How do we pay for pensions?
We still know too little about what we are paying for pensions.
The following statement appears on Standard Life’s website
Employers can be confident that their schemes will all be compliant with the charge cap by April 2015. All new schemes including our 6 minute Good to Go solution for AE are now priced at 75bps or less.
This is very cleverly worded but doesn’t say very much.
It doesn’t tell us what people are really paying, it tells you what contracts are priced at. Anyone who knows anything about financial services knows that what the price says and what you pay are not the same thing.
How do master trust service suppliers get paid?
Mastertrusts have lots of mouths to feed. They have to pay for funds, administrators, lawyers, marketeers, technology suppliers and for trustees.
Let’s suppose for instance that I am the trustee of a master trust. How do I get paid?
Option one; I bill my service to the operators of the master trust who meet my bill from the revenues generated by 0.75%.
Option two; I bill the member’s funds directly (either taking the money before it is invested or actually taking the money from the member’s funds).
Amazingly, both options are legal.
That is because the DWP still have not clarified what charges can be regarded as fund expenses (and are hidden) and what charges are met from the AMC (and are declared).
Why is this important?
Insurance companies have to keep a reserve for meeting unexpected expenses. This is required by the FCA and it’s also needed to meet EU solvency rules. In addition, if there was a failure, members are protected (where insurance is in place) by the Financial Services Compensation Scheme.
Most mastertrusts are not run by insurance companies and do not have to reserve. Many do, because they are run as prudent businesses. But some don’t.
For the mastertrusts which do not keep reserves there is no lifeboat. If they run out of money and cannot pay their bills, they are trading insolvently. Creditors, including trustees who have unpaid bills either have to get in the queue or try option two.
But option two is very dangerous. The more bills are charged to the fund , the lower the fund’s return to members, quickly it becomes apparent- especially where the market is trying to track a market – that there is a difference between the fund’s performance and the performance of the index (known as the tracking error).
Even more dangerous is when bills are paid from available cashflow in the fund. The only available cashflow in a DC pension fund (now that short service refunds are banned), is from inbound contributions. Taking money out of contributions (before investment) is a very dodgy practice and may well be the start of a slippery slope.
If the people managing the master trust run out of money, the temptation to use hidden charges or even to raid contributions can be too great.
Why controls need to be put in place.
The master trust assurance framework, in place at NOW and Peoples Pension (and on its way at NEST), is designed to provide these controls. We want all master trusts to have the controls in place to stop suppliers raiding member pensions and we want the master trust assurance framework universally in place.
Where these controls aren’t in place and where we can’t be sure (as we can with NEST) that there is money to pay the bills. We will not allow a master trust to be advertised on http://www.pensionplaypen.com.
We are constantly reviewing the financial solvency of the providers on our platform and use the services of rating agencies such as AKG to properly understand the likelihood of a master trust running out of money.
What happens when a master trust declares itself insolvent?
The short answer is that until it happens, we don’t know. However an eminent lawyer (Duncan Buchanan) has speculated in an excellent article in Pensions Expert.
Unless, and until, legislation requires mastertrusts to adopt discontinuance plans, members will be at risk that on a wind up of the trust, administration costs would have to be deducted from their savings.
He too points out that the independent assurance framework for mastertrusts developed by the Institute of Chartered Accountants recognises the potential problem, and requires mastertrusts seeking an assurance report to adopt formal discontinuance plans that address how members’ savings are to be safeguarded in the event of it failing.
But it won’t be Peoples or NOW who will be discontinuing. It will be the master trust that no-one has heard of, other than the employers who have signed a deed of participation – typically as part of staging auto-enrolment.
What can be done about this?
Firstly, the DWP must clarify what is legal and what is not legal when it comes to charging services to member’s funds (rather than to the provider). We would like a more inclusive definition for the AMC which allows as few expenses as possible to be borne by members outside the AMC
Secondly , we want to see the master trust universally in place
Thirdly, where the master trust assurance framework isn’t in place, we want much stronger reporting from the providers of workplace pensions qualifying for auto-enrolment. The reporting should be to the Pensions Regulator and should ensure that alarm bells are rung with participating employers well in advance of the money running out.
It should not be down to organisations such as http://www.pensionplaypen.com to be saying these things and to be acting as an unpaid policeman. Auto-enrolment is an important Government project. If we get a provider failure, there will need to be a bail-out.
We should not have to wait till that happens. We should be doing something about this now. The steps we have suggested should be in place, in law at the latest by April 2016.