Premiers' John Reeve tackles the issue of KPIs in relation to the evolving DC landscape. He asks which KPIs are appropriate and how should they be dealt with?

One of our friends recently got a job selling a well-known brand of ice-cream. His employer rewards those who sell more of the (profitable) toppings and so measures how well staff get customers to add toppings.

On one very quiet evening shift our friend sold 6 ice creams, 4 of which had added toppings. 66% was the best yet! Our friend has therefore surmised that his best ploy is to try to sell toppings to the first 4 customers in any shift and then try not to sell any more ice cream for the rest of the day!

The pensions industry has been struggling with inappropriate (or at least sub-optimal) KPIs for many years. For example, we have an administration industry which, despite the best efforts of some of us, is still measured by speed rather than the accuracy or the clarity of communications.

All of this led me to wonder what the appropriate KPIs are for our new DC world. Over the last 12 months the DC market has faced two fundamental changes. First, in November 2013, came The Pensions Regulator's Guidance on DC Governance, this put a number of key responsibilities on Trustees which may have been news to many.

Whilst the aims of the Regulator's guidance can only be applauded one is left wondering how Trustees will be able to show that they have met their new responsibilities. Then, in March this year, we had the budget bombshell.

Space precludes me from looking at all of the areas that might be of concern to Trustees so let me focus on just one.

The Regulator's guidance states that (TPR Code of Practice No:13 – para 117):

In a quality scheme, trustees will:
- ensure that arrangements are established to review the ongoing appropriateness of investment options
- ensure that the performance of each investment option, including the default strategy, is regularly assessed against stated investment objectives
- monitor the ongoing suitability of the default strategy for the membership.

However the Budget has put into some doubt what it is that members will do at retirement. Will they buy an annuity? Will they take the 25% tax free commutation? Will they take it all as cash? If they take cash, what will they do with it? Buy a Lamborghini? Take income drawdown? Put it under the bed? All of these will be possible from next April. However, according to the Regulator (TPR Code of Practice No:13 – para 113 and 117 – so it must be important):

In a quality scheme, trustees will:
- monitor the ongoing suitability of the default strategy for the membership.

In this world what constitutes good investment performance from a default fund? Is it a good income in retirement? The highest possible lump sum? Reduced volatility (whatever that is)?

In the past Trustees have agreed default funds that focus on the fact that most members take 25% as cash and use the rest to buy an annuity. Thus they moved towards gilts close to retirement. The (often implicit) KPI here was stability of the pension at retirement. However this is not going to be helpful to the member who wants cash.

If the Trustees assume that the member will take the cash then they need to consider whether they should look to maximise growth or minimize volatility. Maximum growth might suggest a KPI of say Gilts + 2% investment return. However this would increase volatility. What do Trustees say to a member who retires with a lump sum less than was on his annual benefit statement two years earlier? To avoid this they may look to minimise volatility (which would suggest a capital protection KPI).

So where does this leave us?

To my mind it suggests that Trustees should be very careful before they fall into the trap of showing that they have met their regulatory responsibilities by focusing on performance against KPIs. More than ever before the default fund will not meet all members' needs even if they do what was intended. Thus a single KPI is not appropriate.

The Regulator's guidelines are common sense and, whether or not you agree that it is right for Trustees to have this responsibility, it is undoubtedly right that someone does.?However Trustees must be allowed to do what they do best; act in the interest of the members. But only members really know what is in their interests and so Trustees will need to ensure greater engagement.

They should focus on clear, open and regular communication and help members reach decisions at the right time (not just at retirement). The KPI should be for high levels of engagement and education as well as assisting members to make the decisions that are right for them.

As our friend with the ice creams has found, people shouldn't be encouraged to buy the strawberry sauce just because it suits everyone else!

Written by John Reeve, senior consultant, Premier?

john.reeve@premiercompanies.co.uk