Should there be an industry-wide methodology for measuring value?

It is no surprise then that the financial and the pension regulators have been tasked with ensuring members receive value for money from their workplace defined contribution pension pots.

Assessing value for money in practice can be hard for DC schemes to do. Although the Pensions Regulator has already provided helpful guidance on the issue, there is no industry-wide methodology in place

Nigel Peaple, PLSA

In 2013, a report from the Office of Fair Trading found £30bn of DC savings were at risk of delivering poor value for money, which set the wheels in motion for a more forensic analysis of how members were charged.

Joining forces to drive outcomes

Five years on from the OFT report, the Financial Conduct Authority and the Pensions Regulator have joined forces to ‘deliver better outcomes for members’.

In October this year, the two watchdogs announced a root-and-branch review of the consumer pensions journey and said there would be more forceful use of powers to ‘drive value for money for members of pension schemes’.

Speaking at the time, the regulator’s chief executive Lesley Titcomb said: “We are being clearer, quicker and tougher in the pursuit of [protecting savings].”

Laudable aims and important action, but there remain numerous challenges in the pursuit of value for money.

Do we need value for money ‘metrics’?

The first is a consistent understanding of just what ‘value for money’ means.

Nigel Peaple, director of policy and research at the Pensions and Lifetime Savings Association, says:“Assessing value for money in practice can be hard for DC schemes to do. Although the Pensions Regulator has already provided helpful guidance on the issue, there is no industry-wide methodology in place.”

Peaple says the Pensions and Lifetime Savings Association’s members complain that the lack of an agreed industry benchmark makes it hard to know whether they are achieving value for money or not.

He adds: “We believe the pensions sector should work together to develop value for money metrics.”

Be clear about what you want

In the meantime, trustees are bound by existing guidance. Since 2015, trustees have been obliged to prepare an annual governance statement, known as the chair’s statement. This should appear on a public website within seven months of the scheme’s year end. Failure to do so means a fine, as well as negative publicity.

From April this year, the statement was extended to include, among other things, charges and transaction costs for each default arrangement and alternative fund option. Importantly, fees should show the impact of the cumulative impact on a member’s total fund in pounds and pence.

These new requirements sit alongside the original governance demands to show members what services they receive. Essentially, the regulators want schemes to get what they pay for, and to understand the impact fees have on final pots.

In the absence of ‘value for money metrics’, Mark Futcher, partner and head of DC and workplace wealth at Barnett Waddingham, says trustees need to be clear about what they want, document it clearly and then measure what they receive against their strategy.

Timing remains challenging

Futcher says: “[Barnett Waddingham] has a clear idea of what value for money is and we have a framework for assessing it. When you have a documented core strategy in place it is simpler to ensure things are going well and understand where you can improve.”

For example, the statement of investment principles plays a key part in assessing value for money, since it can used to measure whether expectations met reality. Importantly, the SIP should be clear on return objectives and whether this will come from active or passive management

David Heathcock, DC business development director at Schroders, says this is particularly important because comparing the cost of one investment strategy against another is not the same as measuring value for money.

“A passive investment strategy might charge 35 basis points to deliver market return, while an active approach charges 50bp but delivers an extra 100bp year on year. Which is better value for money?” Heathcock asks.

However, this leads to yet another challenge; the timeframe against which a scheme measures value. If the true success of a strategy can only be known when one retires – possibly at a date many decades in the future – it is difficult for trustees to make more immediate value calls.

Heathcock says: “Trustees are not going to know whether they have achieved the right outcome and whether the scheme was good value for money until members retire.”

Rising complexity

The arrival of freedom and choice legislation in April 2015 has made assessing value for money even more complex. The rules allow people to draw on their pension pot with impunity, choosing any number of options from annuities, to total cash withdrawals, to flexible drawdowns or some sort of combination.

If trustees fail to put in place default investment options that cater for their members’ needs at retirement, the scheme could be considered poor value for money. Yet meeting the myriad different needs presents yet another challenge, and demonstrates the need for trustees to be clear from the outset why they have opted for a particular strategy and what they hope it will achieve.

More complications in the quest to assess value comes from transaction costs, which are notoriously hard to track down since asset managers are not obliged to disclose them.

Research published by Kas Bank at the end of November found 80 per cent of pension professionals think more needs to be done to educate trustees on cost transparency.

Progress on cost clarity

However, advances are being made both in terms of asset managers’ willingness to report transaction costs and in trustees’ ability to measure and understand them. PTL, the independent trustee firm, has created Clear Funds, a service designed to assess transactions costs – making it easier to measure value for money.

Heathcock says Schroders was the first asset manager to sign up to the service, which will provide clarity on transaction costs for its clients by the end of the year.

Yet more challenges come from the regulator’s requirement for trustees to only value services for which members bear the cost, rather than across every service they receive.

Futcher says this is an important distinction for members to understand because some schemes bundle administration, communication and investment charges together forcing the 0.75 per cent – at which default charges are capped – to stretch further.

In other cases, employers may pick up the tab for admin and communications, leaving members with more to spend on investment.

“If employers are paying for administration and communications, and members pay 60bp for a sophisticated investment strategy, you could argue that is better value than one where a member pays 35bp for investment and has to bear the cost of everything else.”

Futcher adds: “It is important that figures are not misleading.”

Assessing value for money is difficult but regulators, industry associations and service providers are keen to make life easier.

An agreed definition of value for money might help, but it is more important that trustees understand what they are buying and why. If there is any presence of doubt about what a charge is for or why a service is important, it is impossible to determine whether real value has been achieved.

The old adage of ‘you get what you pay for’ might well be true, but trustees can only be sure if they know what they have and why.