The regulators’ final rounds of consultation on the Value for Money (VFM) reform package, due to come into effect in 2028, have been met with a hail of criticism, with some voices calling for a ‘dry run’ for the policy, over fears it could cause chaos, herding in terms of investmnet performance, and a range of other other unforeseen consequences.
But with policymakers apparently in no mood to change direction, advisers are focusing on how the proposals will shape the market.
Many corporate advisers suggest the proposed VFM framework is already influencing selection. Others say their advice has not changed substantially because their due diligence goes further than VFM.
Some changes to the framework were announced by the FCA in January. These included expanding the red, amber and green ratings to add new light and dark green ratings, fewer cost and backwards-looking performance metrics, the addition of forward-looking metrics and a streamlining of the original service metrics. The comparison to inform the rating will not now be with three other schemes but a “commercial market comparator group”.
CAPA echo
The proposals have settled on much of the approach used for the last eight years by Corporate Adviser’s CAPAdata (capadata.co.uk) data set, using the same three time periods – 30 years, five years and one day (zero years) from state pension age, chainlinking where defaults are switched, and a point-in-time rather than member experience approach to lifestyling data performance metrics.
The latest round of FCA consultation closed earlier this month with the process running in parallel with legislative changes shepherded by the Department for Work and Pensions in the Pensions Schemes Bill. Draft regulations and supporting guidance are being led by DWP and TPR, while TPR has also been encouraging trustees to engage with the FCA part of the process.
In a blogpost in January this year, Joey Patel, director of policy at TPR, wrote: “We want trustees to respond to the value for money consultation. You will be the ones driving improvements in value and challenging your advisers and service providers to deliver more for savers.”
Corporate advisers may be interested to see the regulator suggesting VFM may see trustees challenging their ‘advisers’, but how are they preparing?
Pinch points
Kelly Parsons, head of DC proposition at Broadstone says: “The VFM framework is already creating real pinch points in the DC market, particularly around governance, scale and long term sustainability, rather than headline cost alone. As the framework moves value for money from a periodic consideration to a standing requirement, providers increasingly need to demonstrate that they can operate confidently under ongoing regulatory scrutiny.”
Gavin Zaprzala-Banks, Secondsight’s head of consulting, employee benefits, says: “For advisers and governance teams, the shift introduces new scrutiny and a more data-driven environment that’s ultimately positive. It should help highlight where schemes are delivering genuine long-term value and where improvements are needed.
“While the transition will create pressure points, particularly with reporting and forecasts around future performance, this is an opportunity for the industry to raise standards and strengthen outcomes for members. What really matters is that members can have confidence in their pension and, by extension, their employer.”
Legacy challenge
Sophia Singleton, head of DC at XPS Group sees a big challenge for legacy books. “Certain parts of the market have plenty of legacy products that aren’t delivering value and need to be tidied up. The Pensions Bill provides a contractual override to enable consolidation of underperforming FCA regulated schemes. And the government has said there will be a ministerial review, involving the FCA and The Pensions Regulator, in 2029 to assess the market impact and operation of the contractual override measure and VFM framework. It will be a busy few years for providers who have legacy books, as transferring policies isn’t easy – it’s not just changing the investment strategies but, in many cases, it will also require changing platforms etc,” she says.
“Linked to this, specialist resource will be required to implement private markets investments and decumulation solutions. Getting these right will be crucial to the success of each provider and therefore there may be competition for these skills.”
Influence now
Parsons adds that VFM is already feeding into how schemes are assessed. “From an adviser perspective, this is feeding directly into how schemes are assessed and selected. As part of our ongoing provider review work, there is a growing focus on scale and a provider’s commitment to the workplace pensions market, including their ability to invest in governance, data, investment capability and member servicing over the long term. Advisers are conscious that today’s recommendations must remain robust through future
VFM assessments, not just meet current expectations.”
She says this also means advisers are being more cautious about some types of selection given the risk of an amber rating.
“This is already influencing behaviour. Advisers are becoming more cautious about recommending schemes where there is limited evidence of long-term commitment, weaker governance structures or a higher risk of falling into an amber rating once the performance and service tests are applied more consistently and publicly.”
Singleton says that it is not impacting the advice they give to clients as they carry out a robust due diligence on the providers recommended, and this diligence can go further than VFM.
“This due diligence includes looking at backward and forward-looking investment performance analytics similar to those outlined in the VFM consultation. Our process goes much further than the VFM framework and looks at other factors we think correlate to good outcomes for members, e.g. guidance, well balanced self-select range, technology, etc. We expect most of the products we recommend should pass
the VfM test. As mentioned, we expect it will generally be the legacy products that will struggle,” she says.
They also incorporate ESG assessments, which is not part of VFM at present.
In it for the long-term
Jonathan Parker, head of defined contribution, UK Investment, at Gallagher says: “Against the background of a consolidating DC market, we’re seeing employers and trustees wanting reassurance that their current – and potential future – provider will be around for the long-term.
“So, decision-makers are favouring larger, well-established providers, with clear commitments to the DC market, backed by strong funders. This can result in some strains around implementation bandwidth and service quality, which a lack of historic investment can expose.”
Otherwise, he suggests that there is limited direct impact. He adds: “In terms of how VFM is driving provider selection, at the moment there is limited direct impact, although alongside the scale requirements in the Pension Schemes Bill, there is more of a consideration of who will be able to effectively compete once
all the new requirements come into effect.
“We work with clients to consider a very large range of different factors when assessing the DC provider market, and tailor selections based on client-specific requirements.
“The quantitative factors like charges and investment performance (past and expected future returns) can be relatively easily assessed, but often the more important considerations for clients are those that are less easily measured, like member experience, governance, and innovation.”
Potential disruption
Parsons adds that there is also ‘understandable concern’ about the potential disruption caused by the performance test.
She adds: “Schemes that are evolving their default strategies, for example to improve diversification or long-term outcomes, may experience short-term performance volatility, which could increase the risk of an amber rating even where the underlying strategy is sound. That creates a tension between designing
for long term member outcomes and managing short term regulatory optics.”
Singleton adds: “There is a risk that the laser focus on performance will drive herding in the market and remove capacity for innovation. Alongside this, the framework is one of a number of incentives
to invest in private markets, but the cost vs value issue hasn’t been resolved – so there’s a risk that some providers try to do private markets at lower cost which will result in disappointing returns.”
She adds: “Investment performance is important to employers, but they will look at their pension provision holistically when selecting a provider. And it’s worth noting, changing provider is not a quick and easy exercise so I don’t expect employers will rush into a change. But more employers are putting in place oversight committees to keep their provider and product under review and hold them to account and that will lead to some movement. My advice to those who are in a poorer performing (often legacy) product is to drive a move now before it’s forced on you.”
Considering disruption, Parker notes just how complex the determination process will be. He rattles off the factors, by way of illustration – past performance over multiple periods of time; two risk metrics, over multiple time periods; investment costs; forward-looking returns; factors 1-4 for three different age cohorts; relative weighting between backward and forward factors; and your scheme’s performance relative to the commercial comparator group.
He adds: “Differences in the performance test are more likely to materialise for the ‘0 years to retirement cohort’ where asset allocation across the market is much more varied due to deliberate targeting of different member retirement choices (e.g. cash, drawdown, universal).
“Notwithstanding all of this, if trustees/IGCs do decide on an amber rating, they will then have a period of three years to improve the rating, and importantly, need to have a credible plan for achieving this.”
Reputations at stake
There is also a reputational risk. Parker says: “With public disclosure of the new VFM assessments, the reputational impact of an amber rating is likely to be consequential, with scrutiny coming from members, employers, regulators and wider industry actors.
“So, whilst the performance test has the potential to disrupt the market, it’s quite possible that other factors will drive changes ahead of the first assessments, especially the requirements for scale and the investment needed from schemes to deliver meaningful improvements.”
Dummy run before final rules
Although, he notes that final VFM rules are yet to be finalised, trustees/IGCs are likely to already be discussing with their service providers how they can support the new assessments. “It will be worthwhile undertaking a ‘dummy run’ using available data. This process will highlight any data gaps and provide early indication of where any challenges might arise.”
Zaprzala-Banks says they have already been taking a traffic light approach to governance. “Schemes that fall into amber or red will also face corrective action requirements, which increases operational complexity. For some time, we’ve been applying a traffic light system to our governance approach so clients can see where they stand but, importantly, everyone else in the value chain, including providers, has clear visibility as well.”
Overall, Parsons says that the VFM framework is accelerating an existing trend. “Adviser due diligence is becoming more forward looking and iterative, with greater emphasis on provider resilience, governance quality and long term commitment to the DC market. In that context, value for money is no longer a one-off judgement, but something that needs to be demonstrable and defensible on an ongoing basis.”
Singleton adds: “We’re working with the providers to understand their plans for ensuring their strategies pass the VFM test and, aligned to that, how they are going to incorporate private market investments. For employers, it’s important that they understand whether current arrangements are likely to meet new VFM and scale requirements and to have a structured method of oversight on their provider – for example, annual reviews or having an employer committee that properly oversees the arrangement. Employers need to be on the front foot as they don’t want to have any changes forced on them.”