The Department for Work & Pensions acknowledged there are industry concerns around their ‘traffic light’ rating, which is due to be implemented in the forthcoming Value for Money (VfM) regulations.
Consultation is still underway on this legislation, which looks set to have a transformative effect on the DC workplace market.
Speaking at the Corporate Adviser Summit, DWP DC investment analyst Daniel Hatton outlined some of the department’s primary aims behind this legislation and discussed potential future issues around implementation.
Hatton pointed out that these VfM regulations have been based on Australia’s performance test for pensions but with several key differences.
He said that the UK tests will not be as prescriptive as the Australian ones, which effectively require schemes to close if they underperform the benchmark for two consecutive years. This underperformance needs only to be by half a percentage point.
Hatton explained that the UK VfM regulations attempt to provide schemes with the ability to contextualise performance data, although he highlighted that the DWP was conscious that this should not allow schemes to “game” the results. In addition to performance, the VfM assessment will also include service metrics — absent from the Australian system — and give schemes a longer timeframe to implement improvements, with the current proposal extending this to four years rather than two.
Hatton also said that when schemes run multiple default options, they should be allowed to transfer members to a newer (or better-performing) default in order to ‘pass’ this value-for-money test.
The VfM regulations also reflect differences between the two systems, particularly regarding the role of employers in the UK’s DC pensions landscape.
Hatton said that these changes were partly to address some of the perceived shortcomings of the Australian system, particularly around ‘herding’ or ‘index hugging’. He said the DWP wanted to improve member outcomes in the worst-performing schemes, but without limiting innovation in the best-performing ones. Figures show that when Australian and UK DC pension performance is compared, the averages are broadly similar, although there is a far larger dispersion of returns in the UK. The top-performing schemes in the UK produce average returns of 10.6 per cent, compared to the top-performing schemes in Australia delivering 7.8 per cent.
Hatton acknowledged that there are industry concerns about how the VfM regulations will be implemented, with many consultants at the event sceptical about how many larger schemes would assess themselves as being in the ‘amber’ or ‘red’ categories.
However, he said there was “broad consensus” across the industry about the need to build a framework that shifts from a cost evaluation to one of overall value. He added that there was also consensus that investment performance, cost and charges, and quality of service should be the three main metrics for evaluating this ‘value’—and that trustees and IGCs should have a key role in making these evaluations.
Looking ahead, Hatton said that it will continue to be a “busy time for the pensions industry” with a raft of consultations, legislation, and government reports forthcoming. Alongside the VfM regulations, these include the Pension Review, the Pensions Scheme Bill, the implementation of the pensions dashboards initiative, wider Mansion House Compact reforms and ongoing work around the decumulation challenge.
Hatton pointed out that when recommending changes, the government made use of industry data, including the CAPA performance data, which is now used by government departments to model potential outcomes in many of these reviews.