To buy or not to buy: the chnaging landscape of housing retirement
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Financial
To buy or sustainability of master
not to buy: the trust
chnaging pension of
landscape schemes
housing retirement
The Pensions Policy Institute (PPI) The PPI is an educational, independent research organisation with a charitable objective to inform the policy debate on pensions and retirement income provision. The PPI’s aim is to improve information and understanding about pensions and retirement provision through research and analysis, discussion and publication. It does not lobby for any particular issue or reform solution but works to make the pensions and retirement policy debate better informed. The PPI is funded by donations, grants and benefits-in-kind from a range of organisations, as well as being commissioned for research projects. Pensions affect everyone. But too few people understand them and what is needed for the provision of an adequate retirement income. The PPI wants to change that. We believe that better information and understanding will lead to a better policy framework and a better provision of retirement income for all. The PPI aims to be an authoritative voice on policy on pensions and the provision of retirement income in the UK. The PPI has specific objectives to: • Provide relevant and accessible information on the extent and nature of retirement provision • Contribute fact-based analysis and commentary to the policy-making process • Extend and encourage research and debate on policy on pensions and retirement provision • Be a helpful sounding board for providers, policy makers and opinion formers • Inform the public debate on policy on pensions and retirement provision. We believe that the PPI is unique in the study of pensions and retirement provision, as it is: • Independent, with no political bias or vested interest • Led by experts focused on pensions and retirement provision • Considering the whole pension framework: state, private, and the interaction between them • Pursuing both academically rigorous analysis and practical policy commentary • Taking a long-term perspective on policy outcomes on pensions and retirement income • Encouraging dialogue and debate with multiple constituencies www.pensionspolicyinstitute.org.uk
This report has been authored by:
John Adams – Senior Policy Analyst
John has been the PPI’s Senior Policy Analyst since 2008. In his time at
the PPI John has worked in a lead role in the modelling of a wide range
of projects including looking at public sector pensions and pension
related tax-relief.
At the PPI, John is responsible for the PPI’s Pension Facts and has
authored briefing notes and reports on subjects such as how housing
wealth can support retirement, tax policy on pension schemes, har-
nessing pension savings for debt alleviation, public sector pension
reforms.
John joined the PPI in 2008 from Hewitt Associates. At Hewitt he
worked primarily on modelling of standard and non-standard De-
fined Benefit pension scheme calculations for the consultants to pres-
ent to the clients.
Prior to joining Hewitt John worked for the Government Actuary’s
Department for 8 years in the Occupational Pensions directorate, dur-
ing which time he calculated public sector pension scheme valuations,
bulk transfer values, and designed models for the use of other Govern-
ment departments.Sponsorship has been given to help fund the research, and does not necessarily imply agreement with, or support for, the analysis or findings from the project. A Research Report by John Adams Published by the Pensions Policy Institute © August 2020 ISBN 978-1-906284-91-6 www.pensionspolicyinstitute.org.uk
Financial sustainability of master trust pension schemes Executive Summary...................................................................................................................................... 1 Introduction.................................................................................................................................................... 4 Chapter One: Automatic enrolment and the introduction of master trusts......................................... 6 Chapter Two: Ongoing costs to master trust schemes............................................................................. 9 Chapter Three: Charges on master trust schemes...................................................................................14 Chapter Four: Projection of the costs and income of the master trusts...............................................18 Chapter Five: Challenges affecting the master trust industry............................................................. 25 Appendix One: the Charge Cap................................................................................................................ 30 Appendix Two: Technical Appendix........................................................................................................ 31 References..................................................................................................................................................... 34 Acknowledgements and Contact Details................................................................................................. 35
PENSIONS POLICY INSTITUTE
Executive Summary
Automatic enrolment has led to a rapid increase in pension savers, with more than 10 million
enrolled since its introduction in 2012. Master trusts have been created to meet this increased
need for pension provision. Setting up a master trust is a capital-intensive venture, requiring
professional advisors, systems for processing contributions, fund management, administration and
marketing. In order to achieve financial sustainability, master trusts must ensure that they are able
to cover both initial start-up costs, and loan repayments in cases where start-up capital has been
borrowed, as well as ongoing costs associated with running the scheme. While a scheme’s chosen
charging structure impacts individual members, it also affects the financial sustainability of the
scheme more broadly, so careful consideration must be given to ensure that this is appropriate for
expenditure needs.
The greatest challenge to the financial sustainability of master trusts is the need
to cover initial start-up and running costs until levels of membership and assets
have grown sufficiently
There are significant costs associated with setting up a new pension scheme, as well as ongoing
running costs, which can be more challenging to cover in the early years of the scheme while pot
sizes are small. In order to meet costs during the period before the scheme income is sufficient,
the master trusts will rely on financial support from other sources. If initial capital is provided
as a loan, then servicing of that loan through regular payments is required as set out in the terms
of the loan and is a cost to the scheme. These repayment cashflows also need to be met from
future charges, alongside the ongoing costs of the scheme. Master trusts set up by an existing
pension provider may benefit from existing administration and IT systems, while master trusts
set up from scratch generally face higher initial start-up costs. As a result of concerns about the
business models of some of the master trusts and the resulting impact on the schemes’ financial
sustainability, the Government introduced an authorisation regime.
Financial sustainability of master trust pension schemes 1PENSIONS POLICY INSTITUTE
Master trusts’ annual expenditure has been growing year on year, with
cumulative expenditure around £1 billion by 2019 and costs expected to continue
to grow
Chart Ex.1
Cumulative investment into the four largest master trusts may be at around £1bn by 2019
Annual costs of setting up and running the largest 4 master trust pension schemes (£millions)
£1,200
£1,000
£1,000
£200
£800
£800
£180
£millions
£620
£600 £140
£480
£370 £110
£400
£270 £100
£180 £90
£200 £110
£70
£60 £50
£30
£30
£0
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Year
Cumulative expenditure Annual expenditure
Chart Ex.2
Costs of master trust schemes are increasing in earnings terms
Projection of costs of master trust schemes (£billions in 2020 earnings terms) under high, baseline
and low cost scenarios
1.4
1.2
master trust schemes (£billions)
Aggregate costs and charges of
1.0
0.8
0.6
0.4
0.2
-
2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035
Year
Baseline Costs Low Cost High Costs
2 Financial sustainability of master trust pension schemesPENSIONS POLICY INSTITUTE
The master trust industry is unlikely to achieve breakeven on costs until around 2025. Thereafter,
the industry may generate annual profits which will accelerate as the funds under management
grow. However, in reality there may be some reduction in the profits as providers seek to achieve
a competitive advantage by reducing their charges, while still having a large enough pool of assets
under management to achieve a profit from the charges.
There are a number of known future challenges which are likely to impact
master trust costs moving forward
• Pensions dashboards: Data cleansing exercises necessary for the implementation of pensions
dashboards are likely to present additional costs for master trusts, both on an immediate and
ongoing basis. While the cost of dashboards to the master trust industry is difficult to accurately
predict, the Department for Work and Pensions’ estimates in the Pensions Bill 2020 Impact
Assessment suggest large schemes would face implementation costs of around £200,000 each.
For medium size schemes, implementation costs are calculated to be around £75,000 each, along
with having to share the cost of £100,000 per administrator. Over the longer-term, this may be
offset by lower costs in other administrative areas as a result of higher quality data.
• Deferred members: Small pots belonging to deferred members are likely to become an
increasingly important issue as job mobility continues to grow. While active pots are more
continuously administered as new contributions are regularly received and allocated, deferred
pots present their own administration issues as a result of inefficiencies in administering
multiple pots for the same person or maintaining contact with an individual without having
a current employer to provide contact information. Schemes with a greater proportion of pots
belonging to deferred members may experience costs that are particularly high relative to
their assets under management, as these pots tend to be small and do not grow with ongoing
contributions. Without policy change, the number of deferred pots in master trust schemes could
grow from 8 million to 27 million by 2035.
• COVID-19: While the full impact of COVID-19 on pensions is not yet certain, 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.
Financial sustainability of master trust pension schemes 3PENSIONS POLICY INSTITUTE
Introduction
This report is informed by desk research, PPI modelling, and interviews with
industry representatives.
Background and approach Other challenges include the issue of deferred
members. The number of deferred members
The success of automatic enrolment has
have grown at twice the rate of active members
been to bring 10 million new people saving
resulting in engagement issues between
into a pension. With such a large number of
the member and provider (no longer able
new pension savers, new pension schemes
to communicate via the employer, email
have launched to meet the demand. The
and postal addresses change) and with no
majority of automatically enrolled savers are
further contributions, a lack of assets under
in master trusts pension schemes, many of
management (AUM) growth for the provider.
which have launched since 2012, changing
the landscape of pension provision in the UK. It is estimated that approximately £1bn has been
The regulatory regime has reacted by setting invested collectively by the largest automatic
out an authorisation procedure which master enrolment providers in setting up and running
trusts must undergo in order to be permitted their platforms. Even after 7 years and increases
to operate. to contribution rates, the charges generated
from the AUM may not be enough to cover the
Setting up a master trust is a capital-intensive
ongoing costs and pay off the outstanding debt
venture, requiring professional advisors,
on the start-up costs. Financial sustainability
systems for processing contributions, fund
remains a challenge in the automatic
management, administration and marketing.
enrolment industry, especially in light of
Some master trusts may be able to benefit from
further investment being required for known
infrastructures available through an existing
challenges such as improving infrastructure
parent company, other master trusts that start
and member portals responding to the current
from scratch face significant up-front costs for
pandemic, data quality, member engagement,
such required items.
pensions dashboards and transfer initiatives
but also for unknown future challenges such as
possible future regulatory change.
4 Financial sustainability of master trust pension schemesPENSIONS POLICY INSTITUTE
Roadmap of the report
This report examines the ways in which examines the ways in which the costs faced, and income
received, by automatic enrolment pension providers can affect their financial sustainability. Like all
PPI reports, this report does not offer policy recommendations.
Chapter One examines the automatic enrolment market including the growth in master trusts and
the process under which they are authorised to conduct business.
Chapter Two describes the expenditure involved in provision of a pension scheme and examines
the levels of transparency and existence of cross-subsidies within different charging structures.
Chapter Three describes the income to pension scheme providers, including charges and the role of
the scheme funder. It considers the relationship of charges to costs and examines the existence of
cross-subsidies within different charging structures.
Chapter Four uses PPI modelling to examine the effects of different charging structures on a
number of hypothetical schemes and show how charging structures and combinations of charging
structures can affect provider outcomes.
Chapter Five examines other challenges affecting the master trust industry as a whole, including
small pots and the impact of COVID-19.
Financial sustainability of master trust pension schemes 5PENSIONS POLICY INSTITUTE
Chapter One: Automatic
enrolment and the introduction
of master trusts
This chapter examines the automatic enrolment market including the growth in master
trusts and the process under which they are authorised to conduct business.
Automatic enrolment has led to a Since the introduction of automatic enrolment
rapid increase in pension savers, with in 2012 pension saving in the UK has grown
rapidly (Chart 1). With fewer people opting-out
more than 10 million enrolled since its
of automatic enrolment pension schemes than
introduction in 2012 expected,1 the number of pension scheme savers
Prior to automatic enrolment, around 40% exceeded the Government’s expectations.
of employees were saving in a pension
scheme. In order to increase pension savings
the Government, with cross party support,
introduced automatic enrolment in 2012.
Employers were compelled to make pension
provision for their employees and to enrol them
into an appropriate pension scheme unless the
employee actively asked to be withdrawn.
1 NAO (2015)
6 Financial sustainability of master trust pension schemesPENSIONS POLICY INSTITUTE
Chart 12
Automatic enrolment has brought millions of people into pension saving since 2012
Number of automatically enrolled pension scheme members (millions at 31 March of year)
12
10.1 10.3
10 9.5
Millions of people
7.7
8
6.1
6 5.2
4 3.2
2
0.3
0
2013 2014 2015 2016 2017 2018 2019 2020
Year
Employers who did not operate their own means that NEST could not refuse to serve any
pension scheme became required to enrol employer, whereas other providers can choose to
their employees into a pension scheme which decline employers if they don’t meet the size or
was suitable for the purpose, so they needed employee profile requirements of the provider,
a pension that was easy to implement. This however, some private sector providers also
meant that there was the prospect of millions adopt the policy of accepting all employers.
of employees saving in a pension scheme for
the first time and many employers, who had Master trusts set up by an existing
no experience in providing a pension scheme pension provider may benefit from
for their employees. This created a gap in the
existing administration and IT systems,
market for pension providers that the employers
could go to as a simple and cost effective
while master trusts set up from scratch
pension solution for their employees. generally face higher initial start-up costs
If the master trust has the backing of an existing
Master trusts have been created to meet pensions provider, then they may have access
this increased need for pension provision to an administration system and an IT platform
that can be used for the new business, reducing
The new boom in pension saving created a large
the start-up costs. They may also have a source
market for pension provision. This gap was
of initial funding without having to attract
filled by the growth of master trusts which offer
external investment. They may also be able to
the same pension scheme to many employers
market on the brand recognition of a trusted
and hope to take advantage of economies of
financial provider. Each of which could reduce
scale to keep their costs down. A master trust
the initial start-up costs.
as set out in legislation3 is a private sector
occupational pension scheme which is intended Other pension providers started to emerge as
to be used by multiple unconnected employers master trusts in the early days of automatic
to provide Defined Contribution benefits. enrolment. This included existing pension
Master trusts are controlled by a board of providers offering a master trust and new
trustees who have a fiduciary duty to operate in providers starting from scratch. Not all the new
the interest of the members of the scheme. master trust pension schemes were well financed,
leading to concerns about whether they would be
The Government set up the National
able to provide a robust and sustainable pension
Employment Savings Trust (NEST) as a master
scheme, this led to the Government implementing
trust pension scheme that would be available
a process which all master trusts have to undergo
to all employers should they wish to use it. This
in order to be authorised to operate.
2 TPR (2020)
3 Pension Schemes Act 2017
Financial sustainability of master trust pension schemes 7PENSIONS POLICY INSTITUTE
As a result of concerns about some Of the 90 master trusts operating before the
master trusts’ financial sustainability, introduction of the authorisation procedure
the Government introduced an 38 applied to The Pensions Regulator for
authorised status, of which 37 were granted and
authorisation regime 1 withdrew its application.5 The unauthorised
The rapid growth in the number of pension master trusts had to shut down and transfer
schemes entering the industry as master trusts and their assets. After the initial round of
concerns over the viability of the business models authorisations, a further master trust has been
of some of the master trusts and the resulting authorised bringing the current number of
impact on the schemes’ financial sustainability, led authorised master trusts in the UK to 38.
to the Government implementing an authorisation
procedure for master trusts to act as pension Following authorisation, the schemes are
providers. Authorisation may be able to increase subject to ongoing supervision where they must
the stability of master trust providers, this could demonstrate that they continue to meet the
benefit individuals, the staff of the master trust requirements of the authorisation procedure.
and improve trust in the pension system.
The greatest challenge to the financial
The authorisation process is performed by The
Pensions Regulator and involves demonstrating sustainability of master trusts is the need
that the master trust has appropriate people to cover initial start-up and running costs
and strategies in place to demonstrate that the until levels of membership and assets
scheme meets the authorisation criteria. The have grown sufficiently
authorisation criteria include:4
Running a master trust is an expensive
• Fit and proper individuals of honesty, integrity proposition; the scheme faces costs relating to the
and have knowledge appropriate to their role. ongoing administration of accounts, IT systems,
• Systems and processes (including IT) in legal and compliance, Investment management,
place to ensure the scheme can run efficiently marketing, data cleansing, regulatory fees, etc.
and has robust systems and processes to Many of these costs are initial start-up costs, or
effectively govern the scheme in accordance unrelated to the size of the pool of assets.
with all the relevant requirements.
• Continuity strategy that sets out to how The costs are recouped by charging the
members will be protected if there is a members a management charge on the assets/
triggering event and how a master trust may contributions, however in the beginning of a
be closed down or how the triggering event master trust’s life there may be very low levels of
will be resolved. assets or membership. This may mean that a cash
• Scheme funder which must be a body corporate injection is required from the scheme funder.
or partnership and only carry out activities The key problem to overcome when starting a
relating directly to the master trust. It must be master trust is that the scheme faces the costs
able to financially support the master trust. involved in setting up and running the master
• Financial sustainability the master trust needs trust immediately, but income is slow to arise to
to have enough financial support to ensure it cover these costs. The income from the scheme
can set up and operate on a day-to-day basis arises from charges made on the pension savings.
and to cover the costs subsequent to a triggering The charges received by the master trust are
event without increasing the cost to members. initially low for two reasons; it takes time to build
In particular, The Pensions Regulator wishes to up a membership base, and savings start at zero in
ensure that certain key roles in the master trust the pot and gradually build up. Charges that are
are filled appropriately. These include the: based on either the number of savers or the amount
• trustees, who are responsible for the running of savings (or both) are likely to start at a low level.
of the pension scheme in accordance with the In order to meet costs during the period before
trust deed and rules and in the best interests the scheme income is sufficient, the master trusts
of the members, will rely on financial support from other sources.
• the scheme funder, which is liable to provide This may be by borrowing with a repayment
funds to meet its running costs if charges are not schedule, and/or from a scheme funder who
sufficient or is entitled to receive profits where is liable to pay the balance of costs, in the early
the charges exceed the running costs, and years of operating, only making a profit after the
• the scheme strategist, who makes decisions assets have grown to such an extent as to exceed
about the business activities of the master the costs of running the scheme.
trust, they are responsible for the business
plan and the continuity strategy.
4 Adapted from TPR (2018)
5 TPR (2019)
8 Financial sustainability of master trust pension schemesPENSIONS POLICY INSTITUTE
Chapter Two: Ongoing costs to
master trust schemes
As discussed in Chapter One, operating a pension scheme for automatic enrolment
requires expenditure, this includes both initial outlay and operating costs. This Chapter
examines the expenditure facing a pension scheme; how that changes through the lifetime
of the scheme and what has been the aggregate cost to the master trust schemes since the
introduction of automatic enrolment. Then Chapter Three examines the income to the
schemes and we can compare the outgo to the income that the schemes receive in charges.
There are significant costs associated Master trusts set up by a parent company which
with setting up a new pension scheme is an existing pension provider may have an
advantage, if, for example, the parent company
It can be very expensive to launch a new master
already has infrastructure in place, has an
trust pension scheme that is authorised by The
existing and proven IT system which can be
Pensions Regulator. To run a pension scheme
modified to fit the needs of the master trust.
successfully, and to gain authorisation from
For example, insurance companies with group
The Pensions Regulator, the scheme must
personal pension business will have a lot of
have the practical elements of the scheme
the required infrastructure and expertise. The
already in place. These include the design of
result may be that it is easier and less expensive
the pension scheme, legal agreements with
for such an existing pension provider to enter
service providers, IT infrastructure, call centres
the market with master trust schemes than a
to answer queries from employers as well as
new master trust starting from scratch.
from members and robust administration
software to process contributions and monitor
pension funds. These can be very expensive but
Once a pension scheme has been set
must be in place before any members join the up, there are ongoing costs associated
pension scheme. with running the scheme
Securing the financing to meet these costs In addition to the initial costs associated with
can itself be expensive, requiring a marketing setting up and launching the pension scheme,
budget to appeal to potential investors, legal are the ongoing costs associated with the secure
services and a fully developed business plan. and robust running of the scheme. These are
The costs of undergoing and meeting the likely to be primarily the administration of
authorisation criteria may be a barrier to entry pensions, the maintenance and improvement of
to new master trust schemes if they are unable the systems and the marketing of the scheme.
to recoup those costs reasonably quickly.
Financial sustainability of master trust pension schemes 9PENSIONS POLICY INSTITUTE
Schemes with a greater proportion separately increasing the cost for the provider.
of pots belonging to deferred Being able to identify multiple pots owned by
the same individual can increase efficiency but
members may experience costs that
imposes a cost on the master trust.
are particularly high relative to their
assets under management Active pots are likely to be larger on average
than inactive pots:
Active pots are more continuously
administered because new contributions are • As a proportion of the size of the pot, inactive
regularly received and allocated, this may pots may then be more expensive to administer.
mean that active pots are more expensive to • Schemes with large numbers of deferred
administer. However, deferred pots present pension pots may therefore have high
their own administration issues, as a result of costs relative to the size of the money they
inefficiencies in administering multiple pots for are managing.
the same person or maintaining contact with an • Large schemes with more inactive pots may
individual without having a current employer face higher relative costs than smaller schemes
to provide contact information. with a larger proportion of active pots.
• As schemes mature they are likely to have
For example, consider an individual who has a
more and more deferred pots, for example
pension pot with “A2Z master trust” as a result
data from large master trusts suggest that the
of their employment. The individual then leaves
number of deferred pots is around the same
their employer and is no longer making any
as the number of active pots, and is growing.
pension contributions, the pension becomes an
inactive pot. They then start work with a new
employer in the same industry who also uses Master trusts’ annual expenditure
“A2Z master trust” as their pension provider. has been growing year on year, with
They could then be in a situation where they cumulative expenditure around £1
have an active and deferred pension with billion by 2019
the same provider, both being administered
Chart 26
Cumulative investment into the four largest master trusts may be at around £1bn by 2019
Annual costs of setting up and running the largest 4 master trust pension schemes (£millions)
£1,200
£1,000
£1,000
£200
£800
£800
£180
£millions
£620
£600 £140
£480
£370 £110
£400
£270 £100
£180 £90
£200 £110 £70
£60 £50
£30 £30
£0
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Year
Cumulative expenditure Annual expenditure
6 Calculations on the finances of the 4 largest master trust schemes from NOW: Pensions
10 Financial sustainability of master trust pension schemesPENSIONS POLICY INSTITUTE
Costs incurred to date are around £1billion Costs associated with running a master
(Chart 2), this includes money that has been trust will continue to grow
spent on setting up the IT infrastructure,
PPI modelling suggests that projected annual
ongoing expenditure on the running and
costs of master trust schemes are likely to
maintenance of the scheme, marketing the
increase in earnings terms (Chart 3). Sensitivity
scheme to employers, paying a levy to The
scenarios for higher and lower costs are also
Pensions Regulator and the financing of debt.
shown which assume ongoing administration
The results in this report rely on publicly
costs of around 25% higher or 25% lower than in
available data and discussion with industry
the baseline scenario.
on the reasonableness of assumptions made.
This results in the figures in this report being
illustrative approximations.
Chart 37
Costs of master trust schemes are increasing in earnings terms
Projection of costs of master trust schemes (£billions in 2020 earnings terms) under high, baseline
and low cost scenarios
1.4
1.2
master trust schemes (£billions)
Aggregate costs and charges of
1.0
0.8
0.6
0.4
0.2
-
2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035
Year
Baseline Costs Low Cost High Costs
There is a slight kink in the cost in 2025, this is However, much of the growth is due to the costs
as a result of the assumed introduction of the of investment management, which are linked to
automatic enrolment Review recommendation to the size of funds. As the fund’s build up through
lower the minimum age for automatic enrolment contributions and asset returns, the investment
from 22 to 18.8 This increases the costs because management’s charge increases proportionally
there are suddenly a cohort of new members, with it. The cost of servicing the pots may be
each with a newly active pot, increasing the more closely linked to the number of pots and
number of pots to be administered. the growth in earnings reflecting the salaries
paid to administration staff (Chart 4).
7 PPI modelling
8 DWP (2017)
Financial sustainability of master trust pension schemes 11PENSIONS POLICY INSTITUTE
Chart 49
Split of costs
Projection of costs of master trust schemes split by investment charges and scheme costs (£billions
in 2020 earnings terms)
1.2
schemes to the provider (£billions)
Aggregate costs and master trust
1.0
0.8
0.6
0.4
0.2
0.0
2019 2021 2023 2025 2027 2029 2031 2033 2035
Year
Scheme Costs Investment Costs
In the modelling it was assumed that fund Some schemes may face higher costs
management costs remain at the same percentage in the short-term as they ready their
of assets under management, despite the fact
data for the introduction of pension
that automatic enrolment assets are increasing
quite rapidly. It might otherwise be assumed dashboards, although data cleansing
that economies of scale may be achieved from exercises could reduce administrative
having larger sums invested, reducing the costs over the longer-term
investment management charge. In this case The pensions dashboard is intended to help
we are assuming that the savings are spent on people with their retirement planning by
more active management and a greater focus having their pensions information securely
on investment opportunities that benefit the online. This will require providers to have
environment but cost a little more to manage. data formatted to the specific requirements
These are the expected future costs, they of the dashboard, or dashboards and an IT
are simply due to the general running of the infrastructure to connect securely to pass the
scheme in the world as it is, however, new costs data through. There are therefore two distinct
could develop in the future. The master trust and separate sources of cost arising from the
industry is still in its relative infancy, regulation dashboard, the IT cost and the data cost.
is still developing, as the introduction of the Data received on each individual originates
authorisation process in 2015 exemplifies, with the data provided by the employer at the
further changes to regulation could introduce time they were an active member. The data
costs, and could lead to changes in the master on the master trust’s admin system can only
trust landscape. be as good as data provided by the employer.
Different employers will have different HR
and payroll management systems and may
therefore produce data with inconsistences,
making comparisons difficult. Master trusts
may also take a more active role in analysing
9 PPI modelling
12 Financial sustainability of master trust pension schemesPENSIONS POLICY INSTITUTE
the contributions they are sent, to ensure and in some cases consolidating the deferred
that employers are providing the correct pots could reduce inefficiencies and costs of
contributions on behalf of the members. administration. Some schemes already try to
match existing inactive pots with active pots
Clean data is a requirement for the proposed
when savers return to the scheme whether with
pensions dashboard, which will enable an
a different employer, or by returning to the
individual to find their pension information
same employer. This helps minimise the cost of
from different providers all in one place. It will
administration and can also reduce the charge
require that master trusts provide clean data to
to the member if their scheme has a flat-fee
the dashboard provider.
charge on each pot.
Data cleansing can be an expensive exercise
Members can also have multiple pots across
as it can be very labour intensive, but the
pension scheme providers. Consolidating
result of having undertaken the exercise
pots across providers requires an industry
may be to reduce costs in other aspects of the
initiative to match and exchange pots. There
administration.
is such an initiative called Member Exchange
that may address this form of cross provider
Consolidation of multiple pots duplication.10
belonging to a single member could
As in the case of preparing for the pensions
help to make master trust running
dashboards, clean and reliable data is essential
costs more efficient in performing a consolidation exercise.
The ongoing costs of the scheme are closely Preparing data for the dashboard may be an
linked to the number of pension pots that the opportunity for the master trust to consider
scheme is operating. If the scheme has a large whether they have any pension pots that can
number of pots, in particular inactive pots, be consolidated. It may be difficult to identify
which have less revenue growth potential, where multiple pots are owned by the same
the scheme may wish to take some action to individual. This makes it difficult to consolidate
mitigate the admin cost of the pots. It may pots appropriately. Care must also be taken to
be the case that some of the pots belong to ensure that the pots are not consolidated with
the same individual, matching the records incorrectly matched individuals.
10 PPI (2020)
Financial sustainability of master trust pension schemes 13PENSIONS POLICY INSTITUTE
Chapter Three: Charges on
master trust schemes
The master trust scheme requires income to cover the costs outlined in Chapter Two.
Income is received by making charges on the pension funds in its care. This Chapter
examines the mechanisms under which master trust schemes receive income and the
potential growth in charge income in the future.
There are five basic forms of charging • A single fund AMC with a flat-fee charge and
structures within master trust default a floor on the fund amount below which no
charges are taken (de minimis).
strategies:
• A single annual management charge The choice of what charging structure a master
(AMC) paid annually as a proportion of an trust implements may be based on the profile of
individual’s funds under management. It is their business, or as part of a strategy on how
paid every year until retirement, irrespective to handle cross-subsidies. A scheme that has
of whether contributions are still being made. a policy to accept all employers may prefer a
• A single fund AMC plus a flat-fee charge. different charging structure to one which has
This is an AMC with an additional flat-rate criteria for whom they accept as their members.
levy, irrespective of whether contributions For the avoidance of confusion, this report will
are still being made. use the following initialisations to refer to the
• A single fund AMC plus a percentage different elements of the overall charge:
contribution charge levied during the periods
when contributions are made. • Proportion of Fund Charge (PFC) to mean
• A variable fund AMC. This is an AMC that a charge (or the part of a charge) which
varies according to the total amount of funds is levied as a percentage of the fund
under management, with a higher percentage under management,
levied against smaller pots, reducing as
they grow.
14 Financial sustainability of master trust pension schemesPENSIONS POLICY INSTITUTE
• Proportion of Contribution Charge (PCC) to proportion of contribution charges, with an
mean a charge (or the part of a charge) which intention that the restrictions under each
is levied as a percentage of the contributions structure are equivalent. However, the various
made to the scheme, caps are not equal in most circumstances,
• Flat-Fee Charge (FFC) to mean a charge (or the equivalence depends on the amount of
the part of a charge) which is levied as a flat money in, and the contribution to, the pot.12 For
monetary amount irrespective of the amount example a combination charge.
of fund or contributions.
For shorthand the charge cap is often expressed
Automatic enrolment schemes can change their in terms of the cap that applies to the pure PFC
charging structure, perhaps at a particular variant, (0.75% of the fund a year), however, this
point in the life of their business when one may be less relevant as more schemes adopt
charging structure is more appropriate than combination charges. While the commonly
another. In the early stages of the master trust’s used shorthand expresses only the cap on
existence the funds held on behalf of members PFC schemes, the other charging variants are
are very low, they have not built up enough also capped.
for a pure PFC to provide a sufficient income
to pay the costs of the scheme. However, as the While the charge cap does not apply to
scheme assets increase, the PFC while staying members who make an active choice
at the same rate, becomes a much larger sum about investment strategy, because
of money, which could at some point allow the
scheme to rely solely on a PFC, and if the fund
99% of master trust members are in the
continues to grow, to eventually reduce the default strategy, it protects them from
charge rate. high charges that could erode the value
of their pension pots
Pension schemes that are used for Members who make an active choice to opt for
automatic enrolment are subject to a a strategy other than the default are not covered
charge cap by the cap; however, currently 99% of members
in automatic enrolment master trusts remain
The master trust recoups costs and provides
with the default strategy.13
a return on investment for the scheme funder
by levying charges on the fund assets, and/ Capping the charges is intended to protect the
or contributions into the pension scheme. scheme members from high charges that erode
However, they are subject to restrictions on the value of their pensions. It puts a limit on the
the amount of charges that may be applied income that the provider can obtain from the
to members. A full description of the current members, however, competitive pressures may
charge cap is set out in Appendix One. be more at play than strictly the charge cap.
Master trusts generally charge somewhat below
In 2015, the Government introduced a system
the level of the charge cap. There has been a
of capping on the charges that apply to
move to combination charges. Individuals who
pension schemes being offered to employees
are enrolled into a master trust now are very
as automatic enrolment schemes. This was to
likely to be in a scheme with a combination
ensure that members, who had not made an
charge, because 99% of employers who use
active choice to be entered into an automatic
master trust schemes are using one with a
enrolment scheme, were not burdened by
combination charge.14 Combination charges
high charges. The requirements specify
may enable providers to more quickly cover
the maximum charge that can be applied
the costs of providing a pension scheme where
to a pension fund under different charging
funds have not built up to such an extent
structures.11 The capped charging structures
that a pure PFC would be adequate to recoup
allow for charges in the form of proportion
the costs.
of fund charges, flat-fee charges and for
11 See Appendix One for charging cap description
12 PPI (2019a)
13 PPI (2019b)
14 Industry analysis by NOW: Pensions
Financial sustainability of master trust pension schemes 15PENSIONS POLICY INSTITUTE
PFC charging structures involve cross- they are covering their own costs and someone
subsidisation from members with else’s. On the other hand, if the smaller pots
are each charged the full cost of administration
larger pots to those with smaller pots
this could significantly hamper the build-up
Flat-rate PFC based charges take more money of new pots, and small inactive pots could
from larger pots in the scheme, but the cost of deplete to nothing. Hampering the build-up of
administrating larger pots is not significantly new pots could lead to individuals losing faith
more than to administer smaller pots. There is in the pension scheme and choosing to cease
a mismatch between the charges on the fund membership.
and the cost of managing it, this means that the
smaller pots are cross-subsidised by the larger The cross-subsidy may also be seen as a
funds. The smaller pots are being charged less public good, an aim of the policy of automatic
than the cost of administration, because the enrolment was to bring people into pension
larger pots are able to cover the cost. saving who had fallen through the cracks, this
includes people on low wages, those who move
These cross-subsidies help smaller jobs (creating deferred pension pots) who are
the type of people who may receive the benefit
pots to grow, which for active members
of the cross-subsidy.
can mean that they effectively cross-
subsidise their early years of lower As a pot increases and the PFC are larger in
monetary terms, this may be considered as the
relative charges as their pot size individual cross-subsidising their past self.
increases However, when members become inactive their
The argument, from the individuals’ point of pots do not grow to the extent that they can
view, as to how desirable this is, could be made achieve a cross-subsidy of their past self (Chart
on both sides. Cross-subsidies mean that one 5) in order to successfully cross subsidise their
party is losing out relative to another party, and own past, the member must have longevity in
the losing party may argue that it is not fair that the scheme to actually build up a large pot.
Chart 515
Long-standing active members can self subsidise their early years of loss
Cumulative surplus/loss of a median earner saving at automatic enrolment minimum rates with
an annual charge of 0.45% of fund (crossing the horizontal zero is when the individual’s cumulative
charges exceed cumulative costs) (2020 earnings terms)
£600.0
Cumulative profit/loss to the
£400.0
pension provider (£s)
£200.0
£0.0
-£200.0
2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035
Year
Active throughout Becomes inactive after Becomes inactive after
2 years saving 4 years saving
15 PPI modelling
16 Financial sustainability of master trust pension schemesPENSIONS POLICY INSTITUTE
Charging structures based on a flat-fee combined with other pots belonging to the same
or a combination of a proportional and member, either within the provider or as part
of a cross provider effort. These are considered
flat-fee may reduce the risk of large more deeply in a PPI report “Deferred
potholders transferring out of the scheme Pensioners, Defusing the pensions time bomb”.16
The cross-subsidy could put the scheme at
risk of specialist providers who advertise to As well as covering ongoing running
members who have accumulated large funds, costs, master trusts must ensure that
approaching such members with the promise charges levied on members can cover the
of a lower management charge if they transfer
their pot. By targeting existing large funds, the repayment of initial investment capital
specialist provider can take advantage of charge In order to meet the initial costs of the scheme
income from the larger fund without having the the master trust must obtain capital. If initial
period of losses while the fund builds up. capital is provided as a loan, then servicing of
The specialist provider can offer a lower fee that loan through regular repayment is required
because they only take the larger funds and as set out in the terms of the loan and is a cost
therefore do not have smaller funds to subsidise. to the scheme. These repayment cashflows also
The impact on a master trust scheme of a need to be met from future charges alongside
successful predatory approach like this to the the ongoing costs of the scheme.
larger pots of a provider would be to reduce the Being able to demonstrate a good return on
average pot size of the scheme, and thereby reduce capital will also be required in order to attract
the PFC income. Without having larger funds to further investment which the business needs
subsidise the smaller funds, the provider would in order to fund expansion of the business,
be put in a difficult financial situation, possibly marketing the business, or to pay for arising one-
requiring them to increase the charge level, or turn off expenses. One such one-off expense might be
to the scheme funder to cover the costs. ensuring that the business is fully able to provide
If the master trust were to use a charging cleaned appropriate data in the format required
structure that reduces the cross-subsidy, they for the pensions dashboard when it is released.
would be less susceptible to facing losses of For example, NEST operates a combination
members from a predatory provider, because charging structure where contributions are
having smaller pots that cover their own costs charged a PCC at a rate of 1.8% and funds under
mean that losing larger schemes would not management are charged a PFC at 0.3%. The
put the same financial strain on the provider contribution charge is intended to be used to pay off
in administering the remaining pots. Also, the loan received from the Government to start up
if the larger pots are not cross-subsidising the business, when that loan is repaid it is possible
the smaller ones, then they will not be being that NEST will drop the contribution charge.
charged high fees that another provider could
Two of the other larger master trusts also have
seek to undercut and they would not be such an
a combination charge, both of which have a PFC
attractive prospect to the predatory provider.
and an FFC. One of which also has rebate on
A charging structure that might reduce the cross- the PFC as the fund value increases, this would
subsidies is a combination of the proportional have the effect of reducing the cross-subsidy
fund charge and a flat-fee charge. This could take between larger and smaller pension schemes.
the form of a monetary charge, irrespective of
the size of the pot that is intended to more closely Cross subsidising employer charges
match the costs that arise in administering the
pot. The cost of administration of pots is not Master trust schemes may also have employer
likely to be proportional to the size of the pot, charges, these are charges payable by the
so the flat-fee may more closely match the cost, employer to cover the costs of setting up a new
with a variable element of the charge to cover the employer on the system, and/or monthly charge
investment management costs which are levied by on the scheme for the service provision. These
the investment manager as a PFC. charges may be negotiable, in which case they
The problem with an FFC is that it is unattractive might lead to cross subsidies occurring between
to members with smaller pots and may lead the members of the scheme and the employer.
to the smaller pots being depleted rapidly, The extent to which an employer chooses one
especially over the course of a long working life. scheme over another because of the charge
However, there may be some approaches to pot to themselves, rather than the charges to the
consolidation that could mitigate the impact employees as members may also lead to a form
by trying to ensure that small inactive pots are of cross subsidy of employees to employers.
16 PPI (2020)
Financial sustainability of master trust pension schemes 17PENSIONS POLICY INSTITUTE
Chapter Four: Projection of
the costs and income of the
master trusts
This chapter uses PPI modelling to examine the effects of different charging structures on
a number of hypothetical schemes and shows how charging structures and combinations
of charging structures can affect provider outcomes.
The master trust industry is unlikely under the baseline costs scenario. Thereafter
to achieve breakeven on costs until the industry may generate annual profits which
will accelerate as the funds under management
around 2025
grow (Chart 6). However, in reality there may
Following on from the costs projection in be some reduction in the profits as providers
Chapter Two, PPI modelling of charge income seek to achieve a competitive advantage by
suggests that the master trust industry is reducing their charges, while still having a
currently operating at a loss year on year and is large enough pool of assets under management
unlikely to achieve breakeven until around 2025 (AUM) to achieve a profit from the charges.
18 Financial sustainability of master trust pension schemesPENSIONS POLICY INSTITUTE
Chart 617
The master trust industry may be operating at a loss until the mid 2020s
Charges v cost of scheme under 0.45% proportion of fund charge
1.6
1.4
master trust schemes (£billions)
Aggregate costs and charges of
1.2
1.0
0.8
0.6
0.4
0.2
-
2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035
Year
Baseline Costs Low Costs High Costs Charge Income
Low charges on schemes with large AUM may The costs to the industry are currently higher
serve as a barrier to entry for new providers in than the charge income under the assumption
the future. Lower charges increases the time of an average charge income of 0.45% of the
until a new scheme achieves profitability. If fund value. Changing that assumption, to
the prevalent rates of charges fall, then new reflect a trend to combination charges (Chart
providers would have to balance offering 7), shows that charges could exceed costs under
competitive rates and having been able to either the combination charges of:
service the cost of their start-up expenses and
• 0.3% proportion of fund charge (PFC) and
achieve profitability over a reasonable time
flat-fee charge (FFC) of around £20, or
horizon.
• 0.3% PFC and a contribution charge of 2%.
17 PPI modelling
Financial sustainability of master trust pension schemes 19PENSIONS POLICY INSTITUTE
Chart 718
Moving to combination charges could lead to income exceeding costs
Aggregate costs compared to charges under scenario charging structures assumed for the
entire industry
1.6
schemes to the provider (£billions)
1.4
Aggregate costs of master trust
1.2
1.0
0.8
0.6
0.4
0.2
-
2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035
Year
Baseline Costs 0.45% PFC 0.3% PFC + 2% PCC 0.3% PFC + £20 FFC
Different charging structures can affect members in 2019, their first year of operation,
sustainability for individual schemes to having around 60,000 members by 2035, at
which point a quarter of them are active. Their
At the provider level, the choice of an
active members earn on average at the median
appropriate charging structure might be based
level and make contributions at 8% of salary,
on the profile of the scheme itself, a large fund
leading to an average contribution of around
can sustain a PFC, however a scheme starting
£2,000 a year per member. The outcomes for
out may wish to use a combination charge of a
payback and subsequent profitability may
lower PFC, and either an FFC or a proportion of
be different depending on the approach the
contribution charge (PCC).
scheme takes to charging (Chart 8).
As a simple example, to understand the
interactions of costs and charges, consider a
new provider with £1million in start-up costs.
The scheme grows from 5,000 new active
18 PPI modelling
20 Financial sustainability of master trust pension schemesPENSIONS POLICY INSTITUTE
Chart 819
Combination charges may allow a scheme to break even sooner
Cumulative surplus/loss for a new scheme under different charging structures (crossing the
horizontal zero is when the scheme breaks even) (2020 earnings terms)
£10.0
£8.0
Cumulative profit/loss to the
pension provider (£millions)
£6.0
£4.0
£2.0
£0.0
-£2.0
-£4.0
Start 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035
cost
0.45%PFC 0.3%PFC + 2%PCC 0.3%PFC + £20FFC
The combination charge approaches can pay are levied as a proportion of fund. This is an
back the investment more quickly, taking approach that aims to reduce cross-subsidies
just over three years for the PFC and PCC and to target the charges in a way that reflects
combination charge to generate enough profits the costs of the scheme.
to pay back the initial £1million investment.
The PFC approach takes longer to payback the
The fastest repayment is under the combination initial expenses. The scheme must wait until
PFC and PCC, in this example. In the early the funds are large enough for a 0.45% fee to be
stages of the pension fund, each new year’s of significant value. However thereafter, as the
worth of contributions are a significant fund size continues to increase, the proportion
proportion of the fund. For example, in the of fund approach should generate higher
first year, the entire fund is from contributions returns than the two combination approaches.
received in that year, such that a 2% PCC is When the fund is large enough, the pure PFC
closely equivalent to a 2% PFC. This enables may produce income which is larger than the
the PCC approach to pay off the initial expense other two approaches, which can be seen from
relatively quickly, however in later years, as the the steeper and faster increasing slope upward
funds have grown, the PFC element becomes of the PFC line (Chart 8).
dominant. This is the approach used by NEST
The choice of charging structure may also
to pay off the government loan that was used to
reflect the relative maturity or profile of
set up NEST.
membership of the scheme. Consider the same
In this hypothetical provider, under the hypothetical scheme as above, with £1million in
combination charge with a proportion of start-up costs, the scheme grows from 5,000 new
fund charge and flat-fee charge, each fund is active members in their first year of operation to
charged enough through the FFC to cover the having around 60,000 pots by 2035. However, in
average ongoing cost within this hypothetical this case we run scenarios where the proportion
provider. The PFC cover the repayment of the of active to deferred pots vary. The three
initial expenses and the investment costs which, scenarios are, set out in Table 1.
19 PPI modelling
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