The numbers in the boxes above show how much value a group of savers have done with £523m invested in their pots. On the face of it, they have got a better return on average (4.75%) than if they’d been invested in a benchmark fund (3.85%) and we say that they have scored 58 – considerably higher than the average scheme where the benchmark is 50. At a scheme level, this workplace pension can say that it is giving value for money.
Imagine being told that your pension provider was giving you value for money only to find that you had suffered chronic under performance by comparison to your colleagues.
The idea that a pension provider is giving value for money simply because a value for money/member tells you so should come with this risk warning
“Our assessment is based on generalities, we can’t tell you whether you’ve got value for money from us, you’ll have to work this out for yourself (or get an IFA to help you)”.
Take a look at this chart that speaks to the experience of around 11,000 people in an occupational pension scheme.
You can see from the chart that the vast majority of savers got positive returns of between 4 and 8% pa after all costs but that there was a long tail of lower scores and around 10% of savers who did considerably better than average.
When these savers are compared to a benchmark fund, the distribution of results is dispersed in a slightly different way
the majority of savers have scored better than average (50) but the long tail of low IRRs is much thinner. Only around 0.5% of the sample have got really poor value for money and only about 10% of the members have done worse than an average score.
This would suggest that in general the scheme is giving better than average value for money but the risk warning applies, you may be in a performing scheme but not be doing so well yourself.
Based on your data
What is different about this approach to value for money scoring is that it is based on people’s experience, not on a high-level estimate based on feeds from fund managers and charges worked out with reference to charging methodologies and expressed in terms of reduction in yield, TER or total cost of ownership.
These IRRs and scores are based on real information and the value for money assessment this scheme provided itself with showed that while the overall score for the average scheme member was well above average, there were winners and losers , based on their data.
In a DC scheme everyone carries their own risk
This may seem obvious, but it’s only when you start digging into the reasons for very low or high IRRs and bench-marked IRRs that you start understanding the actual risks that people are taking.
One of the prime reasons for low scores is the choice of assets. People who choose to invest for the long-term using money market funds that give a return on cash typically find themselves getting a bottom decile return, but there are other reasons.
Markets and funds can produce price spikes and troughs
Find yourself investing into a highly volatile fund on a spike and you may find yourself struggling to get yourself value from it. If you are investing a lump sum like a transfer, a bonus or simply money from savings, you are taking a risk which you don’t take from regular even contributions (this is known as pounds cost averaging). Of course you could be lucky and invest in a trough and the difference between the lucky and cursed is what can give a dispersion of IRRs and AgeWage scores between those in a single fund.
Of course this assumes that your contributions got properly invested and a careful examination of contribution histories often shows that contributions can go unrecorded, mis-recorded or even recorded where no units were purchased. Such anomalies are rare but they get picked up by IRRs and AgeWage scores because they produce anomalies in the distribution (we call these anomalies outliers). Quite often plan administrators have discovered outliers have identified faulty data.
Improving outcomes for those in DC schemes.
The DWP at the end of last week, produced an important consultation on improving outcomes for members of Defined Contribution pension schemes.
At the heart of the consultation is a proposal for a much more vigorous assessment of value for money to be applied by the trustees of smaller DC schemes (with less than £100m in them).
The idea is that the assessments can be compared to assessments of other schemes (which may have better metrics) with a view to trustees winding up their under-performing scheme and transferring members into a better plan
The principle is bang on as are the measures to assess (performance, costs, governance and record keeping).
But in practice, but rather than use scheme records, the report recommends using high level fund and cost and charges data and taking trustees word for it on the quality of member data.
I think this does not go far enough. It treats individuals as if they were part of a collective pension – whereas they are effectively managing their own risks.
And the complexity of the reporting makes comparisons look extremely difficult.
Any collective statement about value for money must come with a risk warning that states that the collective assessment should not be relied on by individuals. And at scheme level, it should allow schemes to be compared, not just by the generalities, but by the dispersion of results
But individuals have a right to know how they have done – and schemes who do value assessments based on their member’s actual data, can show members their individual performance bench-marked against a relevant index.
Value assessments conducted using member data can also shine a light on savers whose results do not make a lot of sense , highlighting areas where work on data may be required. The advantages to providers looking to get their data dashboard ready are obvious.
A final thought
The DWP’s aim is to drive consolidation which (for a variety of reasons) they believe will lead to better outcomes. In most cases they will be right. But in order for them to use value for money as a means of comparing schemes, we are going to have to get a lot better at assessing value.
I go into this in more detail in this recent blog. We are likely to see much change in the market for DC provision as a result of the DWP’s work (and work of the FCA on VFM). It is critical that we get this right. The DWP’s consultation runs to the end of October and I will be focusing on this issue in the next six weeks. Get this right and we really can improve the outcomes of those saving into DC pensions.