The most pressing matter on the pension policy agenda (and we should expect a consultation on this in the next two weeks) is clarification on the DWP’s Value for Money agenda. The consultation may be long but it must address three short questions. In the context of our pension savings (the savings on which we (not employers or taxpayers take the risk)
- What is value for money?
- How do we measure it?
- How do we use it to improve outcomes?
This is not the time to get philosophical. Value for Money is a measure of the value people have got from their pensions, in as much as the past is a guide to the future, it may also provide some help for those combining pensions but it is primarily a way of holding those who manage our money to account.
This is precisely the message that the pensions industry has been doing its best to avoid being asked, but it gets to the meat of what people want, they want to know how their savings have done and employers and Government want to know too.
How do we measure it?
In order to avoid being accountable for value for money, the pensions industry has avoided measuring how people have actually done and instead concentrated on a range of measures which focus on how they might do better. Chief among them are means to encourage people to save more, the argument being that the more spent on retirement, the more there will be in retirement. This is a good argument where savings are voluntary but savings aren’t voluntary, they are impelled by auto-enrolment and encouraging voluntary savings in non-enrolled groups (such as the self-employed) does not seem to be dependent on the blandishments of pension products.
What people want is to know how they have done. The Halifax Housing survey may tell people that houses have gone up or down in their area but they want to know more, they don’t want to know about their area, or town or even street, they want to know how much house house is likely to sell for. While house valuations aren’t super accurate, knowing that it’s number 9 Acacia Ave, rather than 13 Acacia Avenue makes all the difference.
So we have to measure VFM based on people’s experience of it, because in DC saving, we are not all in it together. Our experience depends on the timing and incidence of our contributions, people can get violently different returns depending on when they saved their money , what their funds have returned and even when the money they saved was invested. Much more money is lost in transition (lifestyling in particular) than is supposed. Swinging pricing on the buying and selling of units in a DC fund can mean much more than the hidden charges within the fund, what people get from saving , depends on a myriad of things going right or wrong, most of which are not disclosed.
So, we need to measure how people have actually done, person by person, internal rate of return by internal rate of return and we need to compare the rates people have with some meaningful benchmark. It is no use the person in 9 Acacia Avenue feeling smug because her house has gone up more than the owner of 13 Acacia Avenue. They want to know if they’ve done better or worse than the other people buying houses in other places. People want to know whether they have got value for their money and though this may well piss half the people off, half the people will find out they haven’t – if the benchmark is how people have done on average.
Winners and losers
We can measure how people have done relative to others by measuring the return they have got on their money and then giving them the notional return they’d have got if they’d saved into the average fund. This is the fundamental innovation of AgeWage and I’m not shutting up about it just because I’ve been saying this for the last five years.
This will tell 50% of people they are winners and 50% of people they are losers.
This is not what happens in IGC , GAA and Trustee VFM statements, all of which say that everyone’s a winner. You can only say that if you really believe that however badly people’s investments have performed (net of all charges), they are still better off because of tax-relief. That argument falls rather flat when you consider that the tax foregone, comes out of the general taxation paid by those doing the saving. VFM cannot be benchmarked against a less tax efficient way of doing the same thing!
So what if you are a winner? Are you more likely to bring money to your winning fund? Perhaps, we tend to reward winners with more money and losers tend to see a run on their funds. The Australian Government and its Regulator make sure people know if they are winners and losers and money does move to the winning-most environment. Many people in the UK see this as bad, but Darwin wouldn’t.
A great deal of energy is put into foolish marketing that tries to convince people to bring their money to one pension rather than another. Even the kingmakers who arbitrate over the decisions large employers make on where their occupational pensions “consolidate” are thought to be impressed by flim-flam dressed up as VFM.
But of course people aren’t that dumb. Employers may start out saying they are looking for value, but they end up buying on price. Why?
The answer is that Value is conflated with the specious argument that we need to engage savers to increase their contributions. Value is not being measured by how people have actually “done”.
And so, basket cases like NOW pensions can continue to operate, despite destroying saver value in terms of outcomes.
Value comes in different flavours
I am prepared to concede that there are some areas where we might want to modify the fundamental premise that VFM is individualise net performance (or a benchmarked IRR to be more concise).
I am prepared to include a measurement of the good an investment has done as part of the IRR equation and we may well be able to convert TCFD numbers to add or subtract from the main equation. We can of course allow those who choose to dilute the financial outcomes of their savings on other things – to do so. If you choose to pay 1.5% pa to an adviser to manage your money, good for you, you need to feel happy you are getting value for the money you are paying for the advice, but since the vast majority of those who pay for advice seem happy to do so, who is to say that SJP or your local IFA are not offering VFM -even if outcomes are diminished as a result.
But exceptions prove rules
I hope that what the DWP come up with over the next couple of weeks is a consultation which is as robust as this blog. We have been talking about VFM for a long time, but to date we have no “VFM standard”, nothing which the public can hang on to and say “ah-that’s my pension VFM”. That is shocking as private pensions are often more valuable to people than any other equity they hold.
We can always pick holes in standards, but we need standards to take decisions. Right now, people don’t take decisions because they have the wrong information to act by.
Giving people a standard definition of VFM is the best thing the Government could do to restore the public’s confidence in pensions!
That – for me – is what AgeWage and the Pension PlayPen are all about.