Are mastertrusts financially stable?

Mastertrusts exist because of the need to deliver economies of scale to members – they will deliver those economies because of their scale. In other words, they need to be big to succeed from the members’ perspective.

Any new venture necessarily consumes capital before it makes money – think Facebook, LinkedIn or a new toothbrush factory

It was, I suspect, partly this issue that sat behind Warwick-Thompson’s words, although he may also have been hinting at a slightly darker, more worrying issue: can 150 mastertrusts be financially stable? 

The economics of mastertrusts

Despite what some people think, it is not cheap to set up or maintain a proper, decent mastertrust. The base operational costs are high: administration, systems, staff and investment infrastructure and so on, while against this background the prospects for profit are constrained by the charge cap of 0.75 per cent (or some broadly equivalent models).

One provider estimated the first-year costs of installing and administering a pot for one member at around £150, which compares with first-year charges of around £3 for an average earner. Making a mastertrust work economically requires deep pockets, a long-term vision and some resolve.

The maths stack up (for those with deep pockets, long-term vision and resolve) only because there is the prospect of scale and fund growth.

The idea is that the average charge will at some point exceed the running cost and recover the running costs previously spent – hence the importance of scale. Most providers do not expect to make an operational profit for more than 10 years. But that’s not all.

The staging dates of the large employers have all passed, so what are left are the small and micro employers. Staging any employer involves certain fixed costs and these are, proportionately, much greater for smaller employers. In other words, smaller employers cost more to deal with.

Necessarily, the pricing models used do not allow for specific regulatory change – how can they if they do not know what that change will be (albeit some contingency can be built in), yet the one thing we know about the future is that there will be change – which will have to be paid for.

One particular possible regulatory change is the 2017 review of all things to do with auto-enrolment. The DWP has already indicated that during this review the department will consider reducing the charge cap to 0.5 per cent including transaction costs. The economics of mastertrusts are challenging.

So are mastertrusts financially stable?

Financial stability is going to rely on a number of factors, but the key component has to be scale. At the moment, with the possible exception of some of the mature ones, most mastertrusts are a drain on the resources of their sponsor. In other words, few are currently financially stable.

In the long term, the stable mastertrusts will be those with scale. In the short term, those that are must have a sponsor with deep pockets.

Does this matter?

Possibly not. Any new venture necessarily consumes capital before it makes money – think Facebook, LinkedIn or even a new toothbrush factory.

What is important, however, for mastertrusts, are two things: Firstly, is there a realistic business plan based on robust assumptions? Has the sponsor fully considered the economic challenges and worked out how they will succeed?

A core component of that has to be, ‘How are we going to achieve scale?’ – in other words, a fully worked, stress-tested distribution plan.  

Secondly, is there a contingency plan for securing members’ benefits in the event that the business plan fails?

It is early days for most mastertrusts, and these things, along with all of the benefits they will bring to the market, cannot get off the ground without some exposure to risk.

The key to selecting a mastertrust likely to succeed is to look for a good business plan. 

Richard Butcher is managing director at PTL