This month’s Off the Record considers the issue of outsourcing. The trend of pension funds to outsource the management of their assets to external managers is already well established. Less common is the decision to outsource their mid and back office functions.
The reason why a medium small or medium sized pension fund might decide to outsource its back office functions is that running a pension fund is becoming too complex for an in-house team to manage on its own. Regulatory reporting, for example, has become an area of pension fund activity best left to specialists. Outsourcing these and other non-core activities would allow a pension plan to concentrate on its core competencies.
Yet many pension plans are still reluctant to outsource. One of the reasons they give is the loss of control that outsourcing would entail. There is also a feeling that outsourcing could damage staff morale, as jobs are transferred or lost altogether.
Are these fears justified? Or do the benefits of outsourcing outweigh any drawbacks?
An impressive majority (84%) of the pension fund managers and administrators who responded to our survey agree that the complexity of pension fund management and administration today means that small and medium-sized occupational pension funds should consider outsourcing at least some of their functions to third parties.
The decision to outsource should be part of an overall review of operations, the manager of an Austrian pension suggests: “You should develop a clear understanding about the way you wish to structure the value chain.”
But which functions should a mid-sized pension plan fund outsource? Most managers (78%) would outsource asset management, while similar proportion (74%) would outsource IT. Two in three managers (63%) would hand fund administration to a third party while rather fewer (58%) outsource regulatory reporting.
Only a minority (36%) say they would farm out the job of communicating with members of the pension plan. The manager of an Italian pension fund suggests that a fund should keep control of its website, for example, as an essential communication tool.
Other functions that managers see as suitable for outsourcing are ‘employee administration’ (German pension fund), ‘payment of pensions’ (Dutch pension fund), ’custody, official record-keeping and accounting, and investment back office’ (UK pension fund) and ‘risk management’ (Belgian pension fund).
Opinions about the benefits of outsourcing vary. A clear majority of managers (72%) agree that outsourcing mid and back office functions will bring greater efficiencies. But only a narrow majority (51%) agree that outsourcing will provide better service to a pension plan’s membership. And a minority (44%) agree that outsourcing is cheaper than doing the job in-house.
Other reasons for outsourcing mid and back office functions include ‘flexibility and better continuity’ (Dutch pension fund), and ‘benefits from economies of scale which allow service providers to invest in or supply latest technology’ (Irish pension fund).
Adopting a bean-counting app-roach, we asked what percentage of the cost base of a small or medium sized pension plan pension plan you would consider reasonable to outsource: 0 to 10%; 10% to 50%; or more than 50%
Many managers retort – probably rightly - that this is the wrong way to look at outsourcing. “Outsourcing should take place based on control requirements and higher efficiency rather than costs,” one Dutch pension fund manager points out. As a result, the question drew a high proportion of ‘don’t knows’ or abstentions. The largest single proportion of those who ventured an opinion (46%) feel that between 10% and 50% is about right. Rather fewer (39%) feel that it should be more than 50% and only 23% think that it should be no more than 10% of the cost base.
Outsourcing back office pension fund activities is still predominantly a US phenomenon and has yet to make inroads in Europe. So we asked whether you felt that there were enough good providers of outsourcing services in the European market.
A slim majority (51%) are happy with the provision of providers. Here again the abstention level is high, with a significant proportion (7%) of ‘don’t knows’, One Austrian pension fund manager points out that the adequacy of provision is “difficult to evaluate given the different regulatory requirements and pension fund structures.”
Yet the main reasons why pension funds might be reluctant to outsource back office may be less to do with the quality of the providers of outsourcing than with the surrender of control that outsourcing represents. This is usually cited as the single most important reason why US or UK based outsourcing companies face an uphill struggle in the European pension market. The results of our questionnaire bear this out.
A large proportion of our respondents (86%) agree that main reason European pension funds are reluctant to outsource is the loss of overall control that would result. An even larger proportion (91%) suggests that the absence of any cost savings is a big disincentive. On the contrary, they say, outsourcing will mean an increase in costs.
Outsourcing a pension plan’s operations will directly affect the lives and livelihood of the plan’s staff. A clear majority of managers (70%) say that the lower staff morale that would result from job moves and possible job losses are likely to dissuade pension funds from outsourcing.
There are other objections, principally the administrative bungling of outsourcing providers. “Outsourcing means big organisations are to be involved,” says the manager of a Dutch pension fund. ”That means bureaucracy and a lack of urgency,”
The shortage of good outsourcing providers – however this is measured - is not seen as a serious problem. Only one in three (35%) of our respondents cite the lack of suitable providers as a reason for not outsourcing.
Pension fund managers may be simply too busy to afford the luxury of outsourcing. The manager of a German pension fund comments that, with so many urgent projects in hand, he has “just no time left” for outsourcing.
Some may feel that outsourcing means shrugging off the duties laid on pension plan managers by their plan members. One manager says that a strong objection to outsourcing is that it is “relieving a pension fund of its fiduciary responsibility”.
Others may find that the cost of outsourcing simply does not justify the benefits: The manager of an Austrian pension fund suggests, for example, that the benefits of switching to an outsourcer are “lower than expected and not yet worthwhile the undertaking”.
Finally there is a feeling that a pension fund should retain some in-house expertise – perhaps because it is superior to anything that it can buy in. One UK manager probably speaks for many when he (heretically) suggests that “in-house is better if it is managed closely.”
Outsourcing is not a panacea for poor operations, outsourcers will say, and outsourcing inefficient back office operations will not improve the way they are run. Opinion on this is divided with slightly fewer (46%) agreeing and 49% disagreeing. One Dutch pension fund manager observes dryly: “That is as they say in Holland – an open door.” However, the manager of a UK fund suggests that outsourcing is bound to lead to improvements: “Surely it makes changes more likely?”
There are also mixed views about the downside of outsourcing. One in two respondents (51%) agree that communications with pension plan members become more difficult when the plan’s mid and back office functions are outsourced. A similar proportion (53%) agrees that pension funds lose some flexibility when they outsource any of their functions. An Irish manager says this is likely to occur “particularly where the size of the scheme relative to the outsourcer is small.”
A large majority (71%) think that ‘lift-outs’ – where an entire business function and its staff is transferred from a pension fund to an outsourcing provider – are likely to have a bad effect on staff morale. Others suggest that the loss of morale would be only temporary. The key issue is how it is handled. “The communication challenge must not be under-estimated,” says one manager.