Master trusts to face cost challenges in years ahead

The market damage wrought by the pandemic-inspired lockdown, combined with long-term factors like the cost of implementing the pensions dashboard, administering small pots, and remaining competitive in a sector ripe for consolidation, means the master trust industry as a whole “is unlikely to achieve breakeven on costs until around 2025,” the research stated.

In the report, PPI senior policy analyst John Adams wrote that establishing a master trust is a capital-intensive endeavour, and one not expedited by the number of deferred members, which is growing at twice the rate of the number of active members.

Deferred members make no further contributions and thus fail to provide assets under management growth for the provider, Mr Adams noted. 

Reductions in overall contribution levels as a result of increased unemployment and volatility in the stock market are likely to impact master trusts’ income from charges, at least in the short-term

John Adams, PPI

With an estimated £1bn invested in establishing their platforms by the largest auto-enrolment providers, “after 7 years and increases to contribution rates, the charges generated from the AUM may not be enough to cover the ongoing costs and pay off the outstanding debt on the start-up costs", the report read.

Small pots problem lingers

Pensions Expert reported previously on PPI research showing the risk of small deferred pots to auto-enrolment generally and master trusts in particular, with costs of administering them estimated to hit £1bn by 2035.

In the new report, Mr Adams wrote that the size of the average active pot will have to rise to £18,000 by 2035 to support the growth in inactive pots. By contrast, in 2019, that figure stood at £10,400.

Though individual active pots cost more to administer, in part because they are administered more often, the relative number and size, as well as the lack of future contributions and AUM growth, can make small deferred pots a greater financial burden, Mr Adams explained.

Darren Philp, director of policy at Smart Pension, told Pensions Expert that, though they will be a significant force in future, it is still early days for master trusts and a number of significant challenges remain. He concurred with the PPI report in highlighting the problem posed by "the exponential increase in the number of small deferred pots being created by auto-enrolment".

However, "this is not new news," he continued. "The Department for Work and Pensions itself predicted this would happen, but it is increasingly clear that we need a number of solutions to resolve this issue."

Mr Philp argued that the industry needs a "system where it is easier for schemes to transfer the smallest pots to the scheme where members are actively saving through a process of member exchange, as long as it's between authorised schemes that are subject to the charge cap regulations".

He added that it would also "be helpful if the government would consider easing rules around the auto-enrolment opt out window to allow for a refund of contributions when members just miss the opt out deadline, as this not only adds to the small pots issue, but also leads to a poor customer experience from the member's perspective".

Charging structure can mitigate small pots burden

The PPI report details the ways in which the different charging structures open to master trusts are affected by the proliferation of small pots.

Though master trusts should opt for a charging structure that reflects their own unique circumstances, Mr Adams said “combination structures” that might appear to recoup the initial cost of establishing a master trust the fastest way may also be the most susceptible to increases in costs associated with deferred pots. 

A flat-fee scheme, by contrast, may mitigate the increased costs otherwise incurred by small pots.

Meanwhile, among a host of Covid-related challenges, Mr Adams wrote that "reductions in overall contribution levels as a result of increased unemployment and volatility in the stock market are likely to impact master trusts’ income from charges, at least in the short-term".

Though the precise details of the pandemic's impact will not be clear for some time, the report details the results of scenario modelling, with results including a potential 12 per cent fall in active participation in 2021 due to a short-term increase in unemployment.

"All scenarios see a shock and then some eventual recovery," Mr Adams said. "However, the recovery is not complete in any of the modelled scenarios. For example, by 2035 the impact of three years of reduced participation is that fund charges are 2 per cent lower than they would otherwise have been."

The fallout from the pandemic is yet another case where a flat-fee charging structure might prove a boon, he continued, as deferred pots remain subject to the flat fee, and schemes with that structure tend to have "a smaller proportion of their income coming from proportion of fund charges" than schemes with other charging models.

Covid-19 means schemes risk missing master trust transfer dates

An additional logistical and administrative headache may arise, since the pandemic and attendant lockdown slowed down the process of transferring pension funds across to master trusts, according to Premier Pensions head of employer services Sue Pemberton.

Ms Pemberton told Pensions Expert that, in the early days of the pandemic, market volatility “made people quite nervous” and put master trust providers “on the back foot".

“If they were offering pre-funding, then either they withdrew it or they reduced down the level of pre-funding. Transition dates were postponed either by the provider or by their trustees and the employer because of the market volatility,” she said. 

“So, activity slowed down in the actual process of transitioning funds across. I don't think it slowed down in the sourcing of new master trusts in the planning, but the actual final stage of transitioning funds across was held off for a while in those early days in particular," she added.

Now that business is resuming, Ms Pemberton continued, both lawyers and professional trustees are proceeding with greater caution, leading to a protracted process of reviewing legal documentation that could result in schemes missing their transfer dates.

“I have never seen so many changes required or requested in these legal documents as I have in the last three months,” she said.

Delays have potentially significant implications for the affected schemes, Ms Pemberton noted, should they end up entering into a new scheme year and incurring the administrative costs of accounting and chair statements and associated documents.

However, Ms Pemberton added: “I think there's a there's a dawning realisation that these things are going to take a little bit longer. I've done four [transfers] in the last two or three months, and every one of them has taken longer than I think it would have done pre-Covid. And they're all down to the legal documentation and the nervousness around pre-funding.”

The solution, she said, is to be mindful of current conditions and time constraints, to review all legal documentation in a timely manner and to set realistic transition dates.