2023 is shaping up to be a busy year for implementing regulatory change.
Dominating the horizon is, of course, Consumer Duty. This is a wide-ranging, gangling piece of regulation requiring advisers and providers to unpick every process and communication to establish whether it results in good consumer outcomes.
Another set of new FCA rules to implement this year are focused on non-workplace pensions. These rules do two things:
1. They introduce a new default investment option that has to be offered to non-advised customers taking out a pension; and
2. they require providers to give customers a mandatory warning if they stay invested in cash for a significant period of time. The cash warnings have to be given to both advised and non-advised customers.
The implementation date for the new rules is 1 December 2023. This article runs through these new rules and discusses the implications for providers and advisers.
Background to the changes
Following its work implementing changes to help drawdown customers make investment decisions, the FCA also wanted to improve outcomes for those in the accumulation stage of non-workplace pensions.
Over the last few years, it has conducted some thorough research into this market and come up with some startling facts. Not least is that the non-workplace pension market was worth £400 billion in assets under management in 2018 and was continuing to grow. The FCA expressed its concern, though, that many customers felt disengaged from their pension savings and struggled to make decisions, such as choosing an investment strategy.
The main aim of the new rules is to engender competition in the market and improve investment decision making for customers. Put simply, the FCA wants customers to take a more active interest in their investment choices, and not to linger in cash.
The new default investment option
The FCA is asking providers to offer a new default investment option to non-advised customers. This option is targeted at helping those who are unable or unwilling to engage with investment decisions or find it difficult to choose appropriate investments.
Pension providers will have to offer the option to customers when they first apply for a non-workplace pension.
Customers have to be offered – clearly and upfront – one single default option. It can’t be shown solely because the customer has filled in an investment questionnaire or used a filtering tool. However, details of other investments can be shown at the same time.
It’s important to note the customer is not being defaulted into this investment option – they just have to be shown this option upfront. This offers them a ‘fallback option’ if they don’t know what investment choices to make or even how to start thinking about this.
Providers also have to include the default investment option on any menu of investments in a position “most likely to bring it to the attention of clients”. So this is probably going to mean at the top of the list of investment choices.
Who do the rules apply to?
The FCA realise a default investment option is not going to be suitable for all customers, and there are some important exemptions to the rules. These are:
- Bespoke SIPPs – providers only offering an empty shell, where the customer tells the pension scheme what investments they want to hold within their SIPP wrapper, are exempt.
- Advised customers – if the customer has received a personal recommendation on the investment of their contributions or assets in the pension, they don’t have to be offered a default investment option.
- Customers with a DFM – the rules don’t apply where the customer has appointed an investment manager for the investment of their contributions or assets in the pension.
- Legacy providers – as the default option is offered when taking out a new pension, the rules will not apply to schemes that are closed to new business.
The design of the option
The FCA has rethought its plans to give the default investment option a name and instead will allow schemes to call it what they want. This is welcome news – the ‘Standardised Investment Solution’ hardly sets pulses racing. But whatever name providers give it, it needs to be obvious what it does and that it is different to other investments.
Providers have to give a simple description of the fund, and set out what the needs, objectives, and characteristics are of the typical non-advised customer who wants a default investment option. Providers have to make it clear it’s not tailored to individual needs.
The default investment option doesn’t have to include lifestyling if that’s not appropriate for the target market. Again, this is good news. Some customers will have a fixed idea of when they want to access the fund, and in this case de-risking may help. But DIY platform customers are far less likely to have an age in mind, and most probably do not want to buy an annuity but instead continue an active investment strategy.
The rules don’t require providers to offer an ESG fund as a default option. But the FCA believes providers should take account of ESG when designing their default option and consider whether inclusion will meet the needs and wants of the target market.
Pension schemes will have to review their default options at least once every three years to make sure they still meet the target market’s needs. But, for the moment, the design of the default option doesn’t fall under the governance of the IGC or GAA.
Implications for advisers
At first sight it appears the default investment option will have few implications for advisers. Their clients won’t be offered it on taking out a pension. And there is no ‘RU64’ style rule by which advisers have to compare to the default investment option when giving a personal recommendation on pension investments.
However, the default investment option is an important development, and no doubt will play a part in benchmarking investments’ performance especially when discussing value for money and good customer outcomes.
Regular cash warnings – the rules
The second part of the new rules is for providers to warn customers if they have a significant amount invested in cash over a period of time. The idea is to nudge the customer into reviewing their investments.
Providers will have to assess customers once every three months to establish if:
- they have more than £10,000 in cash,
- this is more than 25% of their non-workplace pension
- this was the case in any other assessments carried out during the previous six months; and
- the customer is more than five years away from the normal minimum pension age (NMPA) (or a lower protected age).
Providers have leeway when exactly they will conduct an assessment within this three-month period – it doesn’t have to be on a particular date.
The wording for the cash warning, which usually has to be given within three months of the assessment, will show how inflation can erode savings over a ten-year period.
If the customer receives a warning, then providers don’t have to send another warning for a year, although, of course, some providers may continue to send warnings for every three-month assessment where the customer continues to meet all the conditions.
A provider, though, doesn’t have to always send out a warning immediately. They may decide that a warning is not appropriate at a given time because of the current market conditions, for example turbulence in the market meaning more people have retreated to investing in cash. In this case there would be leeway for the provider to extend so they sent the warning six months after the assessment.
This initiative is copying one introduced for drawdown customers in February 2021. There are however a few key differences. Providers have to monitor cash investments on an ongoing basis, rather than at only one time, when the customer enters drawdown. And there is no need for the customer to return an ‘active decision’ where they tick a box to say they are comfortable remaining invested in cash.
Exemptions to the cash warnings
Cash warnings have to be sent to both advised and non-advised customers. But they do not have to be sent to customers who have appointed an investment manager for their contributions to, or assets in, a non-workplace pension.
A customer could have only part of their pension fund held with an investment manager and be in control of the investment strategy themselves for the remaining funds. In these circumstances, the regulations don’t appear to compel the provider to test the remaining assets, although some providers will choose to do so.
How will it affect advisers working with their clients?
Advisers will find their clients holding a sizeable cash investment will receive warnings direct from the provider. Of course, there are various good reasons why a client may remain invested in cash over a six-month period, and these would have been explored and discussed between advisers and their clients when deciding upon the investment strategy.
So, in the cases where a cash warning will have to be sent out advisers may want to discuss the warnings with the client before they are received.
These new rules will hopefully help achieve the FCA’s aims to improve outcomes for personal pension customers. However, the other big implementation event of 2023 – Consumer Duty – will be an overriding presence. Providers have to follow the new workplace pension rules, but they also have to consider them through the Consumer Duty lens. That might mean testing communications, and it certainly means being clear on who exactly the default investment option has been designed for, that it’s competitively priced, and that it’s reviewed regularly. It is the provider’s responsibility to make sure it is – and continues to be – appropriate.
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