“No alternative methodology was proposed”

UUK’s Q&As on the USS valuation from mid-December end on a perplexingly obviously false note, which I highlight in bold:

“UCU have raised a number of concerns regarding the USS valuation methodology since 2014. As a result, UUK and UCU worked together over a significant period to better understand the valuation methodology, and raised a number of questions for the trustee, which received a full response. No alternative methodology was proposed.

A paper by First Actuarial that UCU forwarded to VCs in December 2016 describes this alternative methodology:

“A model suitable for the planning of an open scheme will …take asset income expectations as an input to the valuation assumptions. The funding regulations require the assets to be shown at market value. Putting these two things together, the expected return on assets is the rate of return which values the income on the asset at the asset’s market value. This is called the ‘internal rate of return’….”

Unlike UUK, USS has at least publicly engaged with this approach, albeit briefly. USS’s initial response was to say that it confirms their own approach because it “generally gives a similar result” (see 5.1.1). When First Actuarial replied, in their September paper (see p. 5), that their approach forecasts expected returns that are higher than USS’s forecasts, USS responded that in that case First Actuarial’s approach is insufficiently prudent (see p. 7).

These responses miss the point, however, of First Actuarial’s proposal. The point is not to dispute the level of USS’s estimates of returns on assets. Rather, it is to iron out the distortions that are introduced by a marked-to-market valuation of the assets. This is how I put this point in the comments thread to an October piece by Alistair Jarvis on the valuation:

“There is the following risk which Alistair may have in mind […]: for the triennial valuation, USS’s assets need to be marked to their market value on a particular day at the end of March every three years, in order to determine the asset side of the scheme’s asset/liability funding position. So the valuation of the assets, which plays a role equal to the valuation of the liabilities in determining the scheme’s funding position, is a hostage to fortune — e.g., whatever animal spirits determine the particular levels of financial markets on 31 March 2020.

This raises the following challenge for First Actuarial’s approach, which involves an investment in growth assets. The market price of growth assets is volatile. So there’s the problem, with a growth portfolio, that if there’s a fall in the value of the assets (e.g., a major drop in the stock market) before the valuation date, there is the fear that this might push the scheme into such deficit that the valuation would force high deficit recovery contributions.

First Actuarial address this problem in some earlier work: They maintain that the best estimate of returns on equity should be based on the internal rate of return (IRR) of the asset in question, which, in the case of equity, is the dividend yield (current annual income from dividends divided by asset price of equities), plus RPI (as implied by index-linked gilts), plus an assumed dividend growth rate over RPI. They describe and defend their IRR approach in their December 2016 paper (see pp. 2–10 […]). IRR-based valuation has the effect that a fall in asset values will be accompanied by a fall in the valuation of the liabilities. See p. 7 of [this linked piece], for a document prepared by First Actuarial in September 2015, where they model USS’s funding level, based on this IRR approach, as compared with USS’s gilts-based monitoring approach. Note that the funding level remains closer to full funding, with less volatility, on First Actuarial’s IRR approach.”

Given that Alistair Jarvis is CEO of UUK, it is especially puzzling that the organisation he leads falsely claims, in their latest Q&As, that UCU has proposed no alternative methodology. Had UUK taken on board this alternative approach, rather than denying its existence, we could have avoided the difficulties to the scheme caused by the 42% of UUK members who ‘broke’ the September valuation by calling for a lower level of investment risk (to which UUK’s proposed move to 100% DC is an incoherent response).

Please see this post entitled “An explanation, via buy-to-let analogy, of First Actuarial’s approach…” for further explanation of the merits of the alternative approach whose existence UUK denies.



Professor of Philosophy, Rutgers. Previously on UCU national negotiating team for USS pensions.

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Michael Otsuka

Michael Otsuka


Professor of Philosophy, Rutgers. Previously on UCU national negotiating team for USS pensions.