The FCA’s consultation on a proposed Value for Money (VFM) Framework closed last month. The results will feed into the Department of Work and Pensions’ proposed Pension Schemes Bill for trust-based schemes — and as a result will significantly shape the future of the DC workplace market.
The purpose of this VFM framework is to shift focus from costs to value, increase scrutiny, transparency and competition between schemes and reduce the number of savers in poor value arrangements.
The current UK DC pensions landscape is framed by the auto-enrolment regime, with employers being the primary ‘buyers’ of DC pensions. But employers do not dictate and influence the market alone; they are reliant on support from consultants to evaluate and oversee their pension provision. And EBCs play a vital role in encouraging employers to review arrangements regularly to ensure they get the best possible deal.
As the DC market matures, employers, with support from EBCs, have ignited a fast-developing secondary market – with transfers between DC master trusts increasing significantly over the last few years – and employers are starting to scrutinise what value they receive from their pension provider.
We think the VFM framework will increase this churn rate amongst providers. To unlock a meaningful shift from costs to value, however, employers will need support from EBCs and other advisers in better understanding their existing arrangemens. Employers will need help contextualising these VFM metrics, particularly around quality of services, in relation to their membership and scheme-specific circumstances. They will also need to understand whether a current arrangement provides overall value to them and their employees, relative to the costs paid and outcomes received.
Given the increase in churn rate, we expect VFM to drive greater competition between providers. But employers’ reviewing and changing providers more regularly does not automatically mean an immediate shift from costs to wider value.
During a market review, there is a tendency for employers to request lower costs from their current provider as a first port of call. And if a provider/scheme has a red or amber rating under the new VFM framework, it’s likely they will lower costs for contributing employers to keep existing business while they try to resolve the issue.
This type of behaviour may entice employers (particularly at the lower end of the market) to stay in poor value arrangements, at least temporarily, in the absence of clear regulatory powers to force winding-up and bulk transfer of savers.
Given costs and charges are still a core component of this new framework, they are likely to stay near the top of the agenda for providers and employers alike. Unless a provider or scheme can show stellar net investment returns, it is hard to see employers prioritising wider value if this comes at noticeably higher cost.
The role of EBCs will be important in shifting the focus towards investment performance and quality of services. This includes information on retirement support, and advice and guidance solutions going forward. This may help shift the focus to value, but will likely be a slow burner.
For employers running their own pension scheme, the new VFM framework will also likely increase governance and operational costs, pushing more employer-run schemes into GPPs and master trusts.
But there is also potential for many ‘own trust’ schemes to compare unfavourably to large commercial master trusts, because employer subsidies are effectively ignored at the disclosure and comparison stage of the VFM framework. Trustees will need to disclose the total costs and charges paid by members and their employers, rather than just those paid by members. The regulatory rationale for this measure is to avoid employer subsidised arrangements automatically appearing better value.
While we appreciate schemes need to be able to compare ‘apples with apples’ under this framework, there is a risk employer subsidies are downgraded as a determinant of value. Although there is scope to factor in these subsidies in a scheme’s overall VFM assessment, it will not be disclosed separately and, we could see employers disincentivised from offering this valuable benefit.
The new VFM framework looks set to disrupt the DC workplace market, and may end up delivering both intended and unintended consequences.
