We’re yet to discover what the long-term impact of the Department for Work and Pensions’ (DWP) recent raft of announcements will mean for workplace pensions but there’s no escaping the fact that this is big news.
Significant announcements on both value for money (VfM) and small pot consolidation are paving the way for the DWP, Financial Conduct Authority (FCA) and The Pensions Regulator (TPR) to reshape the market, in the interests of savers.
The aim seems to be fewer, bigger pots in fewer and better run schemes, backed by the statutory means to consolidate both schemes and pots.
We think those headline-grabbing policy proposals are the right way forward. However, it’s incumbent on the industry to engage in this consultation process to achieve better outcomes for members. The economics literature on pension provision suggests that there are major economies of scale to be achieved, provided scheme governance is strong. Larger schemes are better placed to invest across the economy and achieve higher returns.
Positioning workplace pensions at the heart of economy
It’s important to see the VfM, small pots and illiquids proposals as linked to a broader view of the role pension funds should play in the UK economy.
With this in mind, the Government intends to encourage greater investment in illiquid assets through driving scale and by rebalancing the conversation about value provided by pension schemes. They intend to do this by shifting the focus away from charge levels and towards net returns.
When it comes to VfM, both the targeting and the outline measures are, broadly, sensible but, as previously stated, will need careful scrutiny during the consultation period. We think extending the VfM assessment package to non-workplace pension schemes needs to be implemented at the earliest opportunity. It’s important that policy makers set a timetable for this as soon as possible. It’s odd that value is getting measured and regulated in one part of the pensions market, which is specifically designed to protect members’ interests, and not in an area of the market that does not have such protections.
Lines between workplace and non-workplace pensions have been increasingly blurred for years and it’s important that both are subject to similar regulatory standards. We also see future competition between workplace and non-workplace pension providers, based on VfM metrics as being healthier than competition driven by brand, advertising and cash incentives. Thinking about this another way, members or customers will be making better informed decisions in areas such as consolidating pots.
Value for money in pensions relates to 3 areas
The civil servants and regulatory teams have made a strong start in setting out what value for money is, breaking the subject into 3 areas:
- charges, and
- service quality.
While this captures the key elements of the value offered by a pension scheme, getting the nuance of each of these elements right will be difficult.
On investment, the issues relate more to presentation than substance. There’s no alternative to looking at past performance but, equally, the risks of overweighting it as a factor in decision making are well known. Poor performance tends to persist, good performance may not and funds in the top performance quartile in any given year may well not remain there. Any honest assessment will need to factor in the limitations of available metrics even though the regulators’ proposals look sensible at first glance.
We have stronger challenges to the parts of the package that focus on charging and service quality. Here, the diversity of the sector and the differences between pension schemes that provide services to the whole of the market, those targeting only higher value members or employers and those targeting non-workplace individual customers becomes very important.
The FCA uses 9 questions from its financial lives survey to measure engagement with pensions. Levels of engagement vary by age, gender, income and ethnicity – sometimes for reasons we don’t fully understand.
Here, the regulatory approach needs to be sensitive to diversity in the pensions sector and find ways to measure the value added by schemes serving the whole of the market. It’s important that the new metrics are sensitive to the nuances of pension provision across the entire market. Government and regulators are right to focus on this area but it’s up to schemes to help make this work.