Value for Money underpins financial services regulation in the UK
One of the things that Brexit has thrown up is the importance to the British economy of financial services. We don’t just manage our own financial affairs, we manage the affairs of millions of people around the world, perhaps billions. Through fund management, corporate and personal finance and insurance our financial services system leads the world.
Despite all the uncertainties , London remains at the heart of the European and world financial markets and our leading financial regulators, the PRA, FCA and tPR are considered models for other countries and indeed communities of countries.
One thing that focusses Government’s attention is Value for Money. It is the measure that allows it to compare pensions with mortgages , corporate finance with insurance premiums. It is a measure of efficiency and of fair shares. “Value for Money” had its birth in the writings of Will Hutton who called for a stakeholder economy where each participant dealt fairly with each other.
Value for money in pensions
Nowhere is the disclosure of value for money more important than in private pensions. The idea of a pension plan is to trust a financial institution to look after the money you put aside for older age for as long as you live. The money will swell as you save and shrink as you spend it, but it’s money that has a specific purpose, to provide what Dyson and Evans are calling “Your retirement Salary”. It is what I call an AgeWage, it is the product of a pension pot – it is a pension.
Pensions can be damaged by mismanagement. A lack of attention to the “value” opportunities or to the “money” drag , mean that what you get in your pension pot can be radically different to what your neighbour got or what you’d have got if you’d invested in a different way or with a different pension provider.
When we choose a provider, or in the case of workplace pensions, when our employer chooses our provider, a promise is made that the provider will do their best for you. The promise is implicit and is backed by various fiduciary principles enshrined in contract and trust law. The codes include the principles of “treating the customer fairly” and of “protecting the member” (FCA and TPR respectively).
Since our money is away from us for such a long time, we need fiduciaries to oversee what pension providers do, these fiduciaries are IGCs and Trustees. We need regulators to oversee the fiduciaries , they are the FCA and TPR. The PRA provides a framework for the financial system so that it remains solvent – even in times of financial crisis. This is how it works.
Value for money is the holy grail for pension regulation, for it is the only common measure that links everyone from ordinary people like you and me, to the people who run our regulators and sit in Government. We all get value for money.
Value for money for pensions is critical , for nowhere do we place so much trust in others than we do in giving our money away for a lifetime’s management.
Value for money in saving and in spending
I have defined the job of a pension plan as to provide a means to save for retirement and spend in retirement. The two halves don’t necessarily have to be carried out by the same people and in many cases they can’t be. For instances the trustees of single employer occupational DC plans – (sorry about the jargon), aren’t allowed to provide a drawdown facility for staff by the sponsoring employer. Rene Poisson speaks movingly about this frustration as Chair of the Trustees of the JP Morgan Staff pension .
Sometimes our pension plan involves us having to intervene and change pension provider. If you go to People’s Pension for instance, they’ll point you to the insurer LV= to finish the job they’ve started.
Value for money is equally applicable to spending money as it is to saving. LV= should be as much under scrutiny as People’s Pension. The same should be said for all SIPP providers who take on our pensions wealth and help us spend it. They should be measured by the same standard of value for money as those who help us save.
The FCA has (belatedly) woken up to this and is consulting on allowing IGCs to have oversight of what’s going on “to and through” retirement. The saving and spending phases of a pension plan are to the consumer, two aspects of pensions, not two pensions.
Measuring value for money
The business of measuring value for money should be extremely easy and the fact that it has proved to be very hard suggests to me that it value “for money” is contentious in certain circles where the idea of “transparency” has not taken firm root.
People understand “value” as the benefit of what you get (from a pension plan)
People understand “money” as what you pay (into a pension plan).
Value for money is “what you get for what you pay”.
When you ask people what they get from a pension plan, they will almost universally say money in later life. They may define that as inheritable wealth or a capital reservoir or as a wage for life – but it amounts to the same thing – a sum of money. What you get is money. All the other things that pension providers sell are secondary to the money.
When you ask people what they pay into a pension plan, they talk about their personal contributions and they will usually talk about what their employer pays and sometimes what HMRC pays and very occasionally what the DWP paid. They do not talk about the charges in their pension plan (which is the cost of management) because that is bundled into “what they get”.
Measuring value for money cannot start by analysing the component parts of “what you get” – it must start at measuring what you get. The value of a DC pension plan is the net asset value of the plan at the point it is measured. That is the value. The value is the NAV
The money is the sum of the contributions paid and the only other dimension that matters is time. Money that was paid into a plan in 1980 has a higher time-weighted value than money paid in yesterday. So to measure the money you paid for the value you got , we need to measure the time when you paid your contributions. Technically we need to measure “time-weighted contributions”
We can measure value for money by considering the NAV and the time weighted contributions and working out what value people got for the money they paid in – with due consideration to when they paid it.
Keeping it simple to begin with
I might be able to express your value for money in a number of ways, but the most effective and widely understood is to tell you the internal rate of return you got on your money – which might be anything from negative to hugely positive.
But this number, expressed as a percentage is useless to an ordinary person unless they can compare it to what they might reasonably expect to have got from that money. Working out what your expectation should be is hugely contentious. Experts will agonise on where the money should have been invested and how much should have been taken in fees, they will argue about whether re-balancing should be daily or annually and about measures of risk and whether they should be included.
They will also argue that other things than the NAV should be included in the calculation – for instance the cost of life cover, waiver of premium , guaranteed annuity rates and investment returns. All of this – they will argue, makes it impossible to compare value for money in a simple way.
But this is where the pensions industry goes wrong. This is where it loses its public. Because its public is not interested in considering all these complicated things , until it has got an answer to the simple question “what did I get for what I paid?” .
When we can answer that question, then we can go on to consider the minutiae.
Comparing value for money
If you follow my argument you will see that ultimately , the only way to compare your value for money with everybody else’s is to measure everyone’s VFM in the same way and work backwards. What I mean by that is to work out what constitutes the average value for money and then tell people if they’ve done better or worse.
We can’t do this easily. It has to be done bit by bit and leg me explain.
We have enough data from companies like Morningstar to know how our pension savings have been invested over the last 40 years. If we look at all the funds , we can see that over time people were invested according to trends, sometimes more in bonds, sometimes more in equities, money was often invested in other things like cash and property. The returns on these investments depended on manager skill and charges but if we look accross all the people investing , we can construct an average way people were invested and the average amount they paid their pension provider to run the plan.
So we can compare what people actually got for their money , with what the average person would have got from their money by reinvesting contributions in a time-weighted way into an average fund – what I have recently called “normal”.
And what you’ve got for your money, compared with what the normal person would have got from that money tells us whether you got more value for money than usual or less value for money.
And we can express this as a single number which tells you what value you got for your money.
This is a breakthrough
This is a breakthrough. Regulators know it is a breakthrough, my diary is full of meetings with regulators who know it is a breakthrough. My offices in WeWork Moorgate are full of people who want to hear more about AgeWage scoring and I have hardly time in the day to explain this. Which is why I am writing it down in a blog
Why Government can now move forward
Of course what I am doing will itself have to be regulated. Comparing value for money when you’re saving and value for money when you’re spending may need some extra explanation.
The value of a pot with a guaranteed annuity option needs to be explained as potentially higher than one without.
The person who’s contributions have been paid by an insure when in a waiver of premium claim – needs to understand that they paid less money than the rest of us.
I could go on – but won’t. Because we cannot allow these things to get in the way of the main event – which is that for most people, value for money can be defined by how they did with their money against how the normal person would have done.
The key is defining normal, something I talk about at length in this recent blog.
If we can find out what people got for their money , if we can define normal and if we can compare one with another we – that is the financial services industry and Government can move on.
IF WE CAN DO THIS, WE CAN TELL PEOPLE THE VALUE THEY’VE GOT FOR THEIR MONEY
IF WE CAN DO THIS, WE WILL HAVE CHANGED THE GOVERNMENT OF PENSIONS
Which is why – reader – AgeWage’s work is so radically important and why you should consider investing in this company which is currently crowdfunding.
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www.seedrs.com/Agewage