Member Article

Defined contribution (DC) pension schemes will soon be required to disclose more information than ever before in a bid to assess and improve value for their members.

On 16 September 2021, The Pensions Regulator (TPR) and the Financial Conduct Authority (FCA) published a joint discussion paper on developing a common regulatory framework for measuring value for money (VFM) for DC members.

Background

VFM has become a key element of DC governance in recent years. As the number of traditional defined benefit schemes has decreased, and with the introduction of auto-enrolment, more and more pension savers have sought or been placed into DC arrangements. Since 2015, the government has developed a legislative and regulatory framework aimed at introducing minimum quality standards in respect of DC benefits.

That framework predominantly governs occupational pension schemes providing DC benefits. However, occupational schemes are only a proportion of the DC market, not all of which is governed by TPR, and so there have been some inconsistencies in terms of VFM across arrangements.

It is perhaps no coincidence then that the publication of the discussion paper, which considers a regulatory framework for the wider DC market, coincides with Parliament’s approval on 14 September of the Occupational Pension Schemes (Administration, Investment, Charges and Governance) (Amendment) Regulations 2021 (the regulations), which came into force on 1 October 2021 – see our insight article on the regulations here.

The regulations require most occupational schemes that provide DC benefits to report annually on net investment performance and requires those with total assets of less than £100m to produce a detailed annual value for members assessment. Schemes which are unable to demonstrate good value will need to be able to explain why or face consolidation.

A joint regulatory approach 

This isn’t the first time TPR and the FCA have worked together on the topic of VFM. Three years ago, the regulators published a joint pensions strategy outlining how they proposed to work together to tackle the issues facing the sector, and the inconsistencies between the schemes they regulate in the short to medium term. The strategy identified the absence of comparable information as a key factor behind the lack of effective competition and VFM in the market. One driver behind the joint approach is to promote consistency in approach between schemes that are regulated by TPR and those that are regulated by the FCA.

The new discussion paper picks up where the strategy left off by proposing a regulatory framework for disclosure of information by schemes operating in the DC market which would capture the key elements of VFM in order to allow individuals to compare schemes.

The details are far from finalised, making it difficult to predict how helpful the framework might eventually be. For now, the discussion paper sets out the factors which the regulators believe drive VFM and asks for views from the industry on the relevance and weight of those factors. The deadline for responses is 10 December 2021. In the meantime, we have summarised some of the main considerations laid out by TPR and the FCA.

Investment performance

One of the key elements of VFM is investment performance, and whilst the discussion paper acknowledges that past performance is no indicator of future performance, it recognises that access to investment performance data is important to the decision-making process in pensions. Unfortunately, as things stand, there is no single way of measuring investment performance and so the system lacks transparency and consistency.

The regulations address net investment reporting in relation to occupational schemes, and the regulators have drawn on these new requirements in in the discussion paper. There is a clear recognition by the regulators of the need for a greater degree of uniformity in the way in which different schemes report on investment returns and, they suggest, building on the regulations will facilitate genuine comparability for groups of similar savers.

There is, of course, a need to be proportionate in what schemes are asked to disclose. Pension schemes hold a wealth of informative data, but the average person wishing to compare scheme X to scheme Y will not need or understand most of it. The regulators suggest that the right balance would be struck by requiring public disclosure of past performance data, net of costs and charges, in order to reflect savers’ experiences of investment returns and provide the most useful basis for comparison. This is consistent with the approach taken in the regulations.

The discussion paper acknowledges that performance and, by extension, value is not driven by  net investment returns alone. Costs play a part, as does the level of risk adopted in a scheme’s investment strategy, and any regulatory framework for comparison will need to account for both in order to be effective. As the discussion paper itself acknowledges, there is no perfect way of measuring the risk inherent in any investment portfolio, which makes adopting a standardised approach under the proposed framework challenging. Nonetheless, it is an approach the regulators are looking to consider and so the discussion paper seeks views on the different options available.

Comparison is all well and good, but the wide range of pension schemes in the market in the UK begs the question, is it even possible? Well, in theory yes, but only if you break it down into measurable parts somehow, and the most obvious way to do that is benchmarking. However, finding a suitable benchmark or alternative comparison tool presents a number of challenges, and TPR and the FCA are keen to hear industry views on how this area might be developed.

Even if it is possible, there are questions surrounding the extent to which comparison is necessary and how it would be used in practice. A significant proportion of DC pension savers are in workplace pension schemes, meaning their employer selected the scheme and they most likely did not consider their options before joining. Traditionally, there is a limited amount of shopping around in relation to non-workplace schemes too, and the discussion paper acknowledges that they are thought of by savers as “set and forget”, meaning many people are invested in poor value schemes with no plans to switch.

Clearly, at least in relation to non-workplace schemes, this is not a desirable position for pension savers who may be unaware of the potentially perilous waters in which they have invested their retirement savings. However, it is a complex problem to solve. An assessment based on a common benchmark carries with it the risk members using that approach to switch pension products without considering other important aspects of VFM, which could result in the loss of valuable benefits. Benefits consultants help navigate this issue for workplace savers, and the government is considering how the process might be made more manageable for the rest of the market.

Customer service and scheme oversight

The aim of the framework is to facilitate long-term focus on VFM, and the paper suggests that in order to achieve that stakeholders will need to take a holistic view; one that accounts for things other than investment performance and costs.

Schemes caught by the regulations will also need to take a holistic view in their value for members’ assessments, and the regulations require them to consider a number of qualitative factors in order to do that. The discussion paper narrows those factors down to three: member communications, scheme administration, and governance and oversight.
Those involved in the day-to-day running of a pension scheme will surely agree that the discussion paper hits the nail on the head in its opening sentence on scheme administration: “Scheme administration is fundamental to the running of a scheme and will likely be the main way that scheme savers judge the quality of service that a scheme provides, whether or not that is appropriate, because that is their lived experience of the scheme.”

However, it recognises that administration is rarely a task directly handled by scheme trustees. The quality of administration services on offer to trustees varies greatly from scheme to scheme and is the cause of many headaches. The discussion paper quite rightfully notes that better administration quality would help trustees meet TPR’s expectations and hold their administrators to account. A VFM framework which places additional requirements on administrators (rather than on trustees) to help improve industry standards would no doubt be welcome news to most, if not all schemes. Alas, trustees will have to wait and see (and perhaps cross their fingers) on this point, as for now the regulators have suggested no such thing; they are simply asking for views on just how relevant scheme administration is to VFM.

What we do know is that the framework is unlikely to enshrine a specific method of measuring these qualitative features of VFM because, as the paper notes, they are by their very nature, “difficult to measure with the degree of accuracy that is normally associated with regulatory disclosures”. Rather, a neutral convenor, like the British Standards Institute, could be called upon to help develop standardised metrics on different aspects of customer service. The paper seeks views on whether this would be helpful and what role the regulators should play.

What does this mean?

Schemes are not required to make any immediate changes. The closing date for comments is 10 December 2021, after which the regulators will consider the feedback received and will publish a feedback statement some time in 2022 setting out its next steps. The regulatory framework itself is therefore still quite a way off, but in the meantime the regulators will no doubt be keeping a keen eye on industry feedback on the first VFM reports due under the regulations.

It seems clear, at this stage, that the regulators intend for the proposed framework to reflect and build upon the requirements in the new regulations which became law on 1 October 2021. Schemes wishing to get ahead might therefore want to familiarise themselves with the regulations now, in order to get a better understanding of the sorts of changes they might be required to consider once the framework is eventually in place.