Philosophy at University of Southampton (@rdavidowen, You can find more posts by David here.

Universities were founded as ‘civic corporations’ in the medieval sense (this sense of ‘incorporated bodies’ is most obviously exemplified by Guilds). This is why they have Royal Charters. This guild structure still persists in some professions such as architecture and medicine that are self-governing. Their rule is exercised over their membership (for example, both architects and doctors can be ‘struck off’) and over who can be a member (they control the qualification/certification process).

There are three crucial elements here for conceiving of the University:

  • It is to be conceived as a self-governing community;
  • It is a community oriented to the common good of its members;
  • Its standing as a corporation in the medieval sense is justified only to the extent to which acting for the common good of its members contributes to the public good.

In each of these respects, it is entirely distinct from a ‘private corporation’ in the modern sense. Why does this matter? And how should this inform how we see the University now?

It matters because universities today, struggling with the demands of marketized higher education and the increasing importance of commercial dimensions of their work, have too easily plumped for frameworks, vocabularies and values drawn from the realm of private business corporations – faute de mieux. Yet the ethos and grammar of the private corporation is both alien to, and at odds with, that of the public (or even private) university. So it is worthwhile to recall and explore a historical grounded alternative – what, then, does this alternative involve?

Consider, first, self-government. We need to distinguish two aspects of self-government here – the ‘legislative’ and ‘executive’ functions. The first point that arises from this is that Executive (the University Senior Management) are subordinate to the Legislature (the University Senate) in one crucial respect: although the ends or strategic goals of a university may be proposed by the Executive for the consideration of Senate, they are set by the membership of the university as civic participations in a self-governing community (via their representatives in Senate). The primary role of the university executive is to develop ways of realizing strategic goals compatible with maintaining the university as a self-governing community through policies, targets, etc. The second point is that the executive are accountable for their performance to the community which means that they report to the community and can be sanctioned by the community (via its representatives in Senate). In institutional terms, the legitimate authority of the Executive to issue commands, set targets, etc., derives from their role as agents of Senate who are accountable to Senate.

This picture is slightly complicated by the third feature, namely, that of ensuring the pursuit of the common good of the members of the University is also productive of the public good (the importance of this is illustrated by the history of guilds in which the common good of the membership could and sometimes did lead to practices that were definitely not directed at the public good). This is essentially the role of a body involving external members representing the Public (the Council of the University) – to make sure that the University is productive of the public good (for example by not being a liability for the public purse). The University as a civic corporation, represented for these purposes by the Vice-Chancellor, is thus accountable to Council as representatives of the Public. In this respect, the autonomy of the University, its capacity for self-government in the most general sense, can be limited by Council where this is deemed necessary or advisable for the public good or, put in modern parlance, for ensuring the University fulfills its mission.

(This double relation of the VC as, on the one hand, leading the Executive as servants of the civic community and as, on the other hand, representing the University in its accountability to Council can set up a tension that is liable to drive VC’s to seek greater power so that they can determine as executive that for which they are held responsible as representative.)

If we consider now the second element, namely, the common good of the membership, we need to address two dimensions. First, who is a member? Second, how is the common good to be worked out? The answer to the first is straightforward: every employee of the University from cleaner to professor, from first year student to communications director. It is, of course, the case that there are different kinds of membership in terms of the rights and duties that pertain to their different roles. It is also the case that their different functions have implications for the governance structures of the University, for example, one might adopt a consociational structure comprised of an Academic Senate that governs academic matters, a Professional Senate that governs professional matters and a Student Union that governs student matters encompassed within an overarching Senate in which all are represented. There can be significant debates on the best governance structures to adopt here but the really key point is that this is a civic community in which all are civic participants and should be able to conceive of, and experience themselves as, ‘citizens’ engaged in a cooperative venture directed at the common good and in the service of the public good.

This is, of course, just a sketch of an alternative way of conceiving of the University but it demonstrates that there is such an alternative and that it has significant implications for how we relate to one another as members of a corporate community. The problem that we currently face is that many academic and non-academic staff see themselves in this kind of way but that they are placed within management structures that act in ways drawn from the opposed conception of the modern private corporation and thus, advertently or not, exploit this fact in order to extract greater labour and thereby generate understandable cynicism and disillusionment with, and alienation from, the University. The ‘connected university’ needs to attend to the character of its internal connections.