Excitement for actuaries
Unless you teach at a British institution, you probably haven’t paid much attention to the computation of the deficit in the Universities Superannuation Scheme (which I shall turn into an American naval vessel below), and few readers of this blog are likely to have thought much about the intricacies of the relevant accounting standard (known as FRS17). But an article in the FT by my former colleague, John Ralfe, has stirred up something of a storm, with accusations of Alice in Wonderland economics and worse. The Mad Hatter has been invoked – should this perhaps have been Humpty Dumpty? But so far Wilkins Micawber has been omitted from the authorities cited.
I have known John Ralfe for some 30 years and have always respected his independence of thought, so perhaps the matter is worth setting in a broader context (even at the risk of oversimplification). The question boils down to this. When looking at a pension fund’s accounts, it is easier to value the assets than the liabilities. Unlike the historic cost accounts as used for normal business, pension funds have to estimate future liabilities; this depends on uncertain information, most notably (but not only) the interest rate by which you discount the liability. If I have to pay £1m in ten years’ time, how much should I record today? This is a question to which there is a simple answer; but is it the only answer?
The simple answer is that you buy a fixed rate bond which matures to match the liability, and your discount is effectively set by the market price of that bond today. That, as Ralfe points out, is exactly how corporate pension funds are required to estimate their liabilities, so it should be applied by the USS; and the scheme should have at least enough assets to cover those liabilities. The response of his critics has two main points. Firstly, why use a bond yield when the actual investment portfolio typically outperforms bonds? The FRS17 rate (based on AA rated bonds) is itself arbitrary and unrealistic, and an extreme version of this argument says that any rate is just as good.
And secondly, since the balance sheet is trying to compare apples with oranges in this arbitrary time-shifting (or, if you like, trying to put the dormouse in a teapot), surely what really matters is whether there is enough cash to pay the pensions – and that is certainly the case with the USS, where cash coming in from new members (which Ralfe ignores) substantially exceeds cash going out for retirees. Even its proponents call this argument “intergenerational social solidarity”; others will call it Ponzi economics.
If you’ve already lost interest, remember this matters: a decision that the scheme needs to be topped up as Ralfe suggests has significant implications for taxpayers and those paying tuition fees.
I’m not going to pretend that I have a winning argument in this debate. But what caught my eye was the critics’ accusation that Ralfe’s position was right-wing. Surely I thought there is more of the Roundhead than the Cavalier in his approach: let us not spend others’ money, or rely on something to turn up?
But of course the real significance of this debate is not confined to this one pension fund: it is the fundamental debate that is currently going on about the entire economy. It is in short austerity versus growth. And it is a debate where, following Thatcher and Blair, the traditional positions of the parties have been reversed. If Ralfe’s approach is one with which I find myself in sympathy, I recognise also that it has something of the physiocrat or the Neinsager about it, and that our economy would be a great deal poorer than it is today if this philosophy were applied generally.
We need growth, and some level of borrowing in anticipation of future rewards is necessary. Not all growth is unsustainable, although the market’s blindness to good and bad growth is very much in evidence today, as we are surrounded by the stellar remnants of banking businesses like RBS with its black hole, or the white dwarves of the dot com era, while new examples form constantly. The difficulty is to avoid the sterile confrontation between ideologies that reduces investment choices to political dogma. What our politicians should be focused upon is spending money wisely: making sensible investments that improve our infrastructure (but not at all costs), securing energy sources at reasonable price, sorting out our hospitals and schools. Too often the problem is not excessive Government spending, but bad Government spending, with money squandered on incompetent procurement, unnecessary and unwinnable wars, and – most outrageously – instead of building new homes, propping up house prices unsustainably: and in a way that will force future authorities to keep interest rates artificially low for decades to come, with the obvious corollary in terms of pension fund deficits.