Value for Money: should the UK emulate Australia's performance test?

Mike Ambery: Hello and welcome to the latest episode of Thinking Forward with myself, Mike Ambery, where we explore the trends and developments affecting the UK pensions industry. Today we're talking all things Australia. I'm tempted to do an Australian accent, but I won't. Some of you often know Australia's referenced as the mature pensions market somewhere where we may learn from. We're going to discuss this in a series of episodes. 

This one's going to focus on value for money, a topic which, I think everyone's familiar with here in the UK. Australia may call it something else, like performance test. For the discussion, I'm joined by John Greenwood, Editor of Corporate Adviser, Paul Leandro, Partner from Barnett Waddingham and Femi Adigun. Friday drop star and Senior Proposition Manager and leader within Standard Life. Really pleased to have you all here today.  

All: Thank you. 

Mike Ambery: I'm going to start off with the first question. And John, I'll I'll kick off with you if that's okay. And I'm not going to mention the football. It seems that many in the superannuation industry in Australia think there's one principal measure, that's net benefit outcome. What works and doesn't work well about this approach?  

John Greewood: I mean, I think it's fair to say, that the Australian approach has weeded out bad performance. I think the best of the UK performers, have done better than the best Australian ones, but the worst have done worse. So in terms of the sort of the width of the sleeve of outcomes, it's a lot narrower, but on average slightly higher in Australia than it is in the UK, which is obviously going to be good for all of those people in those poor performing funds. 

And it's been really brutal in targeting them. I mean, I think it's the BT scheme, which is not the same as BT over here, but, got closed down and got rolled into the Mercer scheme. Doubling that in size. That's quite a brutal penalty for failure. You're getting mixed messages from the UK government as to whether that's how far they want it to go, but at the limits when push, they'll say yes, they do see, stringent penalties for going that far. I mean, it's certainly worked in, you know in achieving, a narrowing of good outcomes. They've got, basically a different system to the UK, the Australian model’s simpler. 

So how much we can take from that as a learning. I think we've got to get some other things in place before we can do that. They've got one default per provider. Everyone's got the same full set of options, accumulation, which is basically really straightforward. They haven't got the complexities that we have. So, but yeah, they're in pretty good health. And I think the fact that it's been going for 30, 32 years and people's pots are significantly bigger, there's no opt out, contribution rates are higher. So, they're in pretty good health.  

Mike Ambery: Paul, unpick that one for us.  

Paul Leandro: Well should I give, a Rory Smith explainer about what a performance test is. So just in a nutshell, it's, so all funds, have to measure their default fund, against performance, against tailored benchmarks, and also need to have a look at comparative fees as well. The performance is measured over an eight year period, but if, a fund fails the performance test, they have to write to all of their members saying words as strongly as we failed the test. You should consider transferring elsewhere. If they fail again for a subsequent year, they're effectively closed to new business. Which effectively is meaning that they need to consolidate with another fund. 

So as John says, it has been brutal. So over the last three years, I think there's been nine funds that have exited the market. Arguably people being moved into better quality funds. There's also been the squeeze on fees. So, the members of the funds that failed the first round of tests in 2021 have since had a 20% cut in the fees that they pay, saving them more than $100 million in fees. So it's decisive. It's brutal. It's simple. And, you know, the test is simple. It's easy to understand. But the argument is, is that it could be too brutal, too heavy handed. This criticism from the industry is that, you know, funds don't have the ability to provide context. If they fail the test, there could be good reasons. But no, it's done. 

And it is, I say it's a simple test but there's an argument that it should be more complex. Net performance isn't the only, thing to consider with value for money. There are other facets of a proposition. I mean, from an investment perspective. Arguably, you know, a test should be taken into account. Risk adjusted return, CPI benchmarks, consideration of ESG and other climate factors. Should have different benchmarks for different age cohorts as well. And of course, there's other aspects of a fund's service proposition that can add value. So yeah, It is a brutal test, but it has enforcement and it has impact. You know, change is happening because of it.  

Mike Ambery: And does that give us greater, sort of economies of scale and drive consolidation? Because we see regulators in Australia say if you’re not of certain size, you should be consolidating regardless of these performance tests because they believe that needs to occur. Consolidation, has it occurred at the pace that we imagine, do we need to have more to get to economies of scale like in Australia quicker?  

Paul Leandro: Yeah, I mean, the Australian belief Is getting very clear from the three times I was out there. Bigger is better. So consolidation agenda has been in play effectively since 2005. So as you say, you know, funds with less than 30 billion are considered small. So the encouragement is to move them towards yeah, the larger funds, there's one mega fund at the moment we're expecting to see more because of that consolidation. Will the UK follow suit? I think so, it's very clear that the DWP has a consolidation agenda in play over here. 

All of the regulations are effectively not necessarily nudging assets to master trusts I think there is a shove happening. If we follow the Australian model, you know, their system was codified on UK law. So it effectively reflects our system in terms of types of scheme. They have corporate funds over there which are akin to our single employer trust based schemes. There were hundreds of those. Now there are less than 30. And you're only talking about you know, the very large employers with their schemes. You can see the UK following suit. And I think that's the agenda in play here.  

John Greenwood: One nugget I picked up when I was out there, which shows the culture about the focus on consolidation was, one of the tables that they have in the Sunday money pages over there was they had a table of, charge cost per member by chief executive. So they'd taken the chief executives’ chart salary and divided it by the number of members and shown, highlighted how much, the chief executive of a small fund was taking out of your pots, which put the heat on them. Yeah, there was a shift. 

Paul Leandro: So when we went out in 2014, The industry funds were not for profit. When we went back out again in 2017, the language had changed, the nuance of language changed and it turned to profit for member which is a key difference. And during that period, the salaries of the CEOs and the people who ran those schemes effectively nearly tripled, quadrupled during that time.  

I think that’s a very key learn and key differential. And that choice of wording profit for member is something very different from the UK market. I'll just ask Femi if it's okay for your thoughts on consolidation and where do you think that should occur a little bit quicker than maybe it has to date?  

Femi Adigun: A couple of things stood out to me in this discussion so far. I think one of them was Paul you mentioned that they contact the members if there's a chance that that fund could close. I think that puts a huge responsibility on those members, right, to make sure that they're selecting an appropriate fund for them. 

I think, you know, VFM probably has helped in terms of, in Australia has helped in terms of consolidation. I think from my perspective, I look at this from a DE&I issue or a diversity and inclusion perspective. I'd be very keen to know more about how do you create, you’re almost creating a homogenous industry where do you leave scope for different philosophies and those different philosophies to perform at different times? And I just, you know, I think the word might be investment herding, has it led to that? And what's been the impact of that.  

Yeah, So I'll paraphrase that is what we see is an unintended consequence by the regulator is probably that index hugging if you will. Everyone's going to invest in the same space In your experience, John, if it's okay. Does that occur. And do we see that innovation that Femi has talked about before?  

John Greenwood: I think there probably is that and the feedback I got in Australia was that there was there was some of that going on. And I think if you look at the performance test that they've got what it is, it's a performance test basically against a benchmark and choosing a benchmark is effectively choosing an asset allocation structure. So what the test doesn't do is, compare asset allocation approaches. It compares how well you've delivered versus that asset allocation. 

Now, you could say that's a good thing because if equity do badly for ten years, you shouldn't be kicked out of the market. That's great. At the same time, part of the expertise that you want from your pension scheme is to say, well, I picked the right asset class in the right proportions so you could have a 100% equity, fund in Australia that performs below, without half a percent, I think, isn't it, over a set period, but beats another fund that has got very, very low risk but is bang on its benchmark. And even though it's performing better than the other one, it could fail the test. So that's one of the conundrums that, the UK regulators are going to have to juggle with. So yeah, it obviously in that scenario, you would potentially invest in things that you knew you were going to be able to deliver on, and that would presumably reduce risk. 

At the same time, when you put that to the Australian community, they would say, yeah, well, but then it comes out in who wants to top the tables in the Sunday papers or the financial press. So they see topping the table is still being the priority of what they're trying to achieve and they still think there's sufficient competition to make them want to do that. That's a moot point, tricky one.  

Mike Ambery: Completely agree, John. Paul, I'll ask you the question on homogenous investment strategies there if you will. I know we’ve talked on another episode about private markets, but is there a tolerance for that? 

Paul Leandro: So yeah, I mean, you mentioned the word homogenous. That was a key conclusion from the first time we went to Australia. The market did look, okay, there were some exceptions in terms of service proposition, but in the main pretty homogenous. You know, how does an individual choose from, very similar looking, funds? Well, actually, inertia’s in play in Australia as well because it sort of depends which industry you first have you know, your first job and that's where you remain. 

Yeah, anecdotally we heard, you know, about index hugging as well. And herding. So you know, all the managers are making very similar decisions. And you're looking at the, you know, the range of funds that are there and the asset allocations within them. They are very, very similar.  

Mike Ambery: Okay. If we then turn our attention to VFM consultation as out in the UK at the moment Femi, I'm going to ask you a question in terms of our framework and actually whether it's sufficient enough, compared to an Australian model and whether you think it could be a little bit more punchy, equally in terms of just focus on an investment strategy and investment performance, Paul’s mentioned before that it's really backward looking. You've mentioned it may not allow sort of innovation. What do you think of the things that need to be looked at in terms of VFM?  

Femi Adigun: Yeah, no, definitely. And Paul's mentioned a few of them, that I would certainly agree with. I think ESG, that's definitely something that probably should be considered. The very fact that it's reported in IGC reports and investment governance reports and also master trust statements or chair statements, I think it makes sense for that to be embedded in this, in this framework, especially when if we look at what's happening with private market and Mansion House reforms, almost being told to kind of think about the future. 

And so I would say if we add that into value for money, we should also look at the future value for money. And I would say that’s you know, ESG considerations. I think the particular one is also, forward looking metrics, you know, understanding. And there's ways to do that. Right. It's very difficult. But actually fundamentally the key thing about pensions is what's that member outcome. 

And we need to look at forward looking metrics risk and return profiles. I would say what else could be missing? We're seeing another crisis erupt, which is the pension saving gaps and I probably and this is probably a bit biased because of some of the work I do at Standard Life. I would like to see how we actually, how as an industry were assessing value on those pension saving gaps and trying to support them being reduced.  

Mike Ambery: Brilliant thanks, Femi. Paul, I'm going to give you, some thoughts. Obviously, we've discussed some of your ideas that are in terms of VFM. What else are we missing? We've not talked about quality of service and other areas. I don't know where you think VFM could evolve in the UK a little bit further.  

Paul Leandro: Yeah. I mean, first off, I mean there's positives and negatives. I think from my reading of the proposals, I mean, let's not get away that this effectively is a joint initiative between the FCA, the regulator and the DWP, which I think has to be commended as is it the first consultation between a joint consultation between the three? 

All be it's being led by the FCA, but everybody in the pensions industry and pensions community needs to provide feedback. It also takes into account other aspects that lead to value. It offers a consistent approach. I also like the fact that in multi-employer schemes, you know, the provider has to consider a cohorts of employers operating at different terms within the scheme. From a negative perspective, we probably haven't got enough time to go through them all. But I just want to pick out a couple. I mean, from my perspective, it feels as if there are some lost opportunities. Femi, your point about savings gap is a really key one, you know, we have to address the gaps better. And that has to be, from the member’s perspective, the employer's perspective, the provider’s perspective and policy perspective. Really it's policy that drives that. So, you know, not having savings gaps. You know, alluded to in the regs I think is a missed point. 

It took me about five reads to understand the scope of the new VFM. You know, the 80% rule, less than a thousand members, but it just did occur to me that with those metrics or with those parameters, a lot of schemes could be missed. And something which isn't really talked about is poor administration of legacy schemes. And there could be a lot of legacy schemes who effectively just fall out the scope of this, which really arguably should be a focus. You know, no matter how good the investment performance is, if a member's record can't be found and that loses all value. And then I was also disappointed to read that decumulation was referred to but particularly is out of scope at the moment. Again, I think that's a lost opportunity. 

We are, you say, about, you know, savings gaps crisis. We have a looming, retirement crisis as well. So, I think that, you know, the time is now as effectively to address that, and understanding how providers are providing value to people as they approach retirement and during retirement whilst they're still members of a pension scheme. I think is really important and should be considered as part of the assessment.  

Mike Ambery: Absolutely agree. Thanks, Paul. John, I'm going to give you the final word on this, and, I'll ask you a question on not to criticise the regulation or the policy, the direction, but in comparison to Australia, where, you know, as Paul says, the retirement pot is probably double what it is in the UK. VFM or performance test in Australia has been a little bit more cutting and a little bit more direct in terms of consolidation, actually, setting benchmarks of if you’re less than 50 billion or something like that, you need to get out the market, you need to change. Do you think it's punchy enough? As the consultation stands? I know you don't like to sit on the fence.  

John Greenwood: Well, I think, as the consultation stands, it's quite vague as to what will or won't be. I've been trying to push as to whether, you know, is it possible that one of the, you know. Huge life insurers in the UK could be kicked out of the pensions market if they managed to cock up their default investment strategy. And I've had non-committal answers to that and say, well yeah, feed into the consultation. 

My sense is, so coming to Australia in Australia, you've got one fund, one default, and you live or die by that default. So the pressure is on. My understanding is that the current solution that the government is proposing is or the regulators are proposing is, is that you will be allowed to run multiple defaults. And if one of yours doesn't work, then you can move people to another default. Now that could be fine, but it doesn't feel quite as much pressure. 

And also that suggests that people will run multiple defaults as an insurance policy, potentially creating further complexity. And ultimately, you know, maybe, I don't know. I haven't fully thought through whether that actually takes some, some pressure, out the system and allows people to be a bit creative, because on the one hand, the debate we've had is saying we want people to be able to be creative. And on the other end we're saying, well, they need the whip cracked against them to then kick them out, and woe betide to them if they don't do that? 

Because the other potential unforeseen consequence, which I think needs to be fed into and this is me sitting on the fence, but, needs to be fed into the consultation is what does it mean for the long term planning of providers if they think, yeah, but every year I might be on the way out of the market. And again, I haven't fully thought that through, but I think there's potential sort of planning blight risk there that could intervene if people aren't succeeding. 

So I'd say my gut wants it to be stricter and tighter and do what the Australians have done because there are some unbelievably poor outcomes already out there and have been for 10 or 12 years, to be honest. And the regulators seem to have just allowed it to happen and have been very casual about it. I mean, you know, over ten years, some of the well, the worst performer is probably in three digits below, I'm guessing, but certainly over 70%-80% below, the better performers. So, it's quite significant differences. And it definitely needs, definitely needs teeth. 

Mike Ambery: I agree the industry is about outcomes. And, I know everyone here feels that today. Femi, a final word from yourself.  

Femi Adigun: Yeah, I guess I just wanted to say that, I think one great thing that can come from this VFM consultation is what we do with legacy pots. I think there's a lot of risk aversion among pension providers and, you know, moving members’ money without consent. But as we know, there's too many legacy pots, in the industry at the moment. The other thing, and the last point I want to make is and it's again, something that's been discussed is about the decumulation and consolidated products. I think it would be a shame for us to govern workplace pensions, and then for someone to just move into a consolidated product or a decumulation product that's also not being regulated to the same standard.  

Mike Ambery: Brilliant. Thank you. From me to you, Paul, I know you want to say something. Go on. Please, add in.  

Paul Leandro: Sorry. It's just that point on bulk transfers. Picking up on your point John, does this have teeth. You know, if a scheme is amber or red or if it's red, the current proposals are that the IGC or the provider should consider closing the scheme. They might have good reason why not. 

And you know, this is, this is written loud and clear in the proposals, but, you know, with contract based arrangements, it’s impossible to bulk transfer people without consent. But unless the rules are changed, at policy level, for that to happen effectively, you could have people in poor quality schemes locked in because they're unable to transfer them elsewhere.  

Mike Ambery: Amazingly useful, I won't consider. I will say thank you for your time today. It's really good. John, Paul, Femi, thank you for joining me here on Thinking Forward today. Thanks for joining us today for this episode of Thinking Forward. As always, let me know if there are any other topics you'd like us to cover in future episodes. And you can catch up on previous episodes on our website. Just search Standard Life Thinking Forward.