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ADMINISTRATION, pensioner payroll, accounting, auditing, treasury functions, communications, group risk and insurance. Flexible benefits, web design and build, scheme management and secretarial functions. Actuarial work, legal work, consultancy advice, investment management and even trusteeship can, and are, being outsourced by pension schemes today.

The questions is no longer whether outsourcing is a viable option for schemes, but whether there is any facet of pensions that should remain in-house. And this can only be considered in light of the risks and benefits brought by outsourcing.

The benefits
The 2001 independent Myners Report advised pension trustees to delegate (outsource) any facets of the scheme they did not have expertise in, and the subsequent trustee knowledge and understanding regulations have made outsourcing not only acceptable but widespread as trustees seek to protect and unburden themselves, yet ensure a professional service, reduce risk and – preferably – cut costs.

Although cost-cutting should not be the sole factor for making the switch from in-house to outsourcing, it is still often a prime motivator.

MNPA’s head of client management Geraldine Brassett explains: “Cost is rarely the only objective but if it is, then it is more around cost control and cost certainty. Often third party administrators quote fixed fees around certain parameters so companies can budget better. There is also a lot of benefit in sharing in someone else’s expensive internal control certificate, such as the ARF 106.”

Mercer HR Consulting principal Robert Plumb says: “I do not think many schemes make a decision purely based on the price of the outsource service offered, but you do need to be clear with the provider what your requirements are and what exactly they would be inheriting.

“If there is clarity on both points then you would be in a better position to differentiate between providers, rather than just choosing the one who has given the lowest cost estimate. If you do not have much of a tendering document then you will not have much else to choose on but the cost!”

Brassett adds: “If you do not get the relationship right and the objectives and expectations clear at the outset, then the implementation will of course be affected.

“Outsourcing is driven by a scheme’s current problems. If there are any issues they want to resolve they can be candid about that during the tender. The main trend is that every scheme wants a good, compliant, reliable, member-focused service they can trust. Anything else is in addition to that.”

This clarity of expectations and objectives for both the outsource provider and scheme trustees can be encapsulated in a standard service level agreement (SLA) which outlines what services will be provided, how any additional agreements will be decided upon, and highlights the objectives and expectations of both parties. Standard SLAs have long been used by administrators but could migrate to cover other outsource areas.

Aon Consulting’s client director for outsourcing Ian Bloxham, says: “Administration, consulting and actuarial services have been outsourced for a long while but we are now seeing a trend towards schemes getting rid of any non-core activity from the company, driving down costs and outsourcing it.

“One of the big benefits is cost control and the transfer of risk. Typically the pension function is quite small, so there is little career progression for the in-house pensions team. If you align this with the fact systems need upgrading every few years, and if there is an error it will be the company rather than an outsourcing provider who pays for it – and there is immediately a swathe of potential benefits to outsourcing.”

Bloxham adds: “Clarity at the outset is absolutely imperative. Unless you totally understand what is expected from the whole outsourcing experience, it can be a disappointment on both sides because we could be setting up something that does not meet requirements. A warts-and-all conversation upfront about current frustrations, how things have operated, how the benefits of outsourcing translates into a service delivery model, is critical at the outset.”

As Bloxham says, the migration away from an in-house pensions team has been instigated as member-nominated trustees become over-burdened in their role and have sought to outsource less traditional areas, such as scheme management and secretarial work, which includes organising trustee meetings, preparing documents, gaining input from various advisers, recording minutes and producing output documents.

HS Admin’s managing director Mark Adamson says: “It is not common yet but we do have some medium-sized schemes [2000-3000 members] who do not feel they can support their own in-house pensions manager, or do not want to have to recruit, train and maintain a person in that role, so outsource that responsibility to us too.

“That involves coordinating with the administrator, the actuary, the lawyer, the in-house finance director, human resources team and managing budgets. This really has the opportunity to stop schemes worrying about these kinds of areas and still fulfill their obligations and get a professional and effective service, hopefully at a reasonable price.”

The burden of new regulations, principally trustee knowledge and understanding, has also contributed to a flourishing multi-manager market, which experienced a three-fold increase in assets managed, from $6.8bn (£3.8bn) in 2002 to $22.7bn (£12.7bn) in 2004.

SEI’s head of UK institutional sales Francis Ellison told PP: “Manager-of-manager funds are basically an outsourcing solution. You give us the job of finding the best manager in each field and in so doing, you save a lot of the trustees’ resources and give the job to people who do this day-by-day, not once a quarter or so.”

Russell Investment Group’s managing director of clients service (institutional investor services) John Stannard says outsourcing investment management offers schemes greater governance, performance reporting, access to specialist fund managers and benefits of economies of scale.

Stannard says: “Small to medium schemes have little time to focus on the governance of the funds. By outsourcing, trustees meet their fiduciary responsibility and regulations, and give a specialist responsibility for selecting, monitoring and changing managers.”

Stannard says the process of switching failing fund managers for stronger performing managers can take up to 18 months with voluntary trustees, while multi-managers can make such pressing decisions within weeks, slashing the scheme’s potential losses under that manager.

Stannard adds: “Through outsourcing you can access the resources of a third party’s analytical research and market analysis, which is integral in deciding how to allocate your investments. You can also access some far-reaching assets, such as Japanese equities.”

In the last year, Russell Investment Group has researched around 9000 managers and has a team of 70 staff located around the world. This economy of scale allows them to not only cherry-pick the best fund managers of each specialist strategy or asset area, but also incorporate added value areas such as com-mission recapture, transition management and offering foreign exchange rates – traditional domains of multinational custodian banks.

As the lines blur between service providers and what “added value” functions they can offer, one firm is taking outsourcing to the next logical stage: Off-shoring.

Hewitt Associates launched their first offshore operation in Krakow, Poland, eight months ago to provide human resources support to its clients in Europe and conduct pensions administration and software development services for UK pensions schemes.

Presently, two-thirds of Hewitt’s back-office pensions work is off-shored to Poland, a branch housing 300 employees. This back-office work includes updating forms and liaising with the department for work and pensions, updating member details such as address changes; making transfers, refunds; and processing joining members and defaulting members. Although Hewitt is adamant certain functions, such as customer service, will remain UK-based.

Hewitt Associates’ head of UK and Polish operations Richard Oliver says: “This is the first two waves of Hewitt’s off-shoring operation and we are looking to extend that further. The quality of work in Krakow has been terrific, it is a source of national pride. We could have found a cheaper location elsewhere in Europe but we were drawn to Krakow because it already had offshore knowledge and we could get senior people there to help migrate our project from the UK.”

Although Hewitt Associates acknowledges some trustees, particularly member-nominated trustees with trade union backgrounds, were hesitant to outsource jobs to foreign climes, Oliver believes they will be eventually be persuaded through blurring the distinctions of outsourcing and in-house. He says Hewitt presently runs a “twilight operation” in its Epsom office, doing the same work as is off-shored to Poland, using “non-pensions professionals” during night shifts.

“We do the same process-driven work in our Epsom office, bringing in non-pensions professionals to do the work exactly as [it is done] in our Krakow office, where we do not have permission to offshore the work out. It is a twilight operation” Oliver says.

He adds: “We are a global company outsourcing business. Our competitors do not have a global presence so they are looking to see how we do [with off-shoring] before jumping in.”

The barriers
Outsourcing is not a new concept but its popularity – across all industries and not just the pensions sector – has rocketed in the last 15 years, booming in pensions since 2000.

Adamson explains: “Initially the momentum was gained as a result of ideally seeking to reduce costs and to reduce the amount of time and energy that companies had to put into something that was not their key business.

“It is about the employer’s attitude; they may be able to support an in-house team financially and manage it, and develop it, and train it but these are quite big responsibilities. I do not think that any type of scheme, size of scheme, nature of scheme benefits [from outsourcing] over others, it is more about what the employer wants and can afford to do.”

He continues: “More recently, however, the accent has been on the change from defined benefit to defined contribution schemes; there is even less interest from employers to do that work in-house. Also, people have realised that DC administration is actually quite different to DB, and especially needs to be very accurate and very timely.”

The greater and more specific demands of DC schemes, including their greater reliance on different and more complex technology systems, has triggered the recent flow from in-house services to outsourcing, posing the ideal time to make the switch to an external agency.

Capita Hartshead’s sales and marketing director Stuart Heatley says: “In 2000, around 70pc of schemes had an in-house administrator and that has now swung round to about 63pc of schemes. It has been triggered by a lot of the schemes going down the DC route because their existing systems and processes are no longer suitable.”

Heatley continues: “Ultimately, if a company is looking for cost recognition, if they have a complex pension arrangement and therefore a higher risk of something going wrong; if they have launched a new scheme design or are doing something they have not done before; if there is a greater pressure within the company to remove non-core activities; and if they have a high staff turnover, then I would say any number of those brought together would prompt a strong case for outsourcing.”

Brassett warns: “If a company offers both a DB and a DC scheme, it should not be a given that just because a provider is a good defined benefit administrator, they will also be a good DC administrator. It should not be a given that the same provider is right for both because they are actually very different beasts.”

However, schemes can not simply push a failing process system onto an outsource provider and then hold them accountable to the standard service level agreements when data become corrupted or services disrupted.

“The state of their current operations is definitely something to consider before outsourcing,” Plumb says. “Pensions operations where the records are in a very poor state, or there are no decent interfaces, then you would not want to hand that over to some-one without fixing those areas first.”

There are other barriers to schemes switching to outsourcing. Risks can arise around the data transference process, data integrity, the potential loss of in-house knowledge and company ethos, and concerns around compliance and reporting issues.

Paymaster’s director Robert Branagh says: “There is a real risk of losing local knowledge about the scheme and experience of the sponsor’s culture and ethos. To counter that, outsource providers should really spend the time getting to know their client’s business, speak to their staff, experience their environment and get a feeling for how best top interact with them.

“Paymaster once took their staff down a mine,” Branagh adds, “to speak to miners – members of the sponsor’s pension scheme – and find out how they felt about receiving an added benefit after such a hard day’s work. It is also about finding the right tone and ensuring you provide the service in a way they would appreciate. It is very important to hear about the member’s perception of the third-party customer service, not just the manager’s.”

Bloxham agrees and says: “The major risk we are always conscious of is the inherent knowledge within the in-house team and how we can get it out of their heads and into our systems. They have an awful lot of knowledge about the history of the scheme and how it has evolved, which is not always documented. That is the most significant risk at the point of outsourcing.”

However, others argue that the in-house accumulated knowledge is precisely another reason to outsource, as the risk to the scheme when those individuals left the company could be massive. But then, outsourcing could be a double-edge sword in that respect, as only a few TPA companies such as Capita Hartshead take on the in-house staff when they accept the account, and the perception or reality of job losses to the in-house team can be a bitter pill for members to swallow.

Branagh admits: “I think job losses are an inevitable casualty in outsourcing. There are also some concerns around regional factors, such as when accounts are moved from the north west, say, to the south east. There can be a perception that these things are being taken away from them and that local jobs will be lost. Sometimes members simply feel more comfortable talking to someone from their own area, with their regional accent. That is an especially big hurdle for local government schemes.”

Governance can also be a contentious issue, especially where a potential conflict of interest may arise in the amount of delegates duties held by one outsourcing company. Although third-party administrators are contractually obliged to carry out due diligence, according to Heatley, some say there is more trustees could be doing to ensure they are compliant with their legislative obligations.

Adamson says: “Employers and trustees need to allow a bit more time to actually visit their outsource provider, coming to see what sort of research team they have, how they train people to use their processes, how they produce procedures and processes – actually come and have a look rather than just listening to what we say. There is nothing comparable to seeing things for themselves and I think employers and trustees should have that level of responsibility to their scheme.”

Conflicts of interest should also be closely monitored by trustees. They can arise where the outsource provider caters for the scheme’s whole range of administrative needs and provides their actuarial, legal or accounting services. In the case of multi-managers, a conflict of interest can arise where the provider is advising the scheme’s trustees about the best investment strategies or asset classes in a way that may offer bias towards one of their multi-managed funds or strategies.

Stannard says: “Potentially there could be a conflict of interest but we manage that. In the case where we are providing such advice to trustees then we make sure to disclose everything and make those potential conflicts very clear to the client. It is really a balance between efficiency on the one hand and ensuring objectivity on the other. We have to convince them that we will add value and we can do that by showing them out track record across all our funds.”

Stannard also reiterated that multi-managers must provide six-monthly Investment Management Association reports, introduced following the Myners report, and a transparency tool that trustees would not be exposed to if using a direct manager.

Adamson adds: “These conflicts are very real. Whistle-blowing is an important feature of our industry these days, and quite rightly so. It is much easier for a company to blow the whistle on another than it is for one team within a company to blow the whistle on another team within that company.”

Bloxham takes a more philosophical approach, and sayS: “Those compliance problems would exist whether in-house or outsourced. The regulator is expected to produce guidelines on exactly that; an annual sign-off from the scheme auditor that all processes are fit for purpose, and we expect that to be extended for some administrative functions, where held in-house or outsourced.”

Retaining responsibility
So, having carved up the plethora of different scheme functions and processes, decided to outsource one or all of those segments, what will actually be left in-house if this current migration continues? Unanimously, all of the interviewees felt that fundamental policy and decision-making “could be delegated but not abdicated,” as Bloxham puts it.

He continues: “Ultimately, you still need to have some level of engagement within the [sponsoring] organisation because things change and you have to take a view about which ways you want your administrators to adapt – for example, the tax simplification policy – and how pensions fit into the company’s wider view about staff pay and rewards.”
But even trusteeship is not safe from the progressive creep of outsourcing.

Heatley explains: “Trusteeship is starting to be outsourced, predominantly because there is a greater need to define the line between trustees and the sponsoring company, and the responsibilities of both. Traditionally, the managing director, finance director and human resources director of the company would all sit on the trustee board but now it has become very difficult to define whose interests they should be representing, particularly if there is a deficit in the scheme. Outsourcing top independent trustees has always been there but there will be more propensity to use them going forward.”

Heatley added that some companies are going to the extraordinary lengths of employing separate actuaries to double-check the figures produced by the trustee-employed actuaries, because the impact on the company books if one actuary uses in-aggressive or overly-aggressive assumptions can be vast.

Also, the ability of the sponsoring company to monitor the outsourced services and change the arrangements where necessary is paramount, although that would involve a greater level of hands-on involvement and commitment, as proposed by Branagh, who also advocates the retention of the company’s core ethos for dissemination to members.

Branagh adds: “We believe most areas would benefit from being outsourced where they can be done at least as well, if not better, and more cost-effectively. However, there is a strong risk of a breakdown between what the members expect from the outsource provider and what the company expects; for example, turnaround times for [information about] the value of their fund.”

That said, Branagh concludes: “More employers are less keen to deal with their own pension schemes than they once were, so there is now less motivation to keep the functions in-house. The growth of the outsource market is set to accelerate even more.”