The regulator sees 'value for money' as a key outcome for workplace pension members and as a result both providers and Independent Governance Committees (IGCs) are keen to evidence it. But what is it and can it really be measured?
In reality value for money means different things to different people and quite rightly so. A member who is approaching retirement will value different benefits to a member who is just starting out on their savings journey. Ensuring customers have a meaningful fund at retirement depends on lots of factors such as costs, engagement and contribution levels, investment returns and the governance and controls around default design. The issue for IGCs is how they determine whether these factors deliver value for money for the majority of members. This article looks at some of the key considerations which should be reviewed.
Cost has to be a key factor and more recently regulatory requirements are aimed at identifying all the costs paid by the member. This means that schemes must also consider the transaction costs associated with the buying and selling of the individual securities within the funds. These costs are currently included within the fund return and performance is shown net of these costs. The requirement to show them separately is designed to show how efficient asset managers are at managing the underlying investments and whether this offers value for money relative to the return being delivered. High transaction costs are not necessarily a bad thing if the fund has met, or exceeded, expectations. As this data becomes available it will become important to look at how costs have changed from year to year to understand if asset managers have been able to make improvements in their trading processes.
The introduction of pension freedoms has resulted in more choice than ever in terms of DC default design and the differences between defaults is probably greater now than it has ever been. It is impossible to design a default strategy without relying on a set of assumptions about risk premia, their stability over time, asset correlation, and diversification and risk. These assumptions will drive a set of beliefs which are used to guide the approach to default design. This is important because there is no single universally agreed account of how markets and asset classes behave. Reviewing these beliefs and regularly testing them against current market conditions will give confidence that the design remains fit for purpose in a changing world. Although there is lots of data available on long term asset class returns and correlations, there is less evidence about how we progress from current extreme interest rates to equilibrium, or even what a new equilibrium might look like. In my view this uncertainty should drive a greater requirement to more regularly review and refine default design.
When reviewing investment returns for any particular fund, it is vital to consider the level of risk that that fund is designed to accept. It is unlikely that members are aware of the risks they are accepting. It can be difficult to compare risk and return for each individual member as they will have their own experience based on the asset allocations that applied during their particular journey, however I would expect a governance process to include examples of the level of income different member cohorts could end up with. This can help to identify whether the default has delivered good outcomes against the objectives.
The combination of low financial capability and low engagement means that most customers are not prepared for the complexity of the decisions they need to make at retirement. This is why it’s so important to start retirement conversations earlier so members can start to value their pension savings, understand their options at retirement, and help them to understand how they might use their savings and if they might benefit from financial advice. Reviewing the scheme engagement strategy can highlight any gaps or areas for improvement.
Value for money will continue to evolve as the workplace pension market continues to develop and our understanding of customer behaviour grows. As this interaction between provider, employer, adviser and member becomes greater it should hopefully become much clearer to define and measure value for money.
Head of Investment Solutions
Lorna is responsible for the the ongoing promotion and development of Royal London's investment proposition. She holds the IMC qualification and a Masters in Investment Science.