Deficit, what deficit? The politics of financial fact

by Philip Roscoe March 15, 2018

This article is part of a JCE online curation of the UK university 2018 industrial action.

Pensions for staff at many UK universities are under threat. You will be familiar with the headline numbers – pensions slashed by over half, to a level where the very survival of the university sector seems in jeopardy.

I have done the numbers, like everyone else, and they make grim reading. But how did this whole mess come about? At root, it’s a struggle over risk and who should carry it. The deficit itself is the result of some particular choices made by regulators and administrators. Its very existence is a reflection of the broader struggles over the marketizing of universities and the social contract for public services, and it’s this battle that academics are fighting, whether we know it or not.

Just to be clear, USS (the scheme for all universities older than 1992) is a defined benefit (DB) scheme, with limits. It is not a final salary scheme. Members of the scheme (us) are entitled to a fraction (currently 1/75)  of our average salary for every year of our retirement. If you are paid over £55,000 (only the higher senior lecturer grades and professors are), then you make contributions into a pot of investments, and your return depends on the financial markets. This kind of arrangement is known as defined contribution (DC). DC is something of a euphemism, because contributions are always defined, and the name distracts attention from the fact that the returns – the benefits – are largely due to chance. DC is simply a tax-efficient savings pot.

The deficit exploded into our consciousness after USS’s three yearly valuation in mid-2017 and subsequent politicking. Universities at first accepted and endorsed it, but now Vice Chancellors are lukewarm. This morning Sally Mapstone, Vice Chancellor of the University of St Andrews circulated a letter sent to Universities UK (UUK) , in which she writes: ‘It is now very clear that the current valuation does not command the confidence of USS members at St Andrews, and for that reason we support the call for an independent assessment of the valuation and the scale of the USS deficit’. Her letter is simultaneously encouraging and troubling – troubling because it implies that there is such a thing as a correct valuation and that an independent assessment will get there. Once the truth is discovered, we must all just fall into line. (Much water has gone under the bridge in the week since I wrote this commentary, and Mapstone has now offered to press the regulator for more time to conduct ‘a full and considered examination of the true scale of the USS deficit’ – a conciliatory tone, but the same fundamental endeavour.)

Facts are made. They are made in laboratories and by experts, by machines and instruments and practices. As Donald MacKenzie points out, even the etymology of the word reassures us of the labour involved in assembling the factual.[1] Financial facts are especially made, complex representations of states of the world – and because of that, they are irredeemably political. You may think of your overdraft as very concrete, in the sense that the rock David Hume kicked was all too solid for his toes. But even your overdraft is the result of considerable calculation and social and material coordination: what you paid in and when you paid it, what you bought and when those charges were processed. The overdraft is no innocent; as anyone who has been on the wrong side of a bank fine or wrongful credit card transaction will know, it looks politically charged soon enough. We discover it is a microcosm of capitalist politics: the bank makes the rules, and for the most part we simply have to go along with them. We find ourselves in a similar position regarding the USS deficit. A group of powerful players have changed the rules, and we have been left in the cold.

It is possible, as scholars documenting the sociology of science have been saying for years, to generate different facts – entirely different knowledge worlds – from the same materials. What’s more, they may each be true in their own context. John Law and John Urry write that ‘different research practices might be making multiple worlds […] such worlds might be equally valid, equally true, but simply unlike one another’.[2] USS helpfully demonstrate this point by providing four different valuations (from March 2017), all of which are true and valid but are simply unlike each other.

  • The headline figure comes from USS’s everyday accounting methodology, which it calls a monitoring basis. It writes: ‘The figures given in our Reports and Accounts were on our monitoring basis and reported liabilities of £72.6bn – a funding deficit of £12.6bn and a funding ratio of 83%.’ This estimate (as USS calls it) of shortfall is driven by USS’s assessment of future returns, and I will get back to why these are so bad in a moment. The funding ratio of 83% is roughly in line with other UK defined benefit schemes, by the way.
  • The accounting measure following the set of rules called FRS102 calculates a deficit of £17.5bn. This measure is intended solely for comparison between schemes.
  • On a “self-sufficiency basis” – the amount that would be required if the scheme was to move everything into a risk-free investment – there is a deficit of £27.4bn.
  • Finally, by USS’s ‘best estimate’ view, the scheme is in surplus. According to the trustees of the scheme, there is no problem at all. (But, says USS, ‘our “best estimate” by definition only has a 50/50 chance of success and in order to ensure USS pensions promises are properly secure, and to be compliant with legislation, we have to apply a degree of prudence.’)
  • There is a fifth valuation driven by the amount that an insurance company would demand to take the scheme over, but that need not detain us here.

We may conclude, then, that the USS is operating at somewhere between a surplus and a deficit of £30 billion, depending on how you choose to count. And that is where the politics comes in.

By law, a pension must be revalued every three years. The calculation of surplus or deficit is based on the assumed future liabilities of the pension set against assumed future revenue streams. Neither of these are straightforward, and the basis on which calculate them reveals much about our aspirations for the organization of society.

In terms of sorting out the eventual liabilities, two things really matter: how long we live – for obvious reasons – and the returns the fund can expect on all the money that we and our employers have paid in. To deal with the former, USS has assumed that we will live 1.5 percent longer each year. This may be a ‘prudent’ measure, but it is at odds with current practice in a sector cheerful about slowing growth in life expectancy: the insurance company Legal & General has, for example, just released £330 million of reserves that believes it no longer needs to cover growing life expectancy.

In terms of long-term income, the valuation hinges on the return available from so-called ‘risk free’ assets, usually in the shape of government bonds (gilts). Pension funds are required to keep a certain amount of long-life investments to match their liabilities. But the return on bonds fluctuates with interest rates (and expected future rates). Bonds pay a fixed coupon, in terms of x pence per pound; often they pay this at the end of the term, and so the market adjusts the prices of bonds to make the return fall into line with interest rates. At the risk of oversimplification, if a bond pays more than interest rates, people will buy it. The price will drift up until the return (the coupon as a percentage of the bond’s price) falls into line with interest rates. And vice versa: when interest rates go up, bond prices go down. In a prolonged low-interest environment, like the one we have enjoyed for nearly a decade, it follows that bond investment will be unattractive. Other factors, such as investors looking for safe havens for their funds, drive prices up even further to the point where USS believes that the long-term return on inflation-linked gilts will be -1.5%. In other words, holders of bonds are having to pay for the privilege of keeping their money safe.

At the 2014 valuation, USS had a deficit of £5.1 billion. By law the pension must have a long-term recovery plan, and USS launched a 17-year programme. In the face of low bond yields, USS turned to the stock market (equities) in search of better returns. Stock markets raced upwards: in the five years to March 2017, the value of USS’s assets increased by 12 percent annually, and in the 12 months to March 2017 assets had grown by more than £10 billion, or 20%. But the scheme’s liabilities outpaced the growing assets. Why? It is a matter of future returns, says USS: ‘while there has been significant focus on the existence of a deficit, it is actually the outlook for future returns that has had the most material influence on the outcome’ (my italics).

Alas, the same diminishing returns apply to rising equity prices as they do to bonds: the higher the price of a stock, the lower the dividend in percentage terms (the yield). As we keep paying into the scheme, USS needs to keep buying assets, but it can’t find anywhere to put them. It now has to forecast that it will receive much lower returns than the five percent originally planned. USS states this explicitly, writing: ‘while the investment team has continued to be successful against the benchmarks set, its expectations of how successful it can be in future reflect the reduced returns available in the markets’.

But USS is not a scheme at the mercy of the markets. It is based on a ‘covenant’ between employers and employees designed to pay a retirement wage at a set amount. It is underwritten by the entire higher education sector, and with all the universities standing behind it, USS could take steps to recover from the deficit. In particular, it could place less of its funds into bonds – which, remember, now cost money to own – and more into other areas, be they equities, hedge funds, property investments, green energy, or whatever took its fancy. Or it could simply wait, paying its pensions and running a deficit, until economic times changed, and the deficit contracted once more. It has become apparent, however, that the universities no longer want to sign up to this bargain.

In the summer of last year, USS asked employers – via Universities UK – whether they wanted more or less risk. It might seem a silly question, for out of context everyone wants less risk. But universities have a particular agenda. USS is what is known as a ‘last man standing’ scheme, meaning that should institutions start to fail, risk would pile up on those still operating. And university managers, now thoroughly versed in the language, practices, and salaries of business, are obsessed with avoiding risk. Risk has practical implications, for under current accounting rules employers must carry full pension liabilities on their balance sheet. This affects administrators who, seeing themselves primarily as curators of rankings in a market-driven system, are diverting all the funds they can into an arms race of building and infrastructure investment. Universities can borrow very cheaply – often at less than the cost of inflation, and almost free money is too good a ticket to be passed up. But lenders are not going to offer such preferential terms to borrowers with huge pension liabilities; for a university, the covenant of USS begins to loom as an enormous blot on an otherwise shiny credit rating.

Even then, a majority of employers (58 percent) responded that they were happy with the level of risk. Enter the pensions regulator. In October last year, the regulator wrote to USS instructing it to downgrade its confidence in the institutions. Josephine Cumbo reported the story in the FT and quoted a letter from the regulator: ‘we take the view that there are issues with the sector’s ability to increase payments to the scheme, which might arise under realistic downside scenarios, to remove the deficit over an appropriate period’. Though the modelling will have been complicated, the principle is clear enough: less underwriting means more risk, which must be offset in other ways. USS found itself needing to articulate an investment strategy that poured more money into those costly, risk-free investments, leading it to estimate investment returns of less than inflation for the next decade. (Ironically, that is exactly the kind of return it would get from lending to a safe haven such as a university – where do you think all that cheap money is coming from?) Lower investment returns mean a bigger deficit: simple arithmetic, innit?

Here I speculate, but it seems that UUK took the opportunity offered by the regulator’s intervention to back the large minority of respondents calling for an end to defined benefits, doing away with the employers’ share of all future risk arising from the scheme, forever. The risk doesn’t go away, of course, but simply moves into the laps of employees where – according to neoliberal visions of a market-organized, individualist society – it belongs. (Again, in the week since writing, Felicity Callard has unearthed a string of UUK documents that appear to show the organization actively laying the ground for a move to DC. It is also very clear in Sally Hunt’s account of the ACAS negotiations that the employers were unwilling to consider a move to the risk-sharing position now christened the ‘September valuation’, i.e. pre-consultation levels of risk for employers and associated deficit.)

Let me recap. Racing equity markets and the expectation of low interest rates in the longer term have created an environment for poor future returns on investments. Unnecessarily cautious life expectancy assumptions have increased the expectations of future liabilities. USS has enjoyed some flexibility in generating above-market returns by way of the covenant with the employers, but employers are increasingly unwilling to underwrite the scheme. Once the covenant starts to erode, the ‘last man standing’ nature of the scheme makes membership a prolonged game of prisoner’s dilemma, and as everyone with an MBA knows, the strategic option is to cut and run. Everyone without an MBA – thieves and prisoners included – recognises that the best outcome all ’round comes from sticking together. Honour among thieves if not vice chancellors, but that’s an aside. Finally, the pensions regulator has cast doubt on the sector’s ability to underwrite the scheme and ordered USS to buy more loss-making but safe bonds. And there we have a grotesque deficit.

If this sounds suspiciously like politics, it is. A scheme that is solvent on a going concern basis for 40 years, backed by one of the longest established and most robust sectors in the country – we’re hardly running railways or over-stretching ourselves supplying government contracts – is recast as risky and in deficit by the removal of the foundational assumption of the scheme: that we are all in it together, now and in the future. Prudent assumptions and compulsory stand-on-your-own-feet valuations are a device to crystalize risk now and force it into the matrix of labour relations.

The question of who should mop up the risk then becomes a reflection of the bigger question of how the higher education sector should be organised. Employers, who see themselves as corporate businesses, do not want to carry risk. The regulators worry that our pension scheme might end up in the taxpayers’ lap; as we are now employees of corporate organisations, that would be politically unacceptable. The easiest thing is to offshore the whole lot onto us. That’s an ideological choice, driven by the expansion of a market-style social contract into HE. It’s just another aspect of the barrage of quality measures and assessment, or the toxic problem of student fees, as regulators strive to legislate for a market in a market-averse sector.

It’s also the expression of a particularly nasty form of political meanness that seems to have reared its head in recent years. The Economist’s Buttonwood Notebook (always an academic’s friend) catches the flavour here. ‘In a DC scheme, it [risk] does fall on the employee. In a DB scheme, it rests largely on the employer. But in a sector heavily funded by the public sector that could mean the taxpayer […] With public pensions, the rich tend to subsidise the poor. They are also run on a pay-as-you-go basis with today’s workers paying the pensions of current retirees’. Buttonwood imagines a world where everyone looks out for themselves: God forbid that the rich should subsidise the poor or today’s hard workers should pay the pensions of those skiving retirees. Or indeed that taxpayers should underwrite the pensions of people who work for them, accepting poor conditions and sub-market salaries to pursue the task of educating their children.

It is true that 2017 and 2018 are a low point for pension fund managers looking after defined benefit schemes, but USS needs to be understood in the long term: it will have to last for 70 years and more to cover the obligations it has already accrued. The trustees themselves think – their ‘best estimate’ – that this problem will go away, but regulation demands they act otherwise; our union’s actuary also believes there is no fundamental problem with the scheme. It will continue to be funded by the contributions of future members, because we are all in this together. University administrators have an opportunity to underwrite the covenant and recognise that it is beneficial for everyone to maintain those obligations. They do not have to kowtow to a regulator that demands our valuation starts off from the ground zero of economic apocalypse.

Our current dispute is a skirmish in a longer war. Defeating these proposals is simply a means to a bigger end: forcing politicians, University administrators and the public to think differently about the sector and why it matters.

This is an updated version of a post that was originally posted here on March 8th. For the image, we draw inspiration from Universities UK and their creative use of stock photography. As Felicity Callard observes: 


[1] MacKenzie, D. (2009). Material Markets: How Economic Agents are Constructed Oxford: Oxford University Press.

[2] Law, J., & Urry, J. (2004). Enacting the social. Economy and Society, 33(3), pp. 397.