Consultants feel the ground shifting
Pension professionals in the Netherlands feel that the tectonic plates on which their industry sits are shifting.
“The problems include the turmoil of recent years in investments and returns on investments, a tightening regulatory environment including the development of a governance code, and the new financial reporting standards,” says Maarten van Ginkel, an FS-audit partner at PricewaterhouseCoopers. New international financial reporting regulations have reawakened companies’ interest in implications for their own balance sheet of pension fund volatility.
But while the coincidence of so many pressures and the resulting insecurity suggest that advice will be in demand, the seismic activity experienced by the pensions industry is being mirrored in the consultancy sector. The regulator, the PVK, has warned auditors and actuaries to come up with proposals to rectify a possible conflict of interest issue within a year or face the imposition of guidelines. The new arrangements might result in changes to the way that consultancies offer their services, with a division of roles and so more meters running.
“Such a requirement is still under discussion, but if we retain the existing situation, where one firm does the number crunching, prepares the final reports and signs off the official figures, it would be difficult to explain to the outside world that there is an independent view,” concedes Falco Valkenburg, a principal at Towers Perrin with a responsibility for benefit services in the Netherlands and for its asset consulting group. “I think the most transparent resolution would be to have two actuaries, one a consultant and the other the appointed actuary who only signs off. That would increase costs because it would lead to extra work, as there would be two people reading through all the company and pension fund documentation, and one would have to check the work of another.”
But Gerard Roelofs of Watson Wyatt is more sanguine. “The amount of work and the type of work will not change,” he says. “The pie is going to be divided differently but the overall bill should be the same, otherwise an additional layer of inefficiency driven by government, politics and regulators is coming in and that cannot be the goal.”
Their differing views are symptomatic of the problems consultants are experiencing in hammering out a common response to the PVK. “A broad discussion is underway but reaching a solution is proving difficult as actuaries have many different backgrounds and markets,” says Valkenburg. “The big four consulting firms have proposed two options, one we call pure (or dark) chocolate, and if that is too bitter (high-cost) there may be a milk chocolate version available. We are still discussing it with market parties – the supervisors, the government and, vitally, our clients because they have to pay the bill but we don’t want to give them the impression that we are only looking for new revenues.”
However, consultants’ priorities are already being questioned. “Consultants have a commercial agenda,” says Peter Borgdorff, director of VB, the Dutch association of industry-wide pension funds. “When the relationship operates as it should it is based on trust, but where the two sides don’t have confidence in each other it won’t work. But while the big consultancy firms have a commercial point of view they are aware of a need to be engaged next year too and that if they just adopt a commercial outlook the pension fund will get anxious and go away.”
And some are already sceptical. “The big consultancy firms have a strong and understandable desire to sell what they have to offer, but it is not necessarily what we want to buy,” says Bram van Els of PME Metalektro, the pension fund for the mechanical and electrical engineering industries. “And because of that they have a tendency to make a problem bigger than we think. They need billable hours, after all, so problem definition can sometimes be problematic with a bigger firm.”
The bigger firms include the ‘big four’ referred to by Valkenburg – Towers Perrin, Hewitt, Mercers and Watson Wyatt – and a second tier of major firms, including PricewaterhouseCoopers and Aon. The predominance of international firms is the result of their acquisition of established local players, most recently Aon’s takeover of Zwolle-based Consultas. But there are still several small consultancies and individuals active in the market, and these are PME Metalektro’s preferred option for advice.
”We use the big firms for simple problems and daily work but if we have a really big issue that requires a creative solution we almost always hire an individual consultant, not someone within a firm,” Van Els says. “We think that the individual consultants that we hire are more loyal to us than a consultant from a big firm who also has a loyalty to his company. So they are more loyal, they can take more risks in being more independent and that is one of the reasons they often have a better and more creative solution to the problem that we face.”
The VB’s Borgdorff suggests that this attitude is not universally held. “When I talk to pension funds I never find that they are not using an international firm for the big issues,” he says. “The small independent consultants are mostly involved in a change in a regulation of the fund. So when, for example, there should be a new agreement the smaller funds tend to engage the smaller consultancy firms. But it is mostly a
one-off exercise for a single-issue problem and not a continuous relationship.”
However, recent research by conducted US-based asset management and technology solutions provider SEI among senior finance executives from pension schemes and companies found that consultants have a reputation for being reactive rather than proactive. “So while in principle they should be able to provide pension funds with independent advice, in practice the quality of that advice leaves much to be desired,” says Bart Heenk, SEI’s managing director of the Nordic and Benelux regions.
Willem Brugman, retirement practice leader for Mercer, agrees: “There are certain areas where we are reactive, for example Mercer was not proactive on governance. But that was because the pension fund associations were producing drafts so we decided to look at them. However, in other areas we are quite proactive. For example, four years ago we began talking to clients about new legislation that was still some years off regarding the market value of pension obligations instead of with 4% interest rates, and three years ago we calculated the pension obligations at market value. So our actuarial reports for the past two years already included this information although the legislation is not yet in place. So the clients with which we began discussions on this subject four years ago are well educated in it and are ahead of other companies and pension funds.”
Jan Kars, responsible for retirement and financial management practice for Hewitt, agrees that consultants need to keep ahead of developments in the market. “We create functions to have eyes and ears in the European market and to help us to create a vision, and in the Netherlands we have a research team,” he says. “And this is a big change; 10 or so years ago it was not usual for consultancy firms to have a research team.”
But having well-informed consultants in a time of rapid change can throw up other problems, according to the VB’s Borgdorff. “The balance of power has tipped”, he says. “Currently, most pension funds need consultants for several reasons and one of the most pressing is that most pension fund board members are not professional, so they need consultants to provide the information required for them to make decisions. But we must remember that the consultant is not a board member. The big pension funds are large enough to have their own expertise, and although they also buy consultancy services they know what to buy and they know how to control what an adviser suggests. But the smaller the fund the more influence there is for the consultancy.”
For Valkenburg of Towers Perrin “there is not much difference for a small or a large pension fund. A large pension fund has a similar situation but with its internal board of directors rather than an external consultant. I think that both should make clear to the trustees that they have to make the decisions, that they are responsible and that they have an obligation to inform themselves and to make informed decisions. And we, as consultants, have to provide them with the information and to educate them to enable them to make the decisions. But sometimes it is very difficult, especially with very small pension funds, where people can be too laid back. You don’t have to be an expert to take decisions, but you do have to be able to ask your consultants the right questions.”
And Kars of Hewitt concedes that the relationship can be problematic. “There’s always the danger that we affect their policy and I think that in the past it was even worse,” he says. “What we have gained from the debate on governance is that pension fund boards must look after their own responsibilities. They are aware of this and we point this out to them. But I see that as a big party we do have influence on a fund’s pension policy. We are not necessarily happy with that because the pension boards simply have to look after their own responsibility. They can’t leave it all up to us.”
“We try to stand off a bit,” says Van Ginkel. “Funds have to have an educational plan that describes what capabilities they have and how to ensure that they are up to speed with the requirements of the function. But the fields that are outlined are not very specific: there has to be somebody on board who knows something about administrative organisation, actuarial reporting, governance and so on. The new regulations also specify that there be an audit committee for all pension funds. I’m not
sure that that’s going to fly but it shows a thought process that indicates that the current level of expertise is not good enough and board should go the extra mile or two
to show that they are on top of things.”
And Roelofs of Watson Wyatt goes a step further, asking “how accountable are we for our advice? In case things go wrong I’m fired, or it’s known in this small society
that one is a lousy consultant. However, although someone can’t just declare themselves to be an actuarial adviser because they need to be qualified and accepted by professional bodies, or as an investment adviser because a pension fund is regulated by the PVK, but they can just announce themselves as a consultant because frankly there is no such thing. So for the overall quality control of the advice we give, whether it is concerned with strategy, tactics or implementation, I wouldn’t mind if there were a supervisory board on the quality of consultants.”
But can pension funds afford to buy what consultants are selling? “We see in the market place that we are affordable,” says PricewaterhouseCoopers’ Van Ginkel. “But it’s fair to mention that in the overall environment, where the extra hours needed by boards, the
extra costs of the regulatory bodies, the extra charges from actuaries
for designing plans and ALM studies, and the extra costs of consultants mean that total costs in
terms of hours and cash out are expanding.”
But so is the market share for consultants “so they must be able to afford us,” insists Watson Wyatt’s Roelofs. “And the implications of the new accounting standards mean that if the pension fund is not managed well and it results in a too-volatile funding rate, the corporate partner has a claim on its balance sheet that can lead to a rating agency downgrade and an increase in its financing costs. So it is very much in a company’s interests that the pension fund is run well according to the CEO’s vision.”
And this underlines a shift in focus brought about by the new accounting regulations. “Over the past 10 years we have forgotten that stakeholders in a pension fund include not only the pensioners, the sleepers, the active participants, the labour unions but also the corporate sponsor,” says Roelofs. “And suddenly he’s at the table again.”
“The accounting rules that are being introduced are showing CFOs that pensions are expensive,” says Towers Perrin’s Valkenburg. ”Together with the recent three years’ bad investment results it has provoked a debate on the company side about whether they should stick to the same pension promises, still have a pension fund or seek a group insurance solution. And it’s a debate in which we as consultants have to give input to make clear what the differences are.”
Aon, which traditionally advised companies on their employee benefits and moved further into the pension fund market with last year’s acquisition of Consultas, feels that actuarial consultants have divided loyalties. “We see an increasing number of companies wanting to end their pension fund and go under the umbrella of an insurance company,” says Johan Nieuwersteeg, managing consultant with Aon’s actuarial advice group. “As a result of the new PVK regulations, pension funds need a lot of extra money – 130-140% of the liabilities in the fund – but the extra 30-40% would gain a higher rate of return within the company. However, the pension fund board wants the fund to continue and the actuarial adviser has divided loyalties, realising that if the pension fund ends so will the adviser’s business. But we are increasingly being asked by employers whether they need a pension fund and whether there are other possibilities to execute their obligations.”
But Valkenburg claims that Towers Perrin has “always been impartial whether our client is a pension fund or an insurer. It used to be a rule of thumb that with less than 200 actives it was better to find insurance rather than setting up a pension fund, and this threshold has risen so some smaller companies are no longer very interested in having their own pension fund. But we can still help them find the right insurance company, help them design their pension promise, because that is still done by
the company as part of its total benefit package, and increasingly companies are looking at it from that perspective.
“We had lost sight of just what is the original goal of a pension fund,” notes Kars of Hewitt. “It is to help the company to deliver pensions to its employees. We see our role as strategic consultants being to help not only the pension fund but rather the company including the pension fund. In some cases a pension fund won’t be part of it – it could be that an insurance company might be the right vehicle, but we must figure that out from situation to situation. However, the emphasis must be how to make a total pension organisation which can face all threats, economic downturns or mutations in a participant’s base.”
But Heenk of manager of managers SEI, a former consultant, feels that “the consultancy model itself is under threat from managers of managers and from investment banks, which are beefing up their pension advisory teams. They are linking their initiative with corporate finance capability and asset management expertise, and are offering advice for free as a lead-in for asset management or corporate finance business. That is making it a little hard for the consultants because they charge by the hour so the cost-conscious Dutch are faced with a tough decision.”