One of the questions in the FCA’s consultation on value for money is whether its definition is ok or whether we can find a better one.
This is our definition
Pension value for money’s measured by the amount we can spend for the amount we’ve saved. It takes into account the quality of service we’ve received and the amount we’ve paid in charges.
This is the FCA’s
The administration charges and transaction costs borne by relevant policyholders or pathway investors are likely to represent value for money where the combination of the charges and costs and the investment performance and services are appropriate
a. for the relevant policyholders or pathway investors; and
b. when compared with other comparable options on the market.
We think ours wins for four reasons
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- Ours is inclusive, the FCA’s specifically relates to what IGCs are concerned with but doesn’t talk to people who contribute to defined benefit plans , members of trust based DC schemes and those who save outside the workplace. We prefer a universal measure – it was what the Work and Pensions Select committee called for
- Our is intelligible using phrases that people use in everyday speech. The FCA’s definition sounds like it was written by lawyers.
- Ours is structured to divide what ordinary people measure (outcomes and contributions) from what experts measure (costs and charges and quality of service). The FCAs is hinging the definition on a value judgement, what is “appropriate”. The prominence of this word in the definition suggests that VFM is out of the ordinary person’s reach.
- Ours does not require intimate understanding of the markets but is based on a simple metric – contributions against outcomes. This metric can be benchmarked because it is the internal rate of return – something common to all funded pensions.
Let me expand on that final point. If you read the articles of Iain Clacher and Con Keating, you will recognise that even Defined Benefit plans are based on am implicit rate of return which links assets to liabilities. If over time schemes cannot achieve this return they fall behind and can’t pay the pensions, the payment of pensions then becomes a problem for the sponsor (usually employer).
In Defined Contribution plans there is very rarely an internal rate of return implicitly targeted. One exception is Prudential’s workplace pension which has been set a target by its IGC of CPI + 3% as the return members should be getting. This doesn’t guarantee members any kind of pension but it is the benchmark internal rate of return for members.
The IGC can – using their own definition – tell members whether they have been getting value for their money by measuring how many have beaten the benchmark. This is a complex way of telling people what they can spend for what they’ve saved and it relies on all contributions going in being measured against what’s left after all monies have been taken out. Except where the money out has been a partial transfer or a drawdown, “what’s left” is the net asset value.
Since the money to be spent counts for most of what we value in a pension, we consider the impact of charges and the quality of service are of secondary importance. If someone has had a very high quality of service, they may forgive poor outcomes (the basis of the SJP business model). If the cost of managing the money is very high but the outcomes are good, then there may still be value for money (the private funds model). People can take into account high costs and high levels of service and still consider they’ve had value for money.
Phoney VFM
If the 100 or so IGC reports that I’ve read over the past five years are to be believed, 98% of the time VFM has been achieved. This begs the question – relative to what? The FCA are keen that benchmarking happens, but other than league-tabling the admin costs of workplace pensions to employers, they haven’t found a common benchmark.
We could take the Prudential’s CPI +4% and at AgeWage we seriously considered measuring IRRs against this. We rejected this as we thought that with 60m DC pots , a better benchmark would be the average return of the 60m pots. Ultimately we hope that AgeWage scores tell you how you have done relative to everyone else (simply by reinvesting your contributions in a benchmark fund representing the average person.
Which begs the question, how did 98% of people do better than average? We can only conclude that 50% of people did better than average and the rest is fake news resulting from a phoney marking system – phony VFM.
What of quality of service and cost and charges?
The best advisory service I ever saw was delivered to the steelworkers at Port Talbot. Their every need was catered for, right down to application forms being taxid to their doors. A high quality of service does not mean a great product and ultimately you can only paper the cracks so far (and this is not a pop at SJP who have realized this and are doing something about it). But generally there is a correlation between quality service and good outcomes which means service quality is not only a part of the equation but a validation of the assessment.
High charges are a flag that something may be wrong in the governance of the plan and even when returns are high, there is something to worry about. But we need to understand what charges really are before we say a charge is high or low. You get a lot for Terry Smith’s 1% AMC. As I’ve pointed out many times, some of the AMCs displayed by Fidelity and Old Mutual (two examples only) show only a small amount of the charge (with much of the charge hidden in the unity price) . Workplace pensions with combination charges are further examples.
We need to take account of costs and charges and quality of service in the VFM assessment but they should not drive the assessment itself. Ultimately what matters to savers is outcomes.
So what do you think?
We think our definition of value for money is one that could catch on. It’s not the snappiest but neither is it superficial. We hope it starts people thinking.
We do believe that if people feel they have a way of testing the value they get for their money , they will be more likely to engage with this complex intangible thing – called a pension pot.
We’ll be finding more about that as we test our AgeWage scores in the sandbox, but in parallel we’ll be testing our definition and that process starts here!
Please drop a comment on the blog or email henry@agewage.com with your thoughts or what you consider better alternatives.
