Articles - New value for money tests could see actuaries in demand

I’m sure many trustees are already looking toward 2022 and the need for smaller defined contribution pension schemes to carry out a value for members test. It’s certainly something we’ve been thinking about at Aviva, and it’s becoming increasingly obvious that in many cases it’s going to be far from straightforward. There’s going to be a need for advice, including some actuarial advice. At first glance the guidance from the Department of Work and Pensions (DWP) looks straightforward.

 By Dale Critchley, Policy Manager at Aviva

 Just compare charges in your scheme along with investment performance, with three large pension schemes. There’s guidance on how to calculate investment returns as a geometric mean, with a suggestion that schemes assume a single contribution of £10,000 paid at the beginning of the reporting period “with no subsequent contributions or added fees when the allocation was made”.

 The key here is that schemes will need to make the same assumptions to produce something that is comparable, but those assumptions shouldn’t get in the way of producing a fair assessment of the value provided to members, as real-world returns.

 There are a few opportunities for there to be a divergent approach to calculating returns, especially when it comes to the default fund. The guidance from the DWP says that where returns are dependent on age, we should show returns based on a member aged 25, 45 and 55 at the start of the reporting period.

 Most automatic enrolment schemes will have some sort of lifestyling approach. So returns will vary for those older members as they start to de-risk. The issue, in preparing comparable figures is that to work out the variation in returns by age, we need another variable, the assumed retirement age. If I assume a member aged 55 with a retirement age of 60, the returns over 5 years will generally be lower than if I assume a member aged 55 with a retirement age of 75. While there isn’t a date prescribed, returns could vary considerably and scheme returns will look better if a later retirement age is used. An informal agreement by the actuaries who will be calculating returns to all use 65 would seem sensible.

 I think it might fall on actuaries to calculate the returns, as there is a need to take into account the lifestyle switches that have happened over the reporting period. Simply looking at the asset mix of a 60-year-old, and showing 5 years’ past performance based on that simply won’t be comparable with a target dated fund that will take into account past performance from when the fund had a higher equity exposure.

 Another issue to overcome in producing comparable figures is to agree an interpretation of what is meant by “no…. added fees when the allocation was made”. There are schemes of course that charge initial fees when monies are invested, this might be a combination of a bid offer spread or an allocation rate, or a simple % charge on contribution. One of the likely comparator schemes has a charging structure which includes an initial charge of 1.8% of each contribution made. If we, or a comparator scheme, decide that the DWP mean these charges can be ignored it could have a significant impact on the comparison, especially over shorter reporting periods. A 5% gross return becomes a 2.8% return if a 1.8% initial charge is factored in, while it only drops to 4.68% with a 0.3% annual management charge. An old scheme with a 5% bid offer spread could achieve over 4% return, or a negative return over one year if the initial charge is taken into account. This is something trustees need to be aware of when comparing net returns.

 Finally, we get to the decision that Trustees will need to take as to whether the £10,000 example accurately reflects the charging within their scheme. It’s something that will impact smaller schemes investing in older investments where the charges or returns on a £10,000 single payment may not be reflective of the charges on regular contributions that make up the majority of members’ funds. Differences in bonus rates and loyalty bonuses may apply, the value of guarantees will need to be taken into account. These will all move the comparison away from a simple comparison of two numbers, and toward a more subjective assessment.

 Of course, none of this matters if trustees aren’t able to pass the assessment of their governance activity, in the seven key areas stipulated in the statutory guidance. It might be a good place for trustees to start, and an early decision made. If trustees don’t have the resource to cover ongoing governance requirements a decision to wind up avoids the need to grapple with the value assessment, net returns must simply be reported until the wind up is complete.

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