De-risking: increasing the deficit so that it can be calculated more easily
De-risking sounds like a good thing to do, doesn’t it? You don’t want risk. If you’ve heard this term in relation to the current USS pension debate, you might have understood that USS and the Employers Pension Forum are talking about ‘de-risking’ the scheme. Let’s have a look at what they say about this on the Employers’ Pension Forum:
“• The USS Trustees are also concerned about the risk that the deficit could continue to grow and aim to reduce the risk of this happening in the future. They propose to do this by reducing the investment risk that they take with the USS’s assets.
• If the USS Trustees’ proposals to reduce investment risk were to go ahead, this would increase the deficit from £7 billion to £13.1 billion. This would push the contributions required from employers and employees to unaffordable levels. Therefore the USS Trustees have prompted a review of the benefits provided by USS in order to ensure that USS remains affordable.”
http://bit.ly/increasethedeficit (accessed 19 October 2014)
Let’s take that bit by bit:
1. They don’t want the deficit to grow.
2. To do this, they’ll reduce risks taken with assets – this means they’ll sell some investment vehicles that are a bit riskier (for example, stocks and shares) and replace them with investment vehicles that are less risky (like bonds and gilts).
3. If they de-risk in this way, the deficit will in fact go up, not down (but see 1.). This is because the lower risk attached to an investment vehicle, the lower return you get for your investment.
4. If they do this, it will make the pensions scheme too expensive.
5. It is this de-risking that is causing the need to cut our pensions.
Let’s remember that the deficit is not a real sum. That is to say it does not reflect the actual health of the pensions scheme and its investments. The scheme has in fact a £42 billion surplus, and its debts this year were around £1.6 billion.
The deficit is a calculation that is required by regulations, and originates in single-company schemes. The requirement to calculate a deficit (or surplus, of course) is intended to protect pensioners if the company goes bust. The company needs to be able to prove it can pay all future pensions. So, the ‘deficit’ is a calculation of all the money in the pot at one point, minus all the pensions (and other costs) payable now and in the future. Put in plain English, the deficit calculation and requirement is:
“Is there enough money in the scheme now, not including any future contributions, to pay all current and future pensions? If not, you have a deficit and you need to find ways of removing it by raising money in the scheme or reducing your outgoings.”
Now, of course, the USS scheme is a multi-employer scheme, so there’s no question of all employers going bust at the same time. So there is nothing ‘real’ about the deficit. The consequences of that theoretical sum are very real, though.
What we are being told in the quotation from the Employers’ Pension Forum is that the need to reduce your and my pension is not because of this fictional deficit, but because by ‘de-risking’ the scheme by selling profitable investments and buying less profitable investments they are deliberately and knowingly increasing the imaginary sum that has such an impact on us.
So why are they de-risking, and thereby increasing the deficit that they must respond to by taking our money? Because of ‘volatility’ they tell us. The volatility they speak of is in the deficit, and only in the deficit: “Since 2011 this deficit has increased significantly and has been very volatile. In June 2013 it was £7.9 billion.” (same url)
Even senior managers seem to misunderstand this issue of volatility, and they believe that the scheme’s investments itself suffer from volatility. This is not true. There has been clear growth that has not only been consistent with the stock market, it has even beaten the FTSE in eight years out of ten in the last decade.
No, the volatility they want to remove is simply that the calculation of the deficit goes up and down unpredictably. This is partly because USS use two different means for calculating the assets and the liabilities. The assets are calculated at market value. The liabilities – mostly all future pensions to be paid – are calculated using a system that assumes the prices of gilts for future calculations. So, to make the predictions of liabilities more reliable, and less ‘volatile’, they buy more gilts. The consequence of which, as we have explained, is to increase the deficit. And so we have to lose money from our pension. So that they can better predict a fictional number. There are Vice-Chancellors who do not seem to understand this basic premise to what we are going through.
De-risking is just a process by which the deficit is increased as a result of wanting to calculate it more reliably.
And, remember – we can’t say this enough – the deficit is not real. The current deficit was calculated at 31 March 2014, so though it does include all the future pensions to pay out, it does not include any of the contributions we have made into our pensions since March. Or any that we are likely to make.