Keeping on top of technology
Most pension funds acknowledge the importance of technology to their business, whether they install applications in-house or outsource their requirements. However, technology is not a one-time decision like choosing an office or organisational logo. The questions then arise of how often a fund should review its technology, how it should ensure that it is getting the best out of its investment, and how it should measure the cost?
A pension fund should review its technology annually, says Ad Driessens, a senior consultant with Netherlands-based consultancy Practis. “Because of developments going on in the pension business, in terms of changing requirements from employers and employees and from legal authorities, it is necessary to review the software and infrastructure on a regular basis - at least once a year.”
Murray Burford, investment consultant with Dr Heissmann, consultancy based in Wiesbaden, agrees. “Given the rapid pace of technological change, an annual review comparing the effectiveness of the existing hardware and software to alternatives available in the marketplace, or recently introduced by the respective pension fund peer group, is advisable,” he says. The fund should review both the degree of automation achieved by the technology in terms of improved productivity, and the scope of the capabilities provided by the applications, “with a view to remaining state-of-the-art,” says Burford.
A business application cannot be treated like a coffee-maker or photocopier, where it is simply installed and then used without further thought. Likewise, if a fund chooses to outsource its technology, it cannot simply make the decision and then forget about the operation of the agreement.
“Once the implementation phase for new software and/or hardware is completed, there will immediately be deficits in the desired functionality,” says Burford. As those who have to use the applications go about their tasks it is inevitable that the limitations of the system will become apparent. Most commercial business software is developed to broad and general specifications, while all funds have specific characteristics to the way in which they go about their activities. The fund can either change the way that it operates to conform with the software – sometimes with positive results where the software imposes certain disciplines on the performance of tasks – or the fund will have to request amendments to the application. “These amendments will need to be specified and commitments received from the supplier with respect to the scope and timing of new releases,” says Burford.
It is in the interests of the pension fund to encourage the software supplier to keep enhancing its technology, while not wanting either to be unduly subjected to the role of guinea-pig for new functions or applications, nor to be the one that has to bear the cost for their development. “But the longer that a given system can provide all the desired functionality without being outclassed by newer and better offerings in the marketplace, the longer the time period before the introduction of a new system with its high cost, both financial and in terms of disruption to the pension fund, the better,” says Burford.
An application will be no less essential to the operation of a fund because it is outsourced, therefore the same principles of monitoring the effectiveness of technology should apply to an outsourcing agreement.
“The beneficiaries of the fund will be the first to notice if the outsourcing arrangement is not functioning properly,” says Burford. The decision to opt for outsourcing must not be seen as a negation of responsibility: instead, the required functionality has to be carefully defined and specified within clear service level agreements with the provider. “And as soon as the ink is dry on the outsourcing contract, the pension fund needs to monitor the quality of services being provided as it would for any other supplier relationship,” he says.
There are real dangers for the fund in not regularly monitoring and reviewing its technology provision, says Driessens of Practis. Among the most critical of these will be the increasing costs of administration, and not being able to support the changing business.
Burford warns that failure to review technology can lead to the pension fund failing to achieve increased productivity through automation and the economies of scale that technology can provide. The result can be that the fund becomes too expensive to run and is eventually subsumed by a more efficient provider.
One scenario is that poorly functioning technology leads to an increase in the number and severity of administrative errors by the fund, leading to an operational crisis. As a result, the beneficiaries become dissatisfied with the service, which in turn leads to dissatisfaction and loss of reputation for the fund. Another scenario is out-of-date or inadequate applications lead to a lack of transparency of the accounting framework and of the investment process at the fund, which hampers the trustees in their abilities to manage the fund. This leads to poor decision-making and sub-optimal investment returns. “Eventually management and technology need to be replaced,” says Burford.
So how should a pension fund go about ensuring that it is making best use of technology to support its activities? Given that technology is not a core competence for most funds, Driessens advises that a fund should look for a partner that has the expert knowledge and tools. “For most pension funds, the costs of investing in their own software and infrastructure are too high,” he says.
But Burford advocates retaining and building technological expertise within the pension fund. “Even if the technological competence is outsourced, the supplier relationship has to be monitored and at times renegotiated,” he says. Furthermore, the fund should be open for dialogue with other providers in the marketplace so that they know what is out there. “And an open exchange of information with friendly pension funds within the industry about suppliers and systems’ reliability is necessary,” he says. In addition, at larger funds that do have their own IT staff, there will decisions to be made about whether to build or buy applications or modules, and often the most effective approach can be a mix of both, with some software modules being developed in-house, particularly those which implement some unique or proprietary methods or processes of the fund, while other more generic applications can be bought off the shelf or outsourced.
One aspect of any review of technology should be its cost versus its benefits. Should the fund view the applications and the hardware that they run on simply as a cost on the bottom line, or, because of their integral role in enabling the pension fund to perform its business, should it view them as an investment?
That depends on the kind of business the fund undertakes, says Driessens. The question to ask is: is the technology just to support a single pension fund, or is it to support multiple administrations? “In the latter case the_technology should be regarded as an investment,” he says.
Burford suggests that smaller hardware and software purchases can be charged as a cost directly against the fund’s profit and loss. Similarly, larger purchases and/or development costs can be capitalised and then depreciated over a given time period. “The latitude available will in both cases be subject to accounting standards, tax regulations and the desired degree of conservatism in the accounting framework. The time period for depreciation should adequately reflect the pace of technological change,” he says.
But this is to look at the costs purely in accounting terms. Computers are basically universal simulators mimicking a host of mechanisms and activities, and their applications are generally a matter of automating formerly mechanical or manual processes. In economic terms, technology is the substitution of capital for labour, and any accounting of the cost of hardware and software has to take into account the increased productivity or staff cost savings they bring.
In today’s world, no pension fund can plan future strategies without taking technology into account - in terms of what technology can do, what it will cost, the time it will take to install, and so on, says Driessens. Meanwhile, Burford advises that pension fund trustees: “Keep abreast of technological changes, both to assess the competence of the colleagues specifically charged with responsibility for technology, and to ensure that the suppliers of outsourced competencies do not imperil the reputation of the pension fund.”
Given the key role that technology plays in today’s pensions business, managing it on a wing and a prayer is no longer good enough, says Burford.