Workplace pensions is an ever developing area of the retirement market.
My three key predictions are:
- The workplace pensions market will shift in focus to outcomes, not just charges;
- Charges will go up, not down, for largest pension schemes on average; and
- A greater gap will open between commoditised low-cost options and more effective outcomes focused options.
In recent years, price has been king. Intermediaries’ selection processes have been heavily focused on it. Political policy has been relentless on it. TV news coverage sensationalises it. Provider offerings have been increasingly designed to minimise it.
I’m aware that at least one large intermediary in the UK currently defaults their objective assessment mechanism to weight 50% on price.
When we talk about price, we mean cost to the member of the pension scheme. So if we assume the market is efficient, then all this focus on member price must mean that charges have by far the biggest impact on the member’s outcome. So the key thing is to minimise price and the best outcomes will follow, even if some other aspects suffer along the way. Right?
Means to an end
It is common knowledge in the industry that price is only one factor that affects the end result. How much is paid into the pension typically has the biggest impact, followed by how the investments perform over the lifetime of the pension. Increasingly, making the right choices in how to take your money post-age 55 is becoming equal in importance – the impact on income tax, inheritance planning or benefits entitlement can be crippling if the wrong decisions are made.
In the working party paper Outcomes and Defined Ambition, a table showing the relative importance of these factors is published. This indicates for the example member that while a reduction in charge of 25 basis points can increase a pot that would have been £100,000 to £105,000, the increase possible from better engagement, better investment performance and better retirement income support could easy grow it to £170,000 or more.
Of course, all else being equal it will be beneficial to members to reduce price – for example to the extent that efficiency improvements justify it. But if that reduction comes at the cost of quality of investment, engagement or retirement solutions (or indeed other factors such as robustness and durability), then it will harm member outcomes.
So when large pension schemes are running a provider selection process and seeking the best possible deal for their members, how will they consider the “what you get for it” side of the equation as well as the basic price that members pay.
Is it right that 50% of the focus should be on the member price, with other elements being spread thinly across the remaining 50%?
Added value included
My first prediction is the balance of focus will shift to real value-add factors.
Why now? Because of Independent Governance Committees (IGCs).
The introduction of IGCs for contract-based schemes is designed largely to oversee the value for money that schemes provide for members. They will look at what you get and how much it costs and publish a judgement about whether value is being provided. I believe this will fundamentally shift the focus in the industry.
Why? Perhaps a low-cost scheme will be judged as poor value – despite being low cost. Perhaps a seemingly high-cost scheme will be judged as excellent value. Perhaps the introduction of IGCs will simply require providers to better articulate the value of services being provided and enable better comparison in the industry.
Whatever the reason, IGCs will be looking at the outcomes members receive. And this focus on outcomes, rather than any one input in isolation, has to be a good thing.
My second prediction is that prices for large schemes will increase rather than decrease. Why? Because of my first prediction.
With a greater focus on outcomes, employers and their intermediaries will be asking questions. They’ll put more weight on the engagement, investment, retirement solutions of providers. They’ll put more weight on other factors too – like innovation capability, sustainability of service standards, the experience provided for the employer, member and, where relevant, the trustee.
With this increasing weight on value-add factors, the market will be more willing to sway towards a higher ‘cost’ proposition that provides these factors, above a lower cost one that doesn’t. Of course, if providers can offer the right richness of proposition in all these areas and charge very little, then they’ll be highly competitive.
My third prediction is for a greater gap to open between commoditised low-cost options and more differentiated outcomes-focused options.
There will undoubtedly still be room for basic low-cost propositions for employers who just want to meet the minimum compliance standard for their pension provision. Auto-enrolment has accelerated the growth of such options and as long as they still provide a minimum level of outcome, they may represent acceptable value.
However, the natural consequence of pension freedoms and increased interest from employees will lead some employers to change their mindset towards pensions being a valuable part of the benefits package they offer.
Used well, the member-outcomes-focused propositions will deliver a much better return on employers’ investment in all those contributions and administration requirements.
If they’re going to spend the money, many will expect it to be effective – in boosting their ability to recruit, retain and reward their best people – and in helping their people retire when they want to, rather than become de-motivated staff members because they can’t afford to.
According to a 2013 Confederation of British Industry survey, 94% of employers say there is a good business case for offering pension benefits and 89% say a workplace pension helps recruit, retain and motivate employees.
Perhaps this indicates something about the likely split between low cost and outcomes-focused solutions in the new world.
Alan Ritchie is head of employer and trustee proposition at Standard Life