Long-term sustainability of DC Master Trusts

DC Master Trusts are going to work as sure as Automatic Enrolment has worked (by 2018, the number of eligible employees participating in a workplace pension had increased to 18.7 million up from 10.7 million in 2012). With life expectancy continually increasing, the Government needs to control the cost of state pension provision. As the Government cannot afford for AE to fail, it cannot afford for the pension schemes investing the AE funds to fail.

However, achieving this aim is not easy. To alleviate the stress on state pension provision, policymakers need to ensure the pension schemes investing AE funds are financially robust, governed and tightly regulated, ESG integrated, cyber secure, scam safe, providing Value for Members contributing an average of £177 per month**, done at a cost that puts pip squeezers in the museum, with decumulation options and finally resolving the monumental challenge of effective member communication.

Consolidation phase 1

When the first phase of consolidation began in 2010, there were 4,560 schemes with 12 or more DC members (including hybrids)*. A macro plan was needed to implement the risk controls to an appropriate number of DC pension schemes that could be satisfactorily regulated and governed. Needing to reduce the amount of pension schemes to achieve this isn’t rocket science – but it would need almost unlimited resources that are not available to either TPR or Professional Trustee firms.

The Australian model has been used as a comparison, although it is more mature than the UK’s, holding around $3 trillion of assets under management and growing. The number of individual schemes (Corporate Funds) fell by 96% in the 11 years to 2014 and reduced further from 44 in March 2014 to 24 by December 2017***. A report by Right Lane earlier in 2020 suggested that Australia needed only 15 super funds, the ideal structure for which would be to have three to five generalist mega-funds and seven to ten specialist funds, with no fewer than 500,000 members.  

Back in 2010 there was a reasonable amount of low hanging fruit to make a start; a number of legacy schemes with ancient charging structures and limited governance. Regulation and legislation, e.g. Code of Practice (CoP) 9, set out the internal controls requirements of PA04 to implement arrangements and procedures in the administration and management of schemes and security of the assets. Other industry bodies have assisted with the direction of travel along the way, e.g. PASA’s DC Governance paper in July 2018, designed to improve DC administration governance standards.

M&A activity also assisted in consolidating the number of established providers over this period, including Scottish Widows / Zurich, Aegon / Blackrock, Friends Life / Aviva. 

Since the beginning of 2010, under continuing regulation and legislation, including charge caps, tidying up or winding-up legacy schemes and encouraging consolidation, the total number of schemes with 12 or more DC members (including hybrids) has declined by 62% from 4,560 to 1,740*.

During that time, membership has increased by 723%, although average assets per member have declined every year since 2013, and have fallen by 77% since the beginning of 2012*; the effect of AE on minimum contributions.

This starts to introduce new challenges for the consolidators.

Consolidation phase 2

To improve Master Trusts, TPR initiated a re-authorisation process in 2019. Of the existing 90 Master Trusts in the market, only 38 submitted applications for re-authorisation – 37 of which were granted. One withdrew its application and there was one new entrant. As  a result of the re-authorisation process, the overall size of the market reduced by 58.8%. TPR worked with the 53 Master Trusts that had their authorisation revoked to secure members’ benefits under appropriate arrangements. PASA even produced a good guide for those that didn’t make the grade to help them transition to a Master Trust that did. This guide is also useful for own trust DC schemes that may wish to transition to a Master Trust and wind-up.

Sustainability of the Master Trust  model

Importantly, the successful 37 have made a considerable investment in obtaining re-authorisation (many, many millions of pounds – including some fines reported for information errors), in addition to the required capital adequacy reserves and the infrastructure investment required to set the Master Trusts up initially. Any investment seeks a return, so what’s the expected payback?

Revenue for the Master Trust providers relies upon a mix of:

• Increase in membership;
• Some Employer charges – up to £2k p.a. (Ensign);
• Contribution charges (NEST and Worker’s Pension Trust, 1.8%);
• Monthly fixed fees (e.g. £1.50 per month);
• Fee from AUM (e.g. 0.3% p.a.);
• Increase in AE contributions (April 2019); and
• Receiving transfers in.

How long before this investment is recovered? Twenty plus years, based on £1bn AUM at 0.3% p.a. = £3m p.a. According to NEST’s 2019/20 report and accounts, the pre-Covid projection was breakeven by 2026 and repayment of its loan facility (granted by the government to establish NEST) by 2039!

Within a year of obtaining re-authorisation, the Master Trust providers have been hit with a perfect storm:

• Covid-19 impact on asset values: Initially down between 25% and 30% in equities, still around 10% down (unless invested in technology and precious metals). AUM reduces, so does the AUM related fee.
• Covid-19 impact: Expectation of global recession – job losses and increase in unemployment – contributions then lower than projected, with between 40% and 50% Master Trust members already being deferred.
• DWP consultation on the charge cap questioning the justice of the monthly fixed fee for smaller investors.

These factors place pressure on the revenue expected from AUM, contribution charges and monthly fixed fees, which stretches the 20+ years plan out even further.

How long can some Master Trust providers continue, particularly those without the ‘loan facility’ provided from the taxpayer? Employee benefit consultancies and some Insurers can support their Master Trusts through the revenue created from other activities and consolidation campaigns to transfer clients with own trust schemes and GPPs. Nevertheless, some market commentators have predicted the number of authorised Master Trusts could reduce to between 15 and 20 within as little as 10 years.

One main factor is the operational cost of deferred-members with small funds. The Pension Policy Institute (PPI) July 2020 publication: ‘policy options for tackling the growing number of deferred members with small pots’, estimates that the number of deferred pension pots in the UK DC Master Trust market is likely to rise from 8m in 2020 to around 27m in 2035. In addition, financial instability in Master Trust schemes, arising from too many small pots, could, in extreme circumstances result in trustees triggering an event to wind up the scheme.

Consolidation phase 3

To help resolve the issue, the PPI has suggested a number of alternatives and acknowledges a combination is likely to create the most appropriate outcome:

• Dashboards: a member view for their pension pots in one place could facilitate more consolidation.
• Same provider consolidation: returning members are re-enrolled into their deferred pot.
• Pot follows member: pots move with members to new employer’s schemes.
• Member exchange: a form of pot follows member, which allows for the reassignment between schemes of all existing pots into the current active scheme.
• Lifetime provider: members remain with the same provider throughout their working life.
• Default consolidator: pots deferred for a year transfer to a consolidator provider, with members being given an opportunity to opt out.

Has the requirement to invest in Master Trusts stopped yet?

The many millions of pounds invested so far is not the end of the spending requirement. On the regulation side, Master Trusts are moving to the supervision phase, with either quarterly, half-yearly or annual meetings with TPR. I believe all but one are initially on quarterly meetings. In addition to this, further development is required in various areas, e.g. default fund sophistication and improved guidance / advice particularly at retirement. Digital development has so far been reasonable but a little like one of my old school reports – could do better –unfortunately, we needed a pandemic to increase average on-line usage, rather than the skills of our industry!

So, as a minimum, this will push back the investment recovery period, but will question the sustainability of some of the Master Trusts.

ESG/SRI

Having spent 33 years trying to engage members with their pension savings (with some success) I then see Richard Curtis (Make My Money Matter) do it in six words: where is your pension fund invested?

Covid-19 appears to have had a profound impact on the momentum towards ESG and SRI. From the 2016 Paris agreement, we have had the EU Taxonomy (approved by the EU Parliament in June 2020), PCRIG consultation on the TCFD, the current draft of the 2020 Pensions Bill and EU Shareholder Rights Directive II among the many developments.

Trustees then need to put their linen on-line with SIP and Implementation statements from October 2020, setting out how trustee ESG and stewardship policies have been followed during the year. I’m not sure how many members will be reading the Chair’s statements (17 pages in the very handy template from the PLSA) but I know Richard will, and probably slightly ahead of TPR. If your pension ESG strategy isn’t aligned to your corporate values, expect an article soon.

On July 29, NEST announced its new climate change policy to decarbonise its investment portfolio, with the expectation that carbon emissions in its portfolio will halve by 2030; it has set out a goal of being net-zero across its investments by 2050 or earlier. A great move, which puts pressure on other Master Trusts to do some serious thinking and investing in this area.

Decumulation

On the philosophy of ‘cradle to grave’ financial planning, the development of decumulation options in the surviving Master Trusts is important. One immediate advantage is that if members don’t have to transfer out to establish their pension income they are less likely to get scammed. This is value for members, although what isn’t is the amount of members reported in the FCA’s Retirement Outcomes Review who are investing their drawdown fund in cash or have no idea where it is invested, some of whom will have transferred from DB schemes.

To resolve this issue, the FCA has introduced Investment Pathways for non-advised clients using decumulation and extended the remit of the IGCs and GAAs to report on the Value for Money provided, oversee the choice architecture, governance (the FCA Retirement Income Date Return and annual statements etc.) and consider ESG/SRI issues. The FCA has also published a consultation paper on Driving VfM in pensions and a thematic review of the effectiveness of IGCs and GAAs. Importantly, this is also relevant for trustees of DC schemes providing decumulation options through the FCA and TPR joint regulatory strategy for the pensions and retirement income sector.

The vast majority of Master Trusts do offer decumulation options; some will need to develop these.

Is big always best?

Fewer schemes means less regulation for TPR and allows those schemes to be regulated more efficiently and effectively. Pension mega funds could also be used in various ways. We have a £1tn gap in the UK infrastructure which needs plugging, especially if we are to take advantage of being free from our previous EU constraints, so there may be other political cards at play. The Social Market Foundation published a report in June 2020 arguing that pension superfunds should be created to invest in infrastructure for the UK’s green recovery.

Whether or not big is always best, it seems a whole heap better that what we had in 2010 and before. Early in my career, I recall a DB member retiring and having to take her AVC benefits simultaneously – as was the requirement back then. This was an early retirement (partly driven through poor health) but meant that the AVC fund suffered an early encashment penalty of 95% of its value. This was just simply wrong. Where we are now, and where we are heading in the future, may not be perfect, but currently it just feels simply better.

*TPR DC Trust: Presentation of scheme return data 2019-2020

** ONS: For February 2020, average regular pay, before tax and other deductions, for employees in Great Britain, multiplied by 8%.

***https://www.barnett-waddingham.co.uk/comment-insight/blog/consolidation-defined-contribution/

An abridged version of this blog appeared in Pensions Expert on 25 August 2020