Is it good enough that pension schemes can operate without ANY capital adequacy requirements
To be clear what I mean “capital adequacy” is a measure used in finance to gauge an organisations capacity to withstand a cash call. If there is no capital behind a pension provider, then when something goes wrong, the provider must have recourse to some kind of bail-out. Bail-outs come from banks, from competitors and , in the last resort, from the taxman via the Regulator.
In NEST we trust
The attraction of NEST – above any scheme, is that it is backed by all of us. It is the Government scheme, it is too big to fail and while NEST is not required to hold reserves, it has recourse to a big fat Government loan against which it can draw down- we can trust NEST.
And this lot are pretty sound too..
Below NEST in the pecking order of trustability are a range of master trusts that are backed by strong covenants from their operators. NOW, through its Danish parent ADP has final recourse to the Danish Government’s money while the People’s Pension is backed by a financially secure insurance company B&CE. Other insurers that offer mastertrusts include Zurich, Legal & General, Friends Life, Black Rock and Standard Life.
There are an increasing number of master trusts run by solid pension consultancies such as Mercer, Willis Towers Watson, Aon and Capita. The reputations of these advisers hang on the line with the trusts they manage, I would have no problem as a private investor, with any of these organisations managing funds, not least because they know the traps to avoid.
But there are chancers…
The further down the ladder you descend, the greater the risk you take with your pension. Many of the rivals to my company, offer mastertrusts. This worries us as we don’t consider it our job to manage other’s money (we are advisers not providers) and we don’t feel we have the reserves to meet the particular challenges of something big going wrong from our own reserves.
Indeed, were we (First Actuarial) to properly reserve to provide equivalent security to what can be purchased from a NEST or Legal & General, our costs would shoot up and either members, shareholders or advisory customers would suffer.
When you invest with under-capitalised master-trusts, you are taking a chance. When you do this on behalf of your staff, you are taking a big chance and when you advise clients to invest in chancey pensions you are taking a bigger chance still.
Well meaning?
I have no doubt that most of the operators of small master trusts back themselves as entrepreneurs do. They don’t see themselves as chancers. That is another part of the problem.
But while most entrepreneurs are well-meaning, some aren’t. There is a small group of financial fraudsters at large in Britain who see mastertrusts as an opportunity to steal money and pensions as a water main of money that can be tapped at will.
Frankly , whether an operator meant to lose your money or not , is immaterial to the person who has lost out, unless they have a way of getting back their money- it’s a catastrophe either way.
What’s to be done?
The Regulator’s current stance is that “God is on the side of the big battalions”. So long as a master trust has enough cash to pay to get (and keep) the Master Trust Assurance Framework) – it gets a place on the Regulator’s website as workplace pension. MAF is being used as a proxy for capital adequacy and it would be deeply embarrassing if a master trust ran out of money because it prioritised paying its “MAF bill” above those of other creditors!
I don’t think that MAF is a proper proxy for financial strength. There are proper agencies that stress test the capacity of providers to meet the hard times- AKG being the most notable.
What is needed is an early warning system for employers and Regulators alike, that highlights financial weakness. There isn’t one and that too is a worry. As yesterday’s blog suggested, it is in the DNA of trustees not to expose fraud or simple incompetence among service providers. There is a conspiracy of silence that leads to problems being spoken about “within the industry” until a scandal breaks. This is usually justified by some statement to the effect that “we didn’t want to undermine confidence in the provider”.
Honesty is the best policy
I believe in honesty , transparency and in telling things like they are. This blog has often been criticised for doing just that and I would remind all readers that the views I express are my views and mine only.
I guess I get read because people feel comfortable that I am writing with some authority and some perspicacity (aka insight).
Sometimes I get it wrong and sometimes I have to change my blog when i do (and apologise). But I continue to speak out on matters such as the capacity of mastertrusts to meet unexpected bills, largely because so few people are asking Jo’s question.
Thanks for reading!
Yes, the smaller master trusts are a concern not just because of possible governance concerns but also because they are less likely to have the volumes to be financially viable which could then lead to short cuts being taken. The outcome of the budget will be crucial not just to these schemes but the less efficient established players.
Henry sometimes honesty comes at a price but keep going. On this one I am very much in agreement, I have openly said NEST should may be considered as the default even to the point nationalising it. My gut sense tells me two things. Commercial profitability for many just is not a reality so lets hope consolidation happens before the car crash. And as worrying, if not more, how rife is fraud in the AE space. I think those in power are more aware than us on the ground.
Thanks Chris and Damian
I have to say NEST feels like a nationalised organisation to me! But they only have around 30% of current decision making which suggests that either people are taking informed or uninformed choices- which of course is an “employer duty”.
Good Morning Henry,
As so often you are able to highlight real genuine issues with clarity. At previous industry events I have asked questions about what will happen if a master trust goes wrong, due to misjudgement, error, bad luck, i.e. how many advisers recommending a Master Trust vehicle actually check out the terms for exit, in both good and bad times. Let’s roll on ten years and XYZ master trust has successfully built a fund with £XXm’s, but for some reason a few Employers, or their employees decide they want to put future contributions into a better managed or performing master trust. Why would you leave existing assets in a poor performing trust. Common sense would mean that a bulk transfer may be requested by an Employer, or individual members may wish to transfer their pots. Once a small number start to move out, others will follow, to the point where there will be a run. The Master Trustees will put a halt to transfers, and the remaining assets will be exposed to ever increasing expenses, until the Pensions Regulator steps in to engineer a merger with a better performing Trust.
The members of both trusts suffer!
This has happened in the past with Building Societies, Banks and Insurance Companies. It is just a matter of time.
The Pensions Regulator will in my view have to treat commercial Master Trusts as Insurance Companies, or Investment Managers. [“Commercial” in my view is where there is no industry logic for the Trust, it is there mainly for the sponsors to generate an income stream (akin to hedge fund managers taking 20% of investment gains)]. The current financial service compensation limit dropped as of 1 January this year to £75,000, and whilst this may be adequate for the majority of Auto enrolled employees over the next ten years it is clearly not viable over the long term when the government is trying to encourage retirement savings of up to £1million!