The ongoing challenge of getting value for money from defined contribution pensions – the FCA's consultation on its proposed Value for Money framework

October 24, 2024

The FCA, the Pensions Regulator (tPR) and the Department for Work and Pensions (DWP) have spent more than 10 years tussling with the question of how to measure and demonstrate improvement in value for money (VfM) in the provision of defined contribution (DC) pensions. On 8 August, after a number of attempts to provide an answer through the FCA's rules and regulations issued by the DWP, and a variety of previous consultations and engagements with stakeholders, the FCA issued a new consultation with a proposed framework around assessing and reporting on VfM.

Whilst the FCA's consultation is limited to its own remit which covers contractual pension provision, the DWP has signalled its intention to make legislation that follows similar guidelines and that the FCA, tPR and the DWP will be working together closely on this issue. This is vitally important for ensuring a coherent framework that will have meaningful outputs for trustees, employers and savers. The consultation is framed as focusing on assessing and reporting VfM with an intent to drive consolidation by pushing schemes that are providing poor VfM out of the market, but it is also underpinned by government policy to achieve more investment in UK productive assets. In addition, there is the burning question of how this framework will interact with the roll-out of pensions dashboard requirements, and the challenge for the pensions industry in ensuring compliance with what could be a substantial number of new obligations.

Key proposals

The FCA proposes that the VfM framework should apply to both default arrangements and legacy arrangements used by at least 80% of an employer's active and deferred members, but that it should not apply to arrangements with fewer than 1,000 members.

The proposed key pillars of the VfM framework are for firms to:

• evaluate and publish the measurements of investment performance, costs and service quality for their in-scope arrangements against metrics that the FCA considers will allow for effective assessment of VfM;
• compare the performance of their in-scope arrangements with other arrangements on a consistent and objective basis;
• publish the outcomes of their VfM assessment outcomes using a "red/amber/ green" rating for each arrangement, with amber indicating sufficient improvements can be made to achieve VfM within two years and red meaning that it will not be possible to make acceptable improvements; and
• identify and complete appropriate actions where the outcome of the VfM assessment for an arrangement is rated red or amber.

The ongoing efforts to find a way to improve value for money for savers and allow them to have clarity over what that means for different arrangements are to be applauded. However, there are potential pitfalls that should be addressed as the framework continues to be developed following responses to the consultation and further engagement between government, the regulators and the industry.

The FCA recognises some of these in the consultation itself, such as driving unwanted behaviours including more conservative decision-making (particularly in relation to investments) as well as the possibility of a trend of "herding" behaviours as firms aim for their arrangements to be a good "average" rather than driving true improvements in VfM for savers.

The FCA has also attempted to find a balance between qualitative and quantitative metrics so that there is no overemphasis on costs rather than other elements of value. It is realistic about the difficulties of objective assessment of qualitative factors and has put forward some practical criteria to use data quality and assessment of key services to support the assessment, along with obtaining feedback from savers themselves in respect of their perceptions and satisfaction.

The FCA's proposal to have red/amber/green ratings will provide a simple method for showing VFM. However, as Ofsted has concluded in respect of its one- or two-word summaries, categories that are too broad can actually detract from meaningful comparisons unless you delve into significantly more and potentially unhelpful detail in a full assessment. A more nuanced approach, such as scoring each of the criteria on a scale of 1 to 100, resulting in an overall number, could allow for comparisons to be made more effectively. It would also help to guard against gaming, which is easier to do in relation to a limited number of broad categories. Commercial providers are going to be strongly motivated to avoid an amber or red rating.

What next?

The consultation closed on 17 October, following a great deal of coverage and comment in the pensions press. This is clearly a high priority for the FCA, tPR and DWP. Trustees would do well to track the FCA position to be ready for the new requirements that will apply to their pension schemes in due course. The work they have already been doing in respect of VfM following the introduction of the Charges and Governance Regulations 2015 should stand them in good stead.