The Financial Conduct Authority (FCA) is set to force workplace pension schemes to publish their investment returns, including forward-looking projections, under a new 'value for money' framework, which will see funds ranked under a 'traffic light' system.

Pension schemes' default funds will be rated according to a new colour-coded system, with strong-performing funds rated dark green, those offering 'good value' rated light green, schemes requiring improvements rated amber, and poor-value schemes rated red, according to the proposals by the FCA and the Department for Work and Pensions (DWP).

Schemes that are determined to be consistently providing poor value will have to make improvements or risk being closed and members transferred to a better value pension. Schemes will also have to show the returns and risks savers can expect over the next ten years, at a potential cost to the pensions industry of £36m to £47m over the next 10 years, the FCA predicted.

Rachel Vahey, head of public policy at AJ Bell, said: “They [the FCA and DWP] are asking pension schemes to check how well they’re doing in three important areas: how much they charge, how well investments are performing, and the quality of their service. Each scheme will then be placed into one of four categories: strong performance, good value, needs improvement, or poor value. 

“Hopefully the new proposed requirements will give some workplace pension schemes a nudge to shape up, or risk losing their membership.”

She continued: "One of the challenges faced by the FCA is the possibility of ‘herding behaviour’ developing, where schemes decide to adopt investment strategies that include less risk so that they are never in danger of becoming an outlier when comparing value for money assessments.  In an attempt to prevent this from happening, and encourage investment in diverse assets, including private markets, the rules propose including forward-looking investment metrics.

“However, this approach comes with significant challenges. Although it’s easy to see why the government wants to encourage workplace pension investment in private markets, measuring performance that has not yet happened opens the possibility that some schemes will ‘game the system’ by including overly optimistic returns that in practice may never materialise.”

The proposals come amid concerns from the government and regulator that millions of savers in the UK are not setting aside enough money to live comfortably in retirement, with concerns raised that 'default' workplace pension funds are not offering good value for money.

The FCA said that over five years, a £10,000 pot could grow to £10,400 in a poor-value scheme, compared to £15,100 in a high-performing one - 46% more.