UK: Super trusts – how they work
Gail Moss takes the NAPF's super trust idea and runs an international comparison
The rapid decline of DB schemes and their closing even to existing members, together with the arrival of auto-enrolment, will bring unprecedented numbers of people into DC schemes within the UK.
But given the lack of an established DC culture, will these schemes be able to deliver what individuals need for their retirement?
The National Association of Pension Funds (NAPF) has been asking this question in an effort to kick-start debate over the best template for future DC savings.
According to NAPF chairman Mark Hyde-Harrison, the current retail environment suffers from high costs, little alignment between provider and scheme member, and poor governance, among other problems.
The NAPF's solution is the introduction of super trusts - large-scale schemes offering good reach, good governance and potential economies of scale. These would still be provided through the workplace, which the NAPF believes is the most effective conduit for members to build up retirement savings.
Super trusts are large not-for-profit multi-employer schemes which could be offered on a regional, sectoral or national basis. Their huge size means they can keep costs low, while having the resources to provide high-quality investment management, administration and communications. They also allow employers to focus on their core business without having to worry about the complexities of running a pension fund.
The NAPF suggests up to ten super trusts should be established in the UK, replacing the 42,000 schemes currently in existence. It says that these trusts could each run up to £20bn-worth (€25.5bn) of money, operating at around 40bps.
These trusts would be managed by expert boards of trustees obliged to put members' interests first and to hold providers to account, while ensuring employers give schemes proper support.
The super trusts would run alongside NEST and offer employers more choice. They would operate in a similar way, but with less direct government involvement. As they would be built around auto-enrolment, super trusts would achieve high levels of coverage, especially for those on low or modest incomes.
They would be regulated by the Pensions Regulator, who would authorise entities wishing to run them, such as existing multi-employer schemes, trade associations and affinity organisations. The regulator would also approve trustee appointments.
The NAPF's proposals also include greater risk-sharing between employer and employee than standard DC schemes. This could be achieved in a number of ways, such as guarantees on annuities or investment.
And, says the NAPF, the sheer size of super trusts would allow dynamic investment strategies to minimise both downside risk and the prospect of extreme outperformance.
One problem is that DC schemes place more risk with the member than DB schemes.
The NAPF says super trusts should provide a system of governance to help members make the best decisions on contribution levels and investment choices. However, a mandatory framework needs to be established by the government.
A pioneer of the super trust model has been Australia, where the shift from DB to DC is more advanced than in the UK.
Private sector occupational pension provision is split three ways, between company schemes, industry funds (around 60 of these) and 140 or so master trusts. The two latter segments account for 30% and 40% respectively of the total assets in the industry, though industry funds have the most members.
Industry funds are not-for-profit multi-employer funds set up by unions and employers' associations, the largest being Australian Super, which has 1.8m members and A$42bn (€36bn) of assets under management.
Master trusts are similarly-sized funds for employers and individuals, available from banks, insurance companies and other institutions, and run on a for-profit basis.
Both types of offering have features similar to those proposed by the NAPF in the UK.
They are run by trusts licensed by the Australian Prudential Regulation Authority (APRA), buying in administration, investment and insurance cover on a wholesale basis, often more cheaply than company funds, because of their size.
For instance Mercer Super Trust, the largest of its type with 241,000 members, says its investment costs are only about 35 bps, compared with double that for a medium-sized corporate plan. Mercer Growth, the most popular of its funds out of 50-plus investment options available, has earned 4.9% pa for the ten years to 30 June 2012, although the average for the past five years has been 1.0% pa.
The Aon Master Trust has 58,000 members, 600 participating employers, and over A$2bn in assets. "Many of our costs, for instance for regulation, are fixed, so the more members we have, the better," says Mike Murphy, partner and senior actuary at Aon Hewitt.
While master trusts tend to offer more flexibility and choice than industry funds - for instance, Aon Master Trust offers 35 investment profiles, from 100% equities to 100% cash, and from low-cost index funds to more expensive actively-managed products - industry funds are catching up, typically offering 10 to 15 investment choices.
However, more flexibility and choice sometimes comes at a higher cost for master trusts. But as industry funds have also started to offer more investment and insurance options to members, their charges have risen, says Murphy.
"One advantage of the industry funds approach is that they can offer members within each fund a similar insurance product and premiums, which are appropriate because they are in the same industry," says Murphy. "Master trusts cater for members in many different industries, so we do not standardise products to the same extent, and therefore cannot save so much on costs, although greater benefit flexibility and insurance premium savings can be gained by employers, particularly in occupations with lower risks."
Another drawback for master trusts is that employers can - and sometimes do - move their scheme to another trust, or an industry fund.
"This is a real issue for master trusts wanting to maximise long-term returns, because it inhibits their ability to invest in long-term, illiquid assets," says Murphy. "In contrast, industry funds have in the past enjoyed more stable cash inflows because employers and unions have felt more bound to them, due to their preferred-fund status in union-regulated employment agreements. This status is currently the subject of much debate in the light of further changes in 2013 which may open up preferred-fund status to any APRA-authorised fund."
In Denmark, commercial pension companies providing schemes for single companies serve half the country's 2.7m workforce. The other half is covered by pension funds based on collective agreements between unions and employers; these schemes operate in a similar way to super trusts.
Denmark has an extremely flexible labour market, with frequent changes of job the norm.
"The main benefit of these multi-industry schemes is that members are able to change jobs without changing their pension plan or insurance coverage for events like death, disability or critical illness," says Jens-Christian Stougaard, director at PensionDanmark, an occupational pension fund with 600,000 white- and blue-collar members. "And of course, these schemes offer a different kind of security from DB schemes, since the savings are placed in individual accounts within the fund."
PensionDanmark has also been able to achieve economies of scale because the wage structures are similar across its membership.
"We can provide companies with efficient platforms for paying in the pension contributions, and members with a number of different choices within the same product framework - for example, they can invest up to half their portfolio in a broad range of investment funds and make changes to their insurance coverage," says Stougaard. "It's somewhat like an off-the-peg suit that can be altered in different ways. This means the modular costs of adding extra members are very low, mainly due to a strong focus on digitalisation of all workflow. But if the products were complicated, economies of scale would be limited or much more difficult to achieve."
The fund's administration costs per member for 2012 are around €55, or 22bp.
All members, whatever their age, pay the same level of premiums for the same level of cover.
"This means that some younger members will pay a little more, and some elderly members a little less, than if there were age-related tariffs," says Stougaard. "Some would refer to this as a drawback in the system, but it makes it easier to communicate with members about products and services. And the differences are evened out over their working lives."
One of the clear advantages of these massive funds is the ability to reduce asset management costs, says Laila Mortensen, chief executive, Industriens Pension, a scheme with 390,000 blue-collar members from 9,000 companies.
"You can also employ enough people in-house with specific levels of competence to run the business on a sound basis, besides creating an IT system to deal with changes in regulation and other developments," she adds.
In 2010, Industriens Pension merged with two pension companies covering 50,000 members, without the need to recruit more staff.
"We were able to achieve economies of scale because we had the IT," says Mortensen. "It was also possible because we could provide both new and existing members with virtually the same product, therefore merging the pension benefit system."
Average admin costs per scheme member are under 400DKK (€54) per year, making it one of the most affordable schemes in Denmark, according to Mortensen: "This is because it is a simple scheme with mandatory membership, few options, and a modern IT platform."
Industriens Pension is a private limited company whose shareholders - the working parties - appoint the board of directors; the board includes representatives from the working parties, unions and business. Danish law requires a two-tier governance system, so there is also a management board running day-to-day operations.
In contrast with a single-company scheme, the working parties are the ultimate ruling body, with power to make changes in the collective agreement. More minor changes in the scheme's rules can be made by the board of directors.
Mortensen says the board's ability to adjust the scheme's regulation makes it easier to maintain the same, fairly simple, product for all members, keeping administration costs low and the IT system sharp.
"It also helps in communicating with members, since they can log onto their own personal site to track their pension contributions, returns and insurance coverage," she says.
The management board invests on a long-term basis, with a life cycle overlay on individual portfolios. Average returns were 8.7% per year from inception in 1993 to 2011, although the average for the last ten years has been 8.1%.
"We do not have to consider short-term factors, as we are not competing for new customers every day," says Mortensen. "So we have been able to take a long term investment approach, which has contributed to these high returns over time."