Investment Pathways look simple but they’re not

The latest statement of intent by the FCA to improve value for money in workplace pensions arrived yesterday as Policy Statement  21/12.  This is not a discussion paper but new rules which came into force yesterday and the not so snappy title is not crying out for the document to be read.

Assessing value for money in workplace
pension schemes and pathway investments:
requirements for IGCs and GAAs

But this policy statement is important, not least for formally creating a new concept in UK pensions “the employer scheme”. Until yesterday, the COBS rulebook did not define the section of an HMRC approved personal pension scheme as relating to an employer. Now we have the concept of the employer pension arrangement

“employer pension arrangements” means an arrangement where eligibility for membership of that arrangement or section is limited to the employees of a specified employer or employers.

Providers of GPPs (and Master Trusts) have for many years, recognised that employers can negotiate their own terms in relation to the charges and the funds made available to their employees and former employees who do not transfer away their rights.

But this has never been formally recognised by the FCA, so when the FCA in its value for money paper CP20/9 suggested that IGCs disclose charges at employer level, some IGCs pushed back, saying there was no legal entity on which to report. Well now there is.

The 18 months since the publication of the FCA’s major Value for Money Consultation have been a testy time for relations with the IGCs who are aware that publishing the charges levied by their provider as the FCA would wish them to, would leave their providers open to negotiation with employers who found their employees paying too much.

The FCA has agreed that as an alternative to IGCs reporting on employer specific charges, they can report by cohort, effectively anonymizing employers. I support this relaxation as it still gives employers a starting point in working out what they are paying relative to their size. Underwriting is on a good deal more than “members in a scheme” but this gives employers a start.

The chart above is the very effective disclosure from Aegon in this year’s IGC report. Employers can begin negotiations by establishing which band they fall into and whether they qualify for the lower charges (by dint of the scheme being used for auto-enrolment). This is precisely what the FCA was asking for.

The other important new definition introduced in this paper is the “scheme comparator”

“scheme comparators” means other pension arrangements (that are not provided by the firm) …and which:
(a) are individual employer pension arrangements; or
(b) are cohorts of similar employer pension arrangements;

IGCs will , in their 2022 reports , need to compare the employer pension arrangements with those of other GPP providers and with the option of participating in a master trust. The FCA has dropped its reference to Nest as a scheme comparator, recognizing that Nest’s charges are established by the state and come with a Government subsidy by way of a long term loan from the DWP.

IGCs will have to challenge their providers where they discover charges out of line with the market and if necessary, report a negative response from the provider to the employer.

This Policy Statement makes it clear that it wishes comparisons to be made not just on charges but on “value for money”, a concept that it is jointly working on with the Pensions Regulator. Last month TPR and FCA produced a Discussion Paper on how to define and measure value for money with the emphasis being on “performance and quality of service” as the measures of value and costs and charges being the measures of “money”. That paper explicitly calls on the pensions industry to come up with a standard for quality of service and invites discussion on how performance is best measured.

It should be noted that the value for money of an employer pension arrangement, can vary not just by its costs and charges but by the default investment option (and accompanying funds). Where employer specific defaults are in place, I hope that IGCs will look to provide a more specific measure of value based on the experienced performance of scheme members.

This discussion paper also informs on the guidance that the DWP has produced to help small occupational defined contribution schemes assess whether they are giving value to members or whether better value could be found by consolidating into a master trust. To a degree, the nudge the IGC gives to the employer could be to “look elsewhere” in just this way. It is however a lot harder to consolidate a GPP than an occupational pension scheme. GPPs need member consent to move assets – not the case with occupational schemes.

What does this mean for the consumer?

Savers do not read IGC reports and sadly not many employers seem to either. Partly this is down to their subject matter being dry and partly because the reports have rarely given consumers or employers the opportunity to improve the value they get from the money invested.

The new rules in this document are designed to make future reports more interesting and more useful. By introducing the idea of  “employer pension arrangements” and “scheme comparators”, the FCA is changing the question from “does your workplace pension offer value for money” to “how does your workplace pension’s VFM compare with others?”.

By recognising that VFM is not binary but relative the FCA is making the IGC’s task relevant. Which is why this Policy Statement matters for the consumer. The FCA has found a way past a simple comparison of costs and charges to a point where the IGCs (and GAAs) will be helping decision makers make informed choices on their and their staff’s behalf.

Extending the scope of VFM comparisons to investment pathways

The paper also touches on legacy – non workplace – pensions (which it decides it will look at later) and the new “pathways” which are the investment options people can take when they are moving from saving to spending their savings. These pathways have only been in place since February and are only offered where advice isn’t available (SJP for instance do not offer investment pathways on their SIPP).

Theoretically, pathways are very important but early indications are that they are not being followed by many of the people for whom they are designed. Most people are ignoring the pathways as they are ignoring Pension Wise and stripping their pensions of whatever tax free cash is on offer while leaving the rest of the money for later.

There are big problems looming here, not least because much of the money that is sitting in the pots of the over 60s has been de-risked and is not getting returns from the market (as it would in the relevant pathway). As yet, the FCA has not acknowledged the issues with take-up of pathways but I suspect that this will become a major bone of contention over the next few years with questions being asked of IGCs and providers as to why pathways are not better used.

The FCA want pathways to be compared so we have another new concept

“pathway investment comparators” means other pathway investments (that are not provided by the firm) selected by an IGC

Unlike the misguided pathway comparison site published by MaPS, the FCA is wanting the pathway comparisons to be on a VFM basis, not just a comparison of costs and charges. This is absolutely right, but since the pathways are new, IGCs will argue that there is no investment performance to compare.

The starting date for the comparison of investment pathways could be argued to be the point at which pension freedoms were granted to those saving into workplace pensions (April 2015) or even earlier – if you were rich enough to be able to drawdown under pre 2015 rules.

We now have a large data set – collected by the FCA as part of its retirement income study which could allow IGCs and their providers to model what has been going on with those over 55 and how behaviors are changing over time.

I suspect that the most important questions that need to be answered by IGCs are

1. To what extent are savers taking guidance and separately advice on how they spend their workplace pensions?
2. What does guidance and advice do to the behavior of these savers?
3. How popular are the pathways offered by my provider?
4. What can the IGC do to improve take-up of pathways by relevant policyholders?
5. How good are the pathways of our provider, measured by value for money?

My suspicion is that we are only touching the surface of the problem people have converting pots to pensions and that measuring the VFM of individual pathways is less relevant than answering questions one to four.

When we come to assessing the value for money of drawdown, the quality of service issues change as the employer no longer features as the primary interface ; the provider is now dealing with the policyholder directly. Service issues will focus around withdrawals not contributions and the execution of instructions. If guidance is to play a part in the quality of service, it must focus on alerting spenders to their capacity to self-harm. I hope that those offering guidance will feel they can promote the pathways without this being deemed advice and that they can suggest that following pathways will be like ski-ing on the piste, it won’t stop you falling over, but it will save you from falling over a cliff.

The FCA are now coming to the  end of their journey helping employers to identify value for money. But – when it comes to the use of IGCs to oversee the conversion of pots to pensions, they are still at an early stage.