Capital adequacy rules could ensure master trust providers have enough money if they go bust. James Phillips explores if it is the best way to protect members
Master trusts have come under a lot of scrutiny over fears some may not be sustainable and could end up having to be wound up.
The Department for Work and Pensions (DWP) is reportedly mulling requiring master trusts to demonstrate capital adequacy in order to be approved.
Its discussions with the industry have reportedly pitted the proposed rules as an alternative to a lifeboat fund, such as the Pension Protection Fund (PPF), which protects defined benefit (DB) members when sponsors fail.
The requirement is expected to be introduced in the upcoming Pensions Bill this autumn, but would members be better protected?
A grandfather approach
Capital adequacy would ensure master trust providers have enough funds to cover wind-up costs if they are forced to close, providing better protection for members without being charged for a lifeboat fund.
Dalriada trustee Sean Browes says the requirement is sensible.
He says: "Fundamentally, if newly established master trusts go belly up, members might lose out because the cost of unravelling the trusts needs to come from the assets. So, capital adequacy does make a lot of sense."
PTL managing director Richard Butcher adds it should be phased in alongside a temporary lifeboat fund to ensure existing master trust members are not pushed into difficult positions.
"Capital adequacy is a good idea, providing it's done prospectively rather than reactively," he says. "If you insist on capital adequacy, those sponsors likely to get into trouble will pull the plug now so you end up causing the problem you are trying to avoid.
"The only way around that is to grandfather it in; we'll have capital adequacy at a trivial level in year one, at a less trivial level in year, and so on.
"Then we have a time-limited life boat fund for the current generation of master trusts, which would be funded by the government. This will bail out master trusts that collapse while they grandfather in capital adequacy. That way, everyone is protected."
NOW: Pensions director of policy Adrian Boulding agrees, stating that if a master trust is forced to wind up due to the new rules, it is the government's fault for allowing a fairly unregulated market in the first place.
Master trusts can be set up with little oversight, with checks only taking place when they apply to HM Revenue and Customs for tax relief. However, these checks do not include auditing the trust's financial position, potentially risking members' money. Furthermore, additional accreditation, such as the master trust assurance framework, is voluntary.
Boulding says: "There has been a failure on the part of government, which has allowed some master trusts into the marketplace, which would not have got a licence if we had proper safeguards.
"If there is a cost to winding them up, the government should pay for that."
"But, there needs to be a window during which a master trust can apply for a licence, and if they cannot satisfy The Pensions Regulator (TPR) they merit a licence, then TPR needs to begin winding them up."
Barrier to entry
However, the requirements could reduce competition, with most master trusts in the hands of cash-rich providers.
Butcher argues this will ensure members are always adequately protected, and is better than having a PPF-style lifeboat fund. He says: "With a lifeboat fund you create a moral hazard risk. Those sponsors who are not sure if they can pay say it doesn't matter because someone is going to stand behind them anyway, so they can gamble. With capital adequacy, you've got to come up with some cash in advance.
"It acts as a barrier to entry to less financially stable providers, and it also offers protection. It is a much safer option for members. If providers know they have to provide capital adequacy, they can build that into their financial model."
But Browes believes this could make it harder for competent smaller providers to enter the market, simply because they have not been able to build up the necessary funds.
He says: "If you have capital adequacy, you are then creating a barrier to entry, because master trusts will come from well-established, cash-rich companies able to underwrite the costs. Is that fair for new players in the market that don't have that cash reserve? Do you want to put up barriers to entry and stop fair competition?"
Boulding says although the requirement would reduce the amount of choice for employers, it will not limit the market too much.
"That's a sensible price to pay, so we don't get fly-by-night cowboys that think AE is an opportunity to get rich quick. The remaining level of choice will still provide plenty of choice for employers to choose from."
Protection for members
Nevertheless, capital adequacy would ensure members are properly protected, without being charged for that protection.
Butcher says this is particularly important as most members of master trusts have been auto-enrolled into the pension, with small contributions of just 1% at present, so paying a levy for a lifeboat fund would be unfair.
He says: "It's about auto-enrolment (AE). If you were taking out a personal pension plan, you'd look at the provider and consider if they are sustainable. With AE, you are not going through that process. There's no sense check on the part of the member. You have to have this protection of capital adequacy or you might auto-enrol people into pension schemes which aren't sustainable."
Boulding agrees, arguing the industry needs to ensure all master trusts are made as safe as possible.
"They believe their pension savings are safe. They believe their employers have gone out and chosen a master trust run by professionals. We do need to tighten up on this, to make sure it is not just the majority of master trusts where this is the case, but all master trusts.
"We as an industry owe it to them."
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