News Alert 2023/01

At a glance

Value for money in DC schemes has long been on the Government’s radar, and rightly so.  A new consultation is the latest step in a journey that began over 4 years ago.  If the proposals come into being they will radically shake-up governance arrangements for both trust-based and workplace contract-based DC pension schemes.  Therefore, these proposals are of interest for anybody involved in running DC schemes.

The Detail

On 30 January 2023, the Department for Work and Pensions launched, jointly with the Pensions Regulator and the Financial Conduct Authority, a consultation on the establishment of a value for money (VFM) framework for DC schemes.  This consultation  follows the joint feedback statement issued by the Pensions Regulator and the FCA last May (see Pensions Bulletin 2022/20) and this in turn was the culmination of a process first signalled in October 2018 by the Regulator and FCA in their first joint regulatory strategy statement.

This latest consultation paper applies both to occupational pension schemes and workplace personal pensions, but the proposals will be taken forward by separate consultations by each regulatory body, respectively DWP/ Pensions Regulator and the FCA.

There are three key elements of the framework – investment performance, costs and charges, and quality of services – and we deal with each in turn in this Alert.

The consultation notes that “The VFM framework aims to shift the focus from cost by considering other factors that feed into overall VFM and are important for long-term outcomes. This will enable a more holistic and informed view of the value that pension schemes provide”.  Additionally, the framework is designed to provide “consistent value metrics and a transparent approach to assess and compare the overall value and performance offered by schemes across the pensions industry”.

The consultation starts off by placing the VFM framework within the wider policy intentions such as consolidation, deferred small pots and the new FCA Consumer Duty (see Pensions Bulletin 2023/03).

Our viewpoint

Of note is a comment that the Government is considering whether the new framework could place a statutory requirement on trust-based occupational pension schemes to consolidate following repeated "underperforming” assessment results, where this is in the best interests of savers (so going beyond the existing situation where <£100m schemes not offering good VFM are merely “encouraged” to consolidate or improve).

The proposal is that the framework will be launched in two phases, starting with default arrangements of both occupational schemes and workplace personal pension schemes, whether or not a scheme is used for auto-enrolment (ie including what the Government refers to as “legacy” schemes).  The second phase will extend the framework to include self-select options, non-workplace pensions and DC pensions in decumulation.

In the first phase, the Government intends that the audience for VFM assessments will be pension professionals and decision-makers who oversee the arrangements in scope, and that the assessments will be used by employers when deciding which scheme to use for auto-enrolment or whether their existing scheme offers VFM to their employees.  In the second phase, the Government envisages that pension savers will take an increasing interest in VFM.

We now turn to the details of each of the three key elements of the framework.

1.  Investment performance

The consultation sets out the proposed investment performance metrics for public disclosure.  Investment return data will be backward-looking net of all costs and charges, including transaction costs and performance-based fees.  Any employer subsidies in relation to costs and charges will also be netted off.  The consultation proposes methods for dealing with special features found in legacy schemes, such as guaranteed returns, and bonuses in with-profits funds.

Multi-employer schemes which offer different terms and conditions for different clients (such as master trusts) will group employers into cohorts based on assets under management (AUM) and report net returns for each band.  For each band, these net returns will be disclosed as the range for that cohort as well as the average, possibly excluding outliers.

Reporting will be based on periods of 1, 3 and 5 years, extended to 10 and 15 years if the data is available.  Additionally, where schemes use age-related investment strategies (such as lifestyling or target retirement dates), the investment performance must be reported for ages 25, 45, 55 as well as “at one day before state pension age”.

Our viewpoint

For multi-employer schemes, such as master trusts, with age-related investment strategies this is going to result in a lot of numbers to report.

Under the proposals, two risk-adjusted investment return metrics must also be disclosed – “maximum drawdown” (an investment term which looks for the greatest movement in a portfolio from a high point to a low point, before a new peak is achieved) and annualised standard deviation (ASD) of returns.  These will be reported for each of the reporting periods and ages set out above.  There is also discussion about applying a “chain-linking” methodology in some situations where investment strategies are changed.

Finally, there is discussion and a question about whether there should be a forward-looking investment performance metric.

2.  Costs and charges

The consultation says that the new proposals in this area differ from the existing requirements in two respects.  Firstly, schemes will disclose total charges rather than just “member borne” charges so that schemes with employer subsidies do not appear to offer better value.  Secondly, schemes will also disclose the total amount of administration costs, ie anything other than investment costs.  The consultation notes that this will require bundled schemes to separate these costs out.  For schemes with multiple participating employers, such as master trusts, charges will be broken down according to cohorts of employers based on AUM, as for investment performance data.

Our viewpoint

It is sensible to base comparisons on total charges.  Stripping out employer subsidies may be useful to compare underlying scheme charges, but it should be remembered that such subsidies are an important component of the VFM that the member receives.

3.  Quality of services

The intention is to provide a holistic view of VFM and so take account of factors other than investment performance and costs which “make a meaningful contribution to long-term outcomes that savers value”.  This covers aspects such as scheme administration, governance and effective member communication.  Several metrics are proposed to assess these.

For communications, the suggested metrics are either the percentage of members who update various scheme choices such as selected retirement date, form of benefits and expression of wish forms; or the outcomes of member satisfaction surveys and/ or member feedback forms.

For scheme administration, the proposal is that two of the existing quantifiable metrics currently used to assess value for members for <£100m schemes are extended to all schemes in scope (including FCA-regulated schemes).  The existing metrics are “promptness and accuracy of core financial transactions” and “quality of record keeping”.

No standalone metric for governance is proposed since this would be challenging to reduce to a quantitative figure and will be reflected in other aspects of the VFM framework.

Our viewpoint

This component of the framework was always going to be the hardest to measure objectively.  Given that, the proposals are a sensible starting point.

Disclosure templates and publication timings

The consultation discusses the logistics of how and when VFM assessments will be published.  Some options under consideration include:

• Should each scheme disclose their data on a public website using a prescribed template or should there be a “central repository” where all schemes submit their data
• Should there be a common deadline for the publication of the data used for VFM assessment reports (currently proposed to be the end of the first quarter in each calendar year)? This would then lead to VFM assessments being published by the end of October each year.  The DWP notes that it did consider a radical idea of aligning scheme year ends but push-back from the industry has persuaded it not to do so

Our viewpoint

The proposal appears to be that all schemes will make their own VFM data available for comparison with all other schemes and then subsequently schemes will be able to carry out their assessments using this data in the public domain.  This is quite a radical idea and will lead to significant extra work.

How will VFM be assessed?

The next chapter of the consultation looks at how VFM will be compared and what outcomes are possible from an assessment.

An important question in this section is whether VFM should be assessed against regulator-defined benchmarks or against other schemes and industry benchmarks.

The Government proposes that after completing a VFM assessment, a scheme will be categorised as either delivering VFM, not currently delivering VFM but with identified actions to achieve this, or not VFM.  This categorisation will be included in the published VFM assessment.

The Government also makes clear that it is considering giving the Pensions Regulator powers to enforce wind-up and consolidation where a scheme is not offering value for its members.

Our viewpoint

The questions in this section about what a scheme will be assessed against are some of the most important in the consultation.  There are good arguments for both regulator-defined benchmarks and peer-comparison benchmarks and so it will be fascinating to see which way the Government decides.

Impact on Chair’s Statements?

The consultation also discusses how the proposed VFM framework will interact with Chair’s Statements and the future of those.  The Government referenced its findings from the post-implementation review of Chair’s Statements published in April 2021 (see Pensions Bulletin 2021/18) and states that the DWP is considering splitting the Statement into a member-facing document and a governance document; or whether the Chair’s Statement remains feasible in the context of the VFM framework and other new governance requirements.

Our viewpoint

The Chair’s Statement has been a controversial topic for several years as it has become overly onerous and bloated to complete, whilst serving no discernable purpose for scheme members.  It has been known for some time that the DWP is considering the future of it, and we are pleased that this is referenced in this consultation.

Consultation ends on 27 March 2023.  No timescale is given for when the Government’s next steps are likely to follow.

Our viewpoint

These wide-ranging proposals, as drafted, will have a significant impact on DC scheme governance and should lead to better member outcomes.  However, schemes will be required to do a lot of extra work.

Improving VFM will, of course, improve DC member outcomes, but it is important to remember that these fundamentally depend on the amount of contributions being made into DC pensions – if these are too low then no matter how good a scheme’s VFM is, low contributions will lead to lower benefits at retirement.  This is the inconvenient truth that still needs to be dealt with.