Pension schemes to be rated under new 'traffic light' system

Workplace defined-contribution (DC) pension schemes will be rated green, amber or red to protect UK savers’ retirement prospects, in a new addition to the Financial Conduct Authority (FCA) and The Pensions Regulator’s value-for-money scrutiny.

A further shake-up could also be on the way, as chancellor Rachel Reeves is putting together a plan for a roll-up of DC schemes to give the UK the financial firepower seen in Canada and Australia, where megafunds plough billions of pounds into the stock markets and infrastructure.

The previous government also worked on scheme consolidation, with former chancellor Jeremy Hunt using his 2023 Mansion House speech to put forward the idea of “collective” DC funds and threatening to wind up those with poor returns. What will now be the traffic light scheme even predates Hunt – it has been in the works since 2021.

But this latest step in the push for greater value for money will take into account investment performance and service quality. ‘Red’ funds may be forced to transfer clients’ money across to those with better ratings.

The changes will be included in the government’s Pensions Schemes Bill announced in the King’s Speech last month. A consultation period on the FCA's paper will run over the coming months, with comments until 17 October.

“Focusing on value rather than costs will enable providers to invest in assets which could deliver greater long-term returns but have higher management costs, such as infrastructure or venture capital,” said the FCA.

The FCA’s consultation paper said a simpler rating system would help employers choose schemes, in which most workers remain enrolled due to the 'auto-enrolment' programme.  “While many employers want to support the long-term wellbeing of their employees, they don’t have a direct financial interest and switching a scheme is costly,” the FCA said.

Reeves was in Canada this week pushing for greater investment in the UK and the development of megafunds locally. “I want British schemes to learn lessons from the Canadian model and fire up the UK economy, which would deliver better returns for savers and unlock billions of pounds of investment,” she said.

She has her eyes set on the Local Government Pension Scheme (LGPS), which manages £360bn, according to the Financial Times. This is split between 86 locally administered funds, limiting the size of investments. The discrepancy between the massive funds seen elsewhere and the UK’s far smaller DC funds is largely down to lower contributions from both employers and employees, while funds are also far more concentrated in a handful of providers in Australia and Canada.

Think tank New Financial said in a 2023 report that contributions in the UK were “woefully low”, averaging 8 per cent through a 3 per cent employer contribution and 5 per cent from employees. Employers contribute 11.5 per cent in Australia, and workers will often put in their own cash as well due to favourable tax treatments.

Looking at allocations, when taken as a whole, the LGPS outdoes Australian and Canadian funds in terms of stock market exposure, with 51 per cent of assets in equities according to the Local Government Advisory Board. The chancellor is pushing for more investment in infrastructure, however, and this is 6 per cent of holdings. AustralianSuper, Australia’s largest superannuation fund, has 9 per cent of its £170bn in assets in infrastructure.