“What will Lifestyle buy me?” is a great question. It’s one posed by a lady in a discussion group I’m a part of – looking at how we measure and use value for money as a measure – in workplace pension schemes. Of course for most people “lifestyle” is now much more to do with health than pensions and a simple answer is that Lifestyle should buy you a financially healthy retirement – but that is too glib and doesn’t get us too far!
“Lifestyling” is taken as a USP for each pension scheme. This makes it hard to generalize as one workplace pension will use it differently from another scheme and some schemes don’t use it at all. Nest keeps people invested and offers a side-pocket of cash to those over 55 which can be drawn to meet major cash payments.
Some schemes don’t derisk from growth to defensive assets, some schemes derisk to a point that members could take 100% of their benefit away from the scheme at a targeted point with no market risk at all.
How do you measure and compare the value for money of a lifestyle strategy when they are all different and how do you communicate the value of the strategy you’ve chosen to members who have little idea what their retirement options are? These are real and pressing questions to the trustees of occupational DC schemes and those who manage group personal pensions.
This boils down to 3 issues
- Is the lifestyle meeting the needs of the member – protecting them from risks and so maximizing returns on what they’re buying.
Is the lifestyle properly executed (what are the costs of all those little switches)?
How do you measure 1 and 2 above?
Is Lifestyling aligned to what a workplace pension buys?
We know from the FCA’s market study on at retirement decision making that if there is any consistency in member decision making is that they strip out tax free cash when they can and keep the rest of the pot invested. I wonder how many lifestyle strategies are designed with “strategic empathy” and how many are designed with “strategic narcissism” (this is what we the trustees think you should be doing!).
These terms were coined by an American general in Iraq at the height of the insurgency. The instructions from Washington was to implement a strategy designed for what the General called “Myraq”, the Iraq Washington wanted to happen while the General was dealing with the reality in the ground in Iraq. He called Washington’s approach “strategic narcissm” and his “strategic empathy”. The problem with the Myraq approach was that it drove Iraquis away from the American troops and to more extreme versions of the behaviour Washington disliked.
A lifestyle plan that isn’t aligned to the behaviour of its members won’t mitigate the right risks , telling members what a lifetyle is designed for , when a member wants to do something different risks pissing the member off.
Is measuring Lifestyle about efficient execution and the value of the pot?
Lifestyling usually involves selling units in one fund and buying units in another. In some cases , transaction costs and out of market risks can be mitigated by good investment administration that avoids transactions but sometimes this doesn’t happen and lifestyling can cost a great deal of money – a cost that isn’t picked up by the AMC but by a reduction in member outcomes.
As to the measurement of the overall effectiveness of the lifestyle strategy, this is usually measured top down (estimating performance and fees and trying to work out the cost of switching). It can be measured bottom up, looking at people’s outcomes when lifestyling and comparing them to outcomes from those who stayed in the pre-lifestyle accumulation (people who turned lifestyle off). This can tell us whether the lifestyle was aligned to people’s objectives and was worth it.
If fiduciaries really want to get to the bottom of whether lifestyle is being well executed, they would need to compare the actual outcomes of those lifestyling with the theoretical outcomes (based on a best estimate of net performance of the funds in the lifestyle matrix). This may be being done but I have not seen any data showing the impact of lifestyle transactions and would be grateful for any data people have,
The alternative approach, which assumes that trustees know best asks “did lifestyle nudge people to do the right thing”. Here the question “what will lifestyle buy me?” could be answered by
When the American generals in Iraq came to implement Washington strategy, they complained that Washington assumed that Iraquis wanted what American liberals wanted – which turned out not to be the case,
The worry about lifestyle strategies is that they are too Myraq and don’t recognise what members actually want and do, which can mean the lifestyle strategy is counter productive. But trustees do argue the other way and say that the lifestyle strategy could put the breaks on bad behaviour and nudge members away from self-harm.
My suggestion is that schemes work hard to find out what members actually do from 55 onwards and manage the default around actual behavior. However they can put in a circuit breaker sometime around 50 with an opt-out of lifestyle for people who know what they want to do. Pension Wise can help here
“do you know what your pension fund is designed to do?”
though I suspect that most people will neither know the answer or be interested by the question, unless the financial implications of getting lifestyle right are made clear. This is the “what will it buy me” question.
Or is lifestyle about influencing member behaviour?
The “what will it buy me” message might be that
“for most people, a quarter or the pot will be available as cash from 55 (with no investment risk to you) but that this will mean less opportunity for a quarter of the pot to grow at market rates.You may not be like most people and you can chose now to manage how much of your fund is switched to cash.If you don’t want your cash any time soon, then you should turn lifestyle off.Be aware that you can take cash from money invested in the market but this carries a fair bit of risk (as markets are volatile)”.
It is quite possible for fiduciaries to share factual information based on what has happened in the past (with the usual caveats) to show the impact of needlessly making tax-free cash available.
If you employed lifestyling and didn’t take any cash, for every £1000 you have in your pot , lifestyling would have cost you- over the next ten years – £100
The messaging can be the other way round (employing a value at risk message) but there things get really complicated. I am conscious that these messages rarely get read and even more rarely get remembered.
Reading this , you may feel that trying to run a lifestyle program is more trouble than it’s worth as you can never second guess what lifestyle will buy a member. It may be better to simply continue with the investment strategy you’ve applied to younger people and leave people to it. This of course may be how CDC develops within DC plans – with the only variable being when the member moves from an individual pot to participating in a collective pot which starts paying them back cash and income according to an agreed formula.
Postscript -How can lifestyle strategies be measured for VFM?
Ultimately , VFM can only be measured by its outcomes , not its intentions. Trustees should be wary of trying to create Myraq and measuring success on their not their member’s terms. It is no good complaining after the event that member didn’t “behave as we intended”.
If trustees believe in the value of their interventions, they can measure their own performance by the impact they had on member behaviour. This might be achieved with reference to the FCA’s market study on retirement incomes which plots the changing behaviour of members in taking their pots since 2015. But I don’t think this can be part of a value for money assessment.
I don’t think we are anywhere near measuring the efficiency of lifestyle strategies on a top-down basis – that is just too hard. But comparisons can be made against other lifestyle strategies in other schemes by comparing the internal rates of return achieved (typically against a common benchmark but also one against another). Comparisons can also be made against schemes not employing lifestyle and schemes de-risking through target date funds.
In answering the question “what will lifestyle buy me”, my answer will always be “that depends on how well it’s done” and that will always lead back to looking at outcomes.