New FCA nudges for better long-term outcomes in non-workplace pensions

The intervention was prompted by FCA findings that suggested that, like in defined contribution workplace pensions, the non-workplace pension sector suffered from low consumer engagement combined with complex and confusing products and charges. The regulator said the issue had caused a lack of competitive pressure to drive better value for consumers. It also found that non‑advised customers often may end up investing in products that do not meet their needs for retirement, or may be put off from buying a non-workplace pension altogether.

The new rules (58 pages / 716KB PDF) require that non-workplace pension providers offer a ‘default’ investment option to non-advised customers that are buying a non-workplace pension. The default will be a ready-made, standardised investment solution that providers must make available alongside the other investments they promote, as well as alongside any decision-tree-type tool they make available. Providers must also issue a ‘cash warning’ to customers with significant and sustained levels of cash in their non-workplace pension to warn them that inflation may erode their pension savings.

The default option

The new rules require providers to offer non-advised customers the possibility of investing in a solution designed to enable customers in its target market to have some reassurance that the solution is compatible with the need of those customers to grow their pension pots until retirement. The FCA said providers must also consider the likely retirement age, decumulation strategy and, accordingly, de-risking needs of customers in the target market for the product. Bespoke self-invested personal pensions (SIPPs), where providers do not promote investments for inclusion in the pension, are excluded from the requirement.

While most respondents agreed with the proposal for a single default option, a small number argued for more flexibility, including offering several default options to serve different groups of investors. The FCA rejected this suggestion, stating that a single default option was still necessary to support consumers who are struggling to make a decision. Providers are still able to offer additional investment options alongside the default option.

It will be interesting to see how the one-size-fits-all single default option interacts with the extra layer of nuance and depth added by the consumer duty. Delivering the consumer understanding outcome and complying with the cross-cutting requirement of enabling and supporting customers to achieve their financial objectives is likely to require firms to encourage customers to keep their investment in the default option under review.

This will be of particular importance in relation to the decumulation strategy aimed at by the default option. The consumer duty would arguably require providers to remind customers in a timely fashion of the decumulation strategy aimed at by the default option, and of the degree of ‘lifestyling’ or de-risking involved in it. This would support decision-making by those customers who, having initially invested in the default option, become more engaged at a later stage and realise that their objectives are no longer aligned with the objectives of the default option. A good consumer outcome in that case would be for the customer to move to another investment that is more compatible with their personal objectives.   

Pension providers and manufacturers of default options will also need to consider how the price and value outcome in the consumer duty amplifies the requirement for the price and charges of the default option to bear a reasonable relationship with the services that option comprises. It is also worth noting that the FCA and The Pensions Regulator (TPR) keep working on standards for value for money measurement across the defined contribution pensions industry. Given the complexity of this area, it would not be a surprise if the remit of Independent Governance Committees (IGCs) is eventually extended to also oversee and challenge the value for money of the default option, allowing providers to incorporate the output from IGCs when complying with consumer duty requirements.

Managing risk

If a default option does not perform as expected or is otherwise not fit for purpose, the provider could face mass member complaints and FCA intervention in years to come. This risk has not yet crystallised in the context of workplace pensions or retirement products, but there is a sense of momentum building for US style mass actions on poor investment outcomes. To protect against this, providers should double down on governance, ensuring they have a regular cycle of:

• data-gathering around their target market and its likely retirement age, decumulation strategy and de-risking needs;
• assessment of whether the default is still compatible and adjustment if necessary (including for existing money, building in a legal mechanism to drag across existing money to the new default); and
• informing and warning customers of the decumulation strategy that is being targeted, including the degree of derisking involved.

For the moment there is no IGC second guessing the default – it’s all on the provider to get it right.

The cash warning

The new cash warnings must inform the customer that more than a quarter of their non-workplace assets is invested in cash or investments that are similar to cash. The FCA said the warnings must make clear that that the value of the non-workplace pension is at risk of being eroded by inflation and must include a generic illustration that clearly shows how erosion by inflation would affect a £10,000 pot over 10 years, assuming 0% interest and using the Consumer Prices Index (CPI).

Providers must also advise the customer to consider whether their current investments are likely to grow sufficiently to meet their retirement objectives and tell the customer that the provider offers other investments including the default option, where applicable. Providers should also make clear that the warning is not advice.

Many respondents disagreed with the prescriptiveness of three‑monthly assessments of cash holdings. In contrast, many also disagreed with the flexibility that the rules give to providers in deciding when to send the warning, allowing providers not to send it during a market downturn. The FCA has retained the rules as consulted on, pointing out that the need to exercise professional judgment as to when to send the warning is aligned with the consumer duty’s focus on outcomes, and that the consumer duty would support providers that decide to go beyond the minimum required for the assessment of cash holdings. This answer is not entirely satisfactory, and the discussion shows that the ebb and flow between prescriptive rules and principles will remain, in the new consumer duty era, as current and disputed as ever.

While the cash warning may have appeared the poor relation in the package when the rules where first consulted on, the importance of the measure has come into sharp focus in the current economic environment. The measure is part of the wider regulatory effort to get consumers to invest their savings in growth assets. The latest instance of this effort is the recent consultation on broadening access to streamlined financial advice in relation to stocks and shares ISAs.

Implementation timeframe and approach to legacy business

These changes are an important development for life insurance companies, investment platforms and other SIPP providers involved in this growing sector. They are likely to present fresh regulatory complications for smaller SIPP providers that accept non-advised business from introducers. The rules come into effect on 1 December 2023.

A transitional provision exempts from the requirement to offer the default option to legacy non-advised members those providers that decide to entirely run off their presence in the non-advised market. Guidance on this transitional provision now helpfully confirms that where a provider does not enter into new non-workplace pensions with non-advised customers after 1 December 2023 but still continues to promote investments to existing non-advised customers, the provider will still be considered to only have legacy non-advised business.

Given how the transitional provision and related guidance are drafted, providers will still be able to accept new money into the pensions of existing non-advised clients without needing to comply with the default option requirement, provided no new pensions are being opened on a non-advised basis.

The requirement to offer the default option applies at the level of the provider, so it is triggered as soon as a single new non-workplace pension is opened after 1 December 2023, regardless of whether that pension is housed in a different scheme to those where the legacy non-advised pensions are written. This means that, for example, where an investment platform is involved, the default option may need to be included in the relevant investment menus and made available to legacy non-advised customers too. In the case of smaller SIPP providers that do not promote investments on an ongoing basis, it may be possible to just offer the default option to new non-advised customers at the point they open their pension.