Explain the high gilt-yield dependence of the pre-retirement discount rate

Determine the causal mechanism that explains why the Universities Superannuation Scheme’s pre-retirement discount rate—defined as the prudently adjusted expected annual return on a hypothetical portfolio consisting of 90% equities and 10% bonds—exhibits a 97–99% correlation with the UK government bond (gilt) yield, despite USS’s best-estimate expected returns on equities showing substantially lower correlation with the gilt yield.

Background

The paper documents that USS’s pre-retirement discount rate (a prudently adjusted return for a 90% equities portfolio) is almost perfectly correlated (97–99%) with the gilt yield, whereas the best-estimate expected returns for the same portfolio display markedly lower correlation (~78%). This discrepancy suggests that discount-rate setting may bypass best-estimate assumptions and be tethered directly to gilt yields, producing large cost volatility in contributions.

Understanding the mechanism behind this correlation is central to explaining USS’s valuation volatility and its sensitivity to gilt yields, which the paper argues dominates the determination of contribution rates and discount rates via the Integrated Risk Management Framework.