The ABI’s report yesterday started with a call for greater investment in productive UK assets and tailed off into a list of demands for higher auto-enrolment rates and a demand to end “workplace pension’s “cost is king” culture. Pensions Expert reported
The ABI said ending the “cost is king” culture in the defined contribution market, where charges rather than scheme value was a focus could also help shift funds towards more UK centric investment.
To do this The Pensions Regulator (TPR) would need to “review and update its DC investment governance guidance to encourage trustees to focus on overall value” and that “both TPR and DWP’s default fund guidance should incorporate the framework – once finished – to rebalance the focus on costs towards a more value orientated approach”
There’s no doubt right now , that employers looking to buy a new workplace pension on the secondary market are using price as the primary determinant.
To this end, some workplace pension providers are advertising one default to demonstrate their ESG credentials, typically incorporating investments into private market, and using another default for price negotiations. The other default has no “expensive assets” but invests in passive funds.
It’s a legitimate tactic , it wins mandates and the argument is that once you have the money onboard, a provider can then promote a higher priced default at a later stage.
That’s fine so long as there is good reason to do so. But will an employer see the likely outcomes of a workplace pension improve by putting up the price? Will a Pensions Regulator demand a provider and employer agree to put the price up? I think it is possible, just as skiing uphill is possible, but the general direction for skiing is downhill.
Rebalancing the focus
A lot is made of re-educating dumb employers. The OFT noted 10 years ago
Employers make workplace pension decisions and unless we find a way to get dumb employers to engage or understand their pensions, employers will continue to make dumb decisions.
The ABI wants the Regulator to “rebalance the focus”, but how is TPR likely to do this? Can they install a reverse price cap so that no-one is allowed to charge below say 30 bps? Should there be a minimum allocation of the AMC to investments – say 50%? Should the tax reliefs available to employers and savers be limited where there is not an investment strategy in place that demonstrably makes our money matter?
I have written on many occasions that any test of the cost and charges of a scheme should focus on how the AMC is apportioned. If investments are getting a couple of basis points from a 20bps charge, then there’s a 18bps allocation to “other” – typically member support and engagement and a return to the funder of the scheme to meet the overhead and provide capital for the future. But if investments take up 32 bps of a 50 bps AMC, the retained cost from the provider is the same.
Assuming that £ for £, a 32bps investment budget translates into a 30pbs higher spend than the aforementioned 2bps, we might rely on Hymans Robertson’s 10-10-10 formula.
So an extra 30bps investment spend, can support a 30% allocation to diversified illiquid solutions, which can improve retirement outcomes by at least 30%.
Would the ABI be happy to see their member’s cost test be flagged red for “underspend”?
It is one thing for the ABI to suggest TPR gets tough on the “cost is king” culture. But for costs to be properly understood, they need to be transparent. Knowing how much of the AMC is being spent on investments and their management is critical to knowing the likely outcomes of a workplace pension. It is a forward looking measure – certainly if you agree with Hymans that the more you spend – the more you get (and that the equation is exponential).
Many of the workplace pensions do not reveal the amount of an AMC allocated to investment management, so the cost measure isn’t worth much. After all, it is already counted in “net performance”. If net performance is representative of what a member actually pays (rather than an approximation) , knowing the AMC is irrelevant, the employer needs to know what the AMC is buying.
If an AMC is underspending on investment, an apportionment of the AMC between investment and other will show it. You can own a Bentley , but if you put a lawn mower engine in it, it won’t get you anywhere.
The onus is on the ABI members who provide insured workplace pensions , to come clean on investment budgets and the amount of AMC allocated to the management of the default’s investment.
Tests on costs inform on future growth and transparency
I am behind keeping a test on cost in the VFM Framework so long as it splits the use of the AMC as suggested above. If this information is not available then I suggest a cost score is marked as red as a matter of course. Employers need this information.
If the amount allocated to investment falls below a threshold (say 20bps) then I would argue the workplace pension is underspending and should be marked down, minor underspends should get an orange and major underspends a red.
Workplace pensions getting a red score on cost might risk being stopped for competing for new business or even stopped from doing business. This is the way of it in Australia and it is the explicit threat of the VFM consultation.
If the ABI really wants to stop the “cost is king” culture, I suggest they support proper cost disclosure. Doing so , may avert more radical measures from Government.
The ABI need to be careful what they wish for and explicit about ways it can be achieved.