Service credits are a useful feature of administration contracts, tying performance with fee levels, but they are rarely used. Daniel Taylor argues why more contracts should include them.
Another administration report tells you targets have been missed, member complaints have risen and your attempts to intervene, support and apply pressure have failed - what's your next move? You can use your nuclear option and start the process of changing administrator, but that's going to take months. All the while, your members and reputation suffer.
In desperation, you dust off your long-forgotten service agreement looking for the levers that could breathe life back into your ailing service. A set of clauses that compel your administrator to put things right, to invest more time and resources in getting things back on track. But sadly, this is often the final blow and it's at this point you realise your agreement lacks the instruments that could put your service on the road to recovery.
In other outsourcing markets, one contractual feature that insures against persistent service failures has only made limited inroads into pensions outsourcing. If you work in the technology sector, then service credits are the de facto standard when it comes to outsourcing. It is a feature that goes hand-in-hand with the concept of service levels and one that gives a commercial imperative for delivery and quality.
Effect on fees
Service levels are a well-documented and understood concept in this industry. They define the scope and activities an administrator will complete and are usually event-based. Most focus on turnaround times and some include quality metrics such as accuracy, automation levels and member feedback.
The totality of service levels are what fees are based on, and usually, a major part will be paid for on a fixed fee. Service credits are the mechanism by which amounts are deducted from fees when the administrator's performance fails to meet the stated service levels. This might seem an obvious union: you pay for something to be completed in stated tolerances and when it's not, you pay less. But it's a rare feature of most administration contracts.
Critics of service credits accuse the system of corrupting the principles of partnership, transparency and trust, highlighting that they can remove cooperation and flexibility and create a culture of commercial hostility. Another commonly cited consequence of these systems is that they can quickly make a strained service contract uncommercial, sapping much-needed investment that could remedy the root cause of the problem - a circular penalty process that could send a service into a death spiral.
But, service credits have a place in remedying a fatal flaw in most service agreements; the long-standing problem of compounding failure - or in more common parlance, "backlogs". When your administrator breaches a service level for a trigger event, it means they have to make an uncomfortable report. But that's probably the only thing they have to do. A point-in-time report about a failed process. Other than good faith, what's their motivation for completing an event that has already breached the service level? If you work within this model, then your focus will naturally be on making sure the next event doesn't breach standards. But what happens to those cases that have already breached it? Shockingly, probably nothing.
Most service agreements have no system for motivating an administrator to clear cases that have breached a service level. Failure mounts and backlogs get created.
Well-constructed service credits will have an escalating penalty for anything that has already breached the agreement. The system makes it increasingly costly the longer cases sit waiting for attention. It is often referred to as a solution for addressing "long tails" in service levels. And, they should be commercially significant enough to attract the attention of senior operational stakeholders.
You can construct a useful set of service credits, that avoid degrading the relationship to mere financial accounting, by focusing on severity and significance. Ratings are useful to focus your administrator on the most important aspects of service delivery, such as meeting payroll deadlines, with credits falling away for less significant infractions. Minor issues, or uncommon periods of non-structural underperformance should be ignored, with the focus being on persistent and repeated problems. They should also only be triggered at the minimum range of accepted service standards.
A relatively recent evolution has been the sluggish progression towards qualitative service measures; measures that seek to assure the accuracy, clarity and consistency of service - a welcome move that is slowly changing how the industry perceives quality. But without a mechanism to police and enforce, efforts to focus on better standards are all just good intentions.
Without well-formed contractual levers, motivation for service recovery has relied on personal relationships and influence, or the threat of changing providers. A more sustainable solution is one that seeks to establish a clearer connection between cause and effect. A solution that has an established apparatus to increase commercial pressure the further a provider departs from their committed obligations. A solution that is already well used and embraced in other outsourcing industries. It's time the industry started embracing service credits as a force for good.
Daniel Taylor is client director at Trafalgar House
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