Trustees of occupational pension schemes that provide money purchase benefits (which includes additional voluntary contributions (AVCs) in some cases) are now required to assess annually and report on the extent to which member-borne charges and transaction costs which relate to such benefits under their scheme represent “good value” for members. Whilst trustees are under a legal obligation to do this and are required to explain the outcome of their assessment in their Chair’s annual governance statement, how they assess it is subject to limited regulation. Therefore, trustees need to decide how they will carry out this assessment and the factors to consider.
In April this year a new legal requirement was introduced under the Occupational Pension Schemes (Scheme Administration) Regulations 1996, which requires trustees of schemes that provide money purchase benefits, at least annually, to:
- calculate the charges and, in so far as they are able to do so, the transaction costs, borne by members of their scheme which relate to such benefits, and
- assess the extent to which those charges and transaction costs represent good value for members.
For these purposes, “charges” mean administration charges other than:
- transaction costs
- winding up costs
- costs associated with complying with a Court order
- charges in respect of pension sharing, and
- costs solely associated with the provision of death benefits.
“Transaction costs” mean the costs incurred as a result of the buying, selling, lending or borrowing of investments.
Trustees are required to explain their assessment of the extent to which the charges and transaction costs represent good value for members in the new annual governance statement, which must be signed by the Chair of trustees. So how should trustees go about making this assessment?
The Regulator’s guidance
The Pensions Regulator has issued some guidance (links below) for trustees on how to assess value for money. This was published before the new requirement to assess “good value” was introduced. However, it gives an insight into what the Regulator considers value for money to be and how trustees should approach making this assessment.
The Regulator’s guidance acknowledges that there is no common definition of what represents value for money. In it’s view “a scheme offers value for money (VFM) where the costs and charges deducted from members’ pots or contributions (the costs of membership) provide good value in relation to the benefits and services provided (the benefits of membership), wbhen compared to other options available in the market.”
The Regulator expects trustees to keep value for money in mind on an ongoing basis, to include it on their scheme’s risk register and to document the outcome of their value for money assessments as evidence of their activity in this area, noting in particular any action that they have recommended or taken.
Assessing good value
This will be the first time that trustees have been required to assess and report on the extent to which member-borne costs and charges under their scheme represent good value. There is no precedent for this in the pensions arena and as with any exercise of judgement there is unlikely to be a single right answer.
However, when carrying out this assessment it is important that trustees follow a proper process. As part of this, we would advise trustees to prepare a policy in which they set out how they intend to carry out their good value assessment and identify what factors they intend to take into account when doing so. In our view, these factors should include:
- Cost v quality – As the Regulator’s guidance indicates, assessing good value is not simply a question of cost, it also requires an assessment of the nature and quality of the pension scheme services and benefits provided. Trustees will need to identify the services provided to members and the other benefits associated with being a member of their scheme. This may include the design of the default fund, the investment performance of the various funds, scheme administration, support services for members and scheme governance.
- What do scheme members value? – the Regulator’s guidance states that trustees “need to understand what [their] members will value most when assessing the overall value of the scheme and its individual components”. Trustees will need to decide how they identify this. However, they should be aware that members may attribute high value to things that, in reality, are not a key component of the true worth of their scheme membership and low value to things that are. Trustees will therefore have to critically appraise any member feedback that they receive and decide how much weight to attribute to this in assessing good value.
- Benchmarking – According to the Regulator, assessing value involves comparing the scheme in question with other options available in the market. Therefore, as well as looking inwards at their own scheme’s cost structure and services to see if they represent good value, trustees will also need to look outwards to the market to see if the costs and charges of their scheme are good value relative to what other similar schemes (and potentially other options such as contract-based schemes) are delivering.
- Component costs – When assessing good value, as well as looking at the headline rates of member-borne costs and charges, in our view, trustees will also need to look at each component part which makes up that overall cost to assess whether each element represents good value. So, for example, where administration and investment fees are bundled together trustees should assess the extent to which these component fees represent good value in their own right.
- Cross-subsidies – Most pension schemes operate on the basis that members with larger DC pots cross-subsidise those with smaller pots. Consequently, some members will be paying considerably more than others for the same services. Trustees need to consider how they will deal with this. When deciding this, it should be remembered that, as well as cross-subsidising other members, individuals with large funds are also likely to be cross-subsidising themselves for their early years of membership in which they are likely to have paid much lower charges.
- Scheme discounts – It is common for schemes to be able to secure different levels of charges based on the expected size of membership and the anticipated size of their members’ DC pots. How should trustees deal with this? Can employer A’s scheme represent good value if the members of employer B’s scheme are paying less for the same services? Given that the test is whether charges represent value for money and not whether they represent the best value for money, different pricing does not automatically mean that the higher charging scheme is not good value. However, trustees should be in a position to demonstrate what steps they have taken to secure a good deal for their scheme.
Application to AVCs
The requirement to assess whether member-borne costs and charges represent good value does not apply to a scheme where the only money purchase benefits are AVCs. However, where a scheme provides money purchase AVCs and other money purchase benefits the requirements will apply to all of the money purchase benefits under the scheme, including the AVCs. Therefore, trustees of hybrid schemes which have money purchase AVCs will need to assess the value of member-borne costs and charges relating to the AVCs as well as those relating to the other money purchase benefits under the scheme.
Policymakers and the Regulator are increasingly focused on ensuring that pension schemes representgood value for their members. Trustees will need to explain their assessment of good value to members in their first annual governance statement. Therefore, if they have not already done so, trustees need to decide how they will carry out this assessment, identify what factors they think are relevant and gather the information that they will need to do this.