The story so far…
2014 – the OFT conclude that we are rubbish at buying pensions
2015 – FCA requires big insurers providing workplace pensions to set up IGCs (and most of the rest GAAs)
2016- IGCs start producing statements on provider’s value for money
2018 – NM consumer survey tells IGCs people judge VFM by the money they get out of at the end (the outcome)
2020- FCA report that IGCs have been a mixed blessing and intervenes to get a common definition of value for money.
The FCA feel they can narrow down the sources of VFM to three tributaries
and can map value for money using a single definition
So far so good….
But mapping the source of value for money and determining whether it is flowing towards you or flowing away is a much harder job.
Because workplace pensions are not heterogeneous they present themselves not as a single river, but as a vast delta of different streams, all of which are flowing at different rates often in different directions (we can in this analogy think of flow as efficiency and direction as value). All will get to the sea eventually but some channels will get you there faster and without the rapids.
Where the train hits the buffers.
Most IGCs are Chaired by pension experts brought up in a tradition of defined benefit where governance was and is top down. The few chairs who have been drawn from the world of insurance ( Lawrence Churchill, Mark Stewart and David Hare are examples) operate in a different paradigm. In the DC world , VFM is about the outcome of the saving process.
In the world of defined benefits, value and money are intrinsic in the funds employed. These funds are the building blocks and as long as you can assess how the funds are performing and find the underlying costs of running those funds, you can measure the flow and direction of funds and report on whether the scheme is getting value for money for each fund. The same can be done for administration, member engagement and so on. That is because there is only one fund and everyone gets an equitable outcome based on the defined benefit formula.
But employing this top down methodology to defined contribution workplace pensions is a mugs game. Let me explain why.
Firstly there is not one investment choice, typically there are many choices available to those who choose to self-invest rather than save into a default.
Secondly there is not one scheme but many. As I explained in my blog about the challenge of benchmarking. you cannot regard a workplace pension scheme or most master trust as a single scheme. The FCA refer to entities such as the Aviva workplace pension as the “relevant scheme” and were you to participate as an employer in the scheme on standard terms with standard funds, you could use the value for money assessment in the IGC statement as relevant for you.
But if you were an Aviva client (such as Tata Steel or Three mobile). participating in the Aviva Workplace pension , you would do so on your own terms and possibly with your own funds. The FCA recognise these special arrangements and call them Employer Schemes (distinct from the Relevant Scheme – the one HMRC authorises).
And here the train hits the buffers, because the measurement systems for value for money, laid out in another FCA paper, PS20-02, are simply not up to the job of analyzing all the different charging structures and fund combinations that have developed within these relevant schemes.
At this point we have to realize that the old way of assessing value , by measuring charges with pinpoint accuracy, by measuring gross fund performance and by tweaking the results by a subjective measure for “quality of service”, simply cannot work.
It is easy to see why the FCA has become so obsessed with the measurement of cost and charges, disclosure was one of the principle remedies laid down by the OFT
But too much emphasis has been put on the disclosure of cost and charges. While it is critically important for platform managers to monitor these costs and ensure that they offer value, they are only one part in the value for money chain and much as PS20-02 is a valuable document, it does not resolve the challenge presented by talking to ordinary savers or even employers about value for money,
There are too many tributaries and the business of mapping every one would be a value destroyer.
But there is another way of thinking about value for money…
Imagine I am at the source of the river and I can release pooh sticks, each with GPS tracking. Imagine that I can plot the progress of those pooh sticks to the sea. In a very simple example (which equates to a single premium being paid at the outset of saving), I can see how much value the stick got from taking the channel it did. I can also chart how much value other sticks did, taking other channels and in doing so , I can pronounce whether my pooh stick got value relative to the other pooh sticks.
All I need to do is to know when I dropped the pooh stick into the water and when it got to the sea.
And if you think of every contribution made to a DC pot as being measured by the outcome of the saving , then you can think of both performance and drag as being implicit in the outcome.
This is DC’s eureka moment. So long as you can measure what has happened to all the contributions that flowed down a channel, you can measure the value of the channel for the contributions made. I give you that this measurement cannot tell you how pretty the river banks were or how many locks, weirs, rapids and waterfalls had to be encountered along the way, but if that pooh stick makes it to the sea, we can measure its progress quantifiably.
The eureka moment is upon us.
The history of measurement is punctuated by eureka moments, think Copernicus, think Newton, think Darwin. They are characterized by their mundanity, Archimedes getting out of the bath, Newton being hit by a falling apple.
DC’s eureka moment may be contained in this sentence in a recent mail to me from the FCA
“in order to be meaningful we need the IGC to obtain data on what each employer’s scheme is achieving for its members”
I believe that not only is this possible, but it is practical, provided that the data that is analysed compares inputs to outputs and follows the principles of pooh sticks!
The proposals I am putting forward to reform the measurement of value for money will mean accepting that much of the value for money frameworks constructed over the past five years will be of little use.
Frankly they could not be employed to measure thousands of employer schemes within one Relevant Scheme, they are too dependent on human judgement and just aren’t scale-able to measure VFM in employer schemes.
Nor are they much help in bench marking, since the scoring systems turn one relevant scheme into an apple and another into a pear. Imagine trying to create compatibility beween not just VHS and Betamex, but 20 other operating systems. By comparison, a VFM scoring system that measures outcomes against a consistent benchmark is infinitely scale able, readily understandable and really useful.
But existing value for money frameworks still have value as an internal governance tool. So long as the measures of cost, performance and quality are consistently applied . the application of each individual framework can chart improvements or declines in each measure.
Internal v External measures
The fundamental question that has to be asked of any statement about a scheme’s value for money is “compared with what”. If that answer is “compared to how the scheme was last year of five years ago”, then the measure is still valid. It can show if progress is being made. It is of course subject to bias as few IGC chairs would like to admit to a deterioration of value on their watch.
But if employers can’t use the VFM statement to compare Standard Life’s relevant scheme to the Standard Life BT employer scheme, if the employer can’t compare both to NEST or People’s pension, can British Telecom or Tesco or Suez or any other employer testing whether they are getting VFM, make anything of the IGC’s VFM assessment?
And what of the individual saver? Having read 14 IGC reports , can the saver be any clearer about whether he or she is getting value for their money?
When in 2014, the OFT reported on workplace pensions they made the following observation.
The IGCs were set up to provide the buy side (employers and savers) with a way to engage and understand their pensions, but the IGCs have by and large failed to do this.
We need a new way of measuring value for money and we believe we have found it.