A response to John Ralfe’s Times piece on USS

In ‘University pensions bet has failed: who will pay?’, John Ralfe writes:

The root cause of USS’s whopping deficit is the aggressive bet that it has taken over many years that equities will outperform boring bonds This bet has not paid off, so the deficit has just got worse.

By March this year USS had only 10 per cent of its assets in bonds to match its liabilities [by which he means index-linked gilts], even though pensions in payment are about 40 per cent of liabilities.

I grant that, for many periods going back over 20 years, had USS shifted its equity holdings into index-linked gilts, the value of the scheme’s assets would be greater than it is now, given the rise in the price of gilts in recent years (largely due to quantitative easing). But this would have been more than outweighed by a much greater increase in the discounted value of the liabilities, since the discount rate of a gilts-heavy portfolio would be much lower than that of an equity-weighted portfolio. USSIM’s and Mercer’s best estimates (see Figure 2 on p. 30) of returns on equity over the next 20 years are about 3.5% and 3.1% above CPI, respectively, whereas their best estimates of returns on index-linked gilts over the next 20 years are about 1.2% and 0.9% below CPI, respectively. Hence, USS would be in much greater deficit today on account of a much lower ‘best estimate minus’ technical provisions discount rate if it had exchanged its equities for index-linked gilts.

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Professor, Dept. of Philosophy, Logic & Scientific Method, LSE

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