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The past two years have been very exciting and challenging for US pension fund consultants. Economic recession, stock market losses, corporate scandals and security alerts have been putting retirement plans and their sponsors under pressure. Consultants’ advice and services have become even more valuable in overcoming these multiple crises.
One of the most profitable and growing areas of business is outsourcing. The US market for outsourcing human resource functions is projected to grow 25% a year to $47bn (e44bn) annually by 2004, according to industry analyst Gartner Group.
“If a company is looking to cut costs internally, one of the biggest areas to cut is in the HR side. Outsourcing is definitely the future,” says Tom Rodenhauser, president of Keene, New Hampshire-based Consulting Information Services. While other areas are subject to budgetary cutbacks by employers, outsourcing seems immune so far, consultants confirm, adding that very few companies will bring the work back in house once they outsource it.
A success story is Hewitt Associates, the second-ranked employee benefits consultant in the US. Outsourcing is its largest and fastest-growing business, with revenues having increased 18.2%, to $939m, for the year ended 30 September 2001, from $794m a year earlier. To finance this kind of growth Hewitt went public last June. “Outsourcing is so capital-intensive because you are taking over a company’s entire HR business process,” Rodenhauser explains. “That requires a different capital structure than a partnership.” With the money raised the company can pay for the high-tech computer systems, call centres and internet-based services it needs to manage benefits for about half of the Fortune 500 companies it serves.
The stock market has appreciated this business model. In five months Hewitt stock’s price has increased by around 50%, even if in the meantime the company has made an acquisition, usually not welcomed by investors. It bought UK actuarial and investment consulting firm Bacon & Woodrow, paying £140m (e215m) and taking on liabilities within the firm totalling £16m.
Looking overseas for growth is indeed another ’hot’ trend among US consultants. Dale Gifford, CEO of Hewitt Associates, declared that the UK purchase was not the end of his company’s strategy of overseas acquisitions. Mercer opened several new offices in Europe in the past two years. One year ago Towers Perrin formed a joint venture with German consulting firm Rauser.
According to Joseph LoCicero, chairman and CEO of Buck Consultants in New York, Europe and Asia are probably five to 10 years behind where the US is in outsourcing. “I would suspect that we have huge opportunities there for growth going forward”, he added. But despite the focus, US consultants’ overseas growth in 2002 slowed, as many countries saw their overall economies slow down.
Consultants working for US defined benefit (DB) retirement plans are facing the underfunding problem and sponsors’ inability to make sufficient contributions. A recent Credit Suisse First Boston study projected that the US companies in the S&P 500 Index would be underfunded in aggregate by $243bn at year-end 2002.
“Three consecutive years of bad equity returns, combined with lower interest rates, have produced a double whammy for plan sponsors,” comments Robin Penfold, practice consultant with Frank Russell in Tacoma, Washington. “Many plan sponsors, who had been feeling comfortable until recently, now recognise that their long contribution holidays are over. In some cases there is a confluence of events with accounting rules and separate tax regulations working at odds with each other. Financial accounting standards are compelling plans to contribute more to their funds, while tighter tax rules often say sponsors can’t do all of this on a tax-exempt basis. Many plans are facing challenges with these incongruent rules”. Russell is recommending that clients should aim to contribute the maximum deductible amount.
“Another artifact of this projected underfunding is that plans are looking for their assets to work harder for them,” continues Penfold. “Accordingly, we have heard less about passive management and more about alternative investments.”
This trend is confirmed by Greenwich Associates, a consulting firm based in Greenwich, Connecticut. “In the US, pension fund investment in private equity alone totalled $174bn in 2001, and we expect that our 2002 research, when completed by year’s end, may well show an even greater level of uptake,” says Greenwich consultant William Wechsler.
Kevin Wagner, a retirement practice director with Watson Wyatt, records an opposite effect of under-funding: “The volatility associated with pension funding encourages plan sponsors to invest more heavily in fixed-income securities than they otherwise might. A 100% fixed income asset allocation is likely to provide lower investment returns, but it allows employers to control the volatility of pension contributions and more accurately budget over time. Unfortunately, employees pay the price for these foregone investment returns in the form of lower benefits in the long run.”
To smooth the pension funding process, Watson Wyatt proposes that an employer’s current liability be determined based on interest rates in effect on the date of the plan’s valuation rather than on the current liability based on a four-year weighted average of 30-year Treasuries. “This measurement represents a much more accurate measure of the plans’ funded status at the valuation date,” claims Wagner. Watson Wyatt is heavily lobbying to defend DB plans’ role. “Despite these difficult economic and funding challenges, retirement benefits payable under most defined benefit plans are secure and are in much better shape than the defined contribution (DC) plan system, where employees are bearing the market risk,” says Wagner. “What we need now are changes in the funding process that will ensure employers will want to keep offering a DB plan to their workers.”
Another source of business for US consulting derives from portfolio rebalancing. “Whilst the relative performance of stocks versus bonds has been negative overall, it has also been volatile, with brief periods of strong outperformance. This means clients are spending more time and energy on rebalancing their assets,” observes Penfold. “They continue to recognise the benefits that such rebalancing brings, but they are now very aware of the time commitment involved. Moreover, they’re not just rebalancing assets. Many sponsors also frequently rebalance their manager structures, to ensure that they do not have any unintended sector biases in their total portfolios.”
In the DC field, the two ‘hottest’ problems are corporate stocks and financial advice. “Corporate stock in DC plans is now a high-profile political issue, following Enron employees’ losses of both pensions and pay cheques,” says Penfold. “There are high hopes that legislation will pass soon that will remove some of the barriers to participants holding more diversified portfolios. There also seems to be a positive trend among bigger plans to provide their participants with more advice and education.”
‘Advice, advice and more advice’ is a new trend affecting the US DC market, according to the Institute of Management and Administration in New York. “The issue of offering investment advice to participants has been perched high atop the wish lists of sponsors, providers, and participants for several years now,” say experts at IOMA. “But the law has made it difficult for interested parties (as opposed to independent advice providers) to offer such advice. The stumbling block has been the fear of conflict of interest if a money manager can benefit from its advice. That stumbling block has started crumbling and new rules allow such advice to be offered if certain criteria are met.”
Consultants that help sponsors to design DC plans will have to take into account the need to provide educational programmes for participants, including advice on asset allocation. “The internet will continue to play an important role in such education programmes, with asset allocation models geared to the needs of individual participants,” say IOMA’s experts.

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