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Value for Money Framework – shifting focus from costs to value

  • United Kingdom
  • Pensions


This week, the government published a package of proposals to reform the defined contribution (DC) landscape and close the pensions inequality gap between those with DB pensions and those saving into a DC arrangement.

In this article, we focus on the most material and significant of these reforms – the new value for money (VFM) framework proposed in joint consultation by DWP, FCA and the Pensions Regulator (TPR).

The VFM framework is a common and uniform framework for assessing VFM across all DC workplace arrangements. It aims to deliver better outcomes and drive further consolidation of pension schemes – it is notable that schemes with less than £100m assets will need to move to the VFM framework when it is in force.

The consultation proposes a phased approach to implementation of the VFM framework: phase 1 will apply to workplace default arrangements; and phase 2 will extend to self-select options, non-workplace arrangements and decumulation.

Currently, trustees and IGCs must assess whether member-borne costs and charges represent “value for members”. The government has proposed a radical overhaul of this costs-led assessment.

The new VFM framework consists of three key elements:

  1. Investment performance
  2. Costs and charges
  3. Quality of services

At first glance, it is slightly surprising that costs and charges are a core element of the new framework. It seems more logical to focus on investment performance based on size of pot and risk-adjusted returns net of costs and charges – after all, this is the ultimate outcome for savers.

However, it is also important to note that the new VFM framework is the first stage of the VFM assessment process. The framework (of which costs and charges are a necessary component) will be used by schemes to produce and disclose VFM framework data.

Schemes must use the VFM framework data to assess against other schemes and carry out their VFM assessment using a mandatory assessment process. Broadly speaking, therefore, costs and charges are a factor in determining net investment returns and service quality rather than constituting a separate, standalone element for assessment.

Investment performance

Investment performance is the first component of the new VFM framework.

  • Backward-looking metrics: the proposals look to develop retrospective investment performance metrics. They require multi-employer schemes (e.g. master trusts) to group employers into cohorts based on assets under management and potentially also number of savers. For each band, the scheme would need to disclose annual net returns for 1, 3 and 5-year periods based on the investment strategy and asset allocation for savers at ages 25, 45, 55 and one day before state pension age.
  • Forward-looking metric: the proposals also extend to forward-looking metrics - future investment performance is ultimately what matters to savers. The regulators recognise that schemes and providers may have an incentive to inflate expected returns to attract business and this is an element of the proposals that requires careful attention. Governing bodies will need to guard against over-promising, which could lead to unnecessary costs in needing to independently verify the information provided to them. 

Costs and charges

Costs and charges is the second component of the new VFM framework. There are three main points to note:

  • First, schemes will need to disclose total charges rather than simply member-borne charges – this will include employer subsidies to avoid schemes with subsidies appearing better value.
  • Second, they will also need to disclose the total amount of administration costs (i.e. the amount spent on anything other than investment). The regulators believe that unless governing bodies have access to split costs, they will be unable to properly assess the quality of services. This development means that vertically integrated schemes with bundled investment and administration services will likely need to change their systems and processes to split out these costs.
  • Thirdly, the regulators are considering requiring schemes with a combination charging structure (a percentage of funds under management combined with a contribution charge or flat annual fee) to express those charges as a single annual percentage. This is the latest development in the government’s drive for uniformity of charging structure and has significant implications for the auto-enrolment master trusts who use combination charging structures.

Quality of services

Quality of services is the third component of the new VFM framework. This relates to other factors (other than investment performance and costs) which make a meaningful contribution to long-term outcomes, such as scheme administration, governance and member communications.

To counter challenges with a subjective concept such as “quality”, the proposals look at measuring quality of service against the member outcomes it delivers.

For example, to measure and assess communications, trustees and providers should not look at the communication themselves but whether they drive improved member outcomes – e.g. the percentage of members who update/confirm their selected retirement date or expression of wish form.

In an administration context, an objective metric could be the proportion of core financial transactions (payments in/out of the scheme, investment of contributions etc) that have been completed according to service level agreements.

This type of identifiable and consistent metric would be a significant change and lead to far less subjectivity when assessing services of a scheme.  

There will be no standalone “governance” metric. In our view, this is surprising given the regulators’ drive for diversity, equity and inclusion on trustee boards and call for further accreditation and potential regulation of trustees.

Reporting periods

The regulators propose setting deadlines for publication of VFM framework data and the VFM reports themselves. All VFM framework data would be published by 31 March in each calendar year. There would be an “end point” for net returns data of 30 June of the previous year to ensure consistency and uniformity of investment performance data.

Governing bodies would then use VFM framework data to carry out a VFM assessment and produce their report by the end of October. For occupational pension schemes, this would mean separating VFM publication from the Chair’s statement and IGCs would have one more month to publish their VFM assessment after the IGC Chair’s report.

Reporting templates

To enable meaningful and consistent VFM assessments, the proposals consider requiring schemes to report data against the value metrics using a prescribed reporting template. There are two options for publication:

  1. Centralised approach – this appears to be the preferred option. There would be a central depository which would validate and process the data for a professional audience to use, which would give regulators greater control and visibility of the collected data. It would, however, lead to ongoing costs on the regulated sectors to develop and maintain the data depository and comparator tools.
  2. Decentralised approach – schemes would be required to disclose VFM framework data on a publicly available site as an “open source” of data – all stakeholders would have free access. The downside with this approach is the risk of several different websites and issues with verifying quality of data. 

VFM assessment process

Governing bodies must use the VFM framework data to carry out their VFM assessment using the following step-by-step assessment process:

  1. Overall performance: governing bodies must assess, compare and benchmark investment returns net of all costs (including member-borne costs and employer costs) to enable like-for-like comparisons;
  2. Investment strategy: they must then assess, compare and benchmark returns net of investment charges only (taking into account asset allocation); and 
  3. Services: finally, they must assess the quality of services (using published metrics) against their costs – i.e. the difference between net returns in Step One and Step Two.

Schemes would need to present the assessment results in a clear, transparent way and identify areas where improvements are possible. A “red” rating (not VFM and no credible actions to achieve VFM), “amber” rating (not VFM but actions to achieve VFM) and “green” rating (VFM) could be used for presentational purposes.

Whilst public disclosure will incentive underperforming schemes and providers to improve or exit the market, the regulators recognise that there is a significant risk that underperforming schemes remain in the market. They are considering whether to mandate actions to consolidate after a “red” assessment result and a “three strikes out” policy to “amber” results.

Over time (and after the requirement for publication of VFM framework data), the regulators are considering whether to introduce multiple benchmarks based on framework metrics to allow them to define VFM in an objective way.

The alternative is to require comparisons against schemes that could be used by an employer using their schemes. Trustees and IGCs of commercial schemes would need to conduct comparisons at the level of cohorts of employer as well as the level of defaults used by these employers.

Future of the Chair’s statement

Finally, the DWP is considering splitting the Chair’s statement into two separate documents; one for members and one for governance purposes. In our view, there is a risk that the level and extent of DC reporting and compliance becomes sufficiently severe that resources are not properly apportioned to areas that are materially impactful to members.

We set out below the list of compliance documents for DC schemes if the proposals go ahead (master trust only documents in italics):

  • Members’ annual benefit statement
  • Chair’s statement, Part 1: member-facing
  • Chair’s statement, Part 2: governance
  • VFM framework
  • VFM assessment
  • Own Risk Assessment
  • Single Code policies
  • Master Trust assurance reporting
  • Master trust supervisory return
  • Statement of Investment Principles
  • Implementation Statement
  • TCFD report
  • Scheme return   

In our view, this is too much and the government and industry need to adopt the principles and concepts from the VFM framework to ensure focus on outcomes and saver protection rather than reporting and compliance.