From a trustee perspective, administration is unlikely to be most exciting area in the governance of pension funds. Nonetheless, good day-to-day administration is important, not the least for members, for whom the plan administrator is often the only point of contact with the pension plan. Things are normally expected to run smoothly, but when they don’t, pension plan directors can be exposed to claims of ‘maladministration’.
Delegation: The pension fund boards would, and should, normally not get involved in the minutiae of administration. The job is delegated to an internal administration unit or the sponsors’ pensions department or an external specialist service. The ‘how’ of the delegation differs considerably across countries and pension funds, depending on the type of pension provision, the size of the fund, the national regulation and ‘pensions culture’.
In some constituencies, the trustees of the pension plan delegate directly to the operational unit (eg, a third party administration company). From a governance perspective the ‘indirect’ model seems to be more advantageous, whereby administration management is delegated to the level of managing fiduciaries (eg, CEO of pension plan or pensions manager). In a second step, they will be overseeing the operating administrators.
Administrators’ role: The list of activities is quite long. They include not only administration in the narrow sense but also other services in areas such as payroll, accounting, secretarial and communication:
q Membership database and administration (eg, transfers, benefit statements, death benefits and other ‘biometric risks’);
q Payroll and benefit payments;
qBank accounts and cash flow
qContributions (sponsors and
q Financial accounts and reporting, tax returns and budgeting;
q Secretarial services and administration report for trustee board;
q Regulatory reporting;
q Member communication, sponsors, insurance companies and advisers;
q Investment and custody administration for DB plans;
qMember accounts and investment transactions for DC plans;
q Operational risk control, complaints and disputes.
These activities do not need to be performed solely by one single administration unit. Some areas, such as benefit administration pensions, are often outsourced to specialist companies. Also, most of the investment administration is typically delegated to investment managers or insurance companies. The pension plan may have its own secretarial services and keep member communication under direct control.
Operational risks: It is clear that there are hundreds of things that can potentially go wrong. The main risks are:
q Formal breaches of law, regulation or pension fund rules, eg, missing deadlines, erroneous disclosure, incomplete reports;
q Wrong calculation or payment of pensions and other benefits;
q Failures and delays in member communication;
q Problems with the allocation of contributions or investment transactions in DC accounts;
q Poor disclosure (internal, external).
One can expect that most problems are resolved by the pensions administrators themselves. It is advisable to have a policy of operational risk controls in place that is able to handle administration issues systematically.
Outsourcing: Given the list of (often complex) tasks and risks attached to them, the question arises whether pensions administration should be outsourced or not. Practitioners have very different views about this, and there are many good and bad examples to be found on both sides. There is no general answer but there a number of lessons to be learnt from experience.
q Costs: Outsourcing reduces the headcount but does not necessarily reduce the overall cost of administration. Foe example, do they fully reflect in-house costs? What resources are needed to manage and control an outsourced operation?
q Efficiency: Economies of scale are at work and outsourcing must deliver clear advantages in, eg, systems development or IT processing.
q Quality: Specialist firms may be more efficient in producing standardised services but ‘ye good old pension manager’ knows the individual cases much better and may be popular with members.
q Transition: The process of moving from in-house to external administration is often very painful (eg, high transition costs, loss of records, loss of knowledge and trust).
q Agency problem: How to create the incentives for an external company to work well at the lowest possible cost?
In a nutshell, there are clear ‘specialisation advantages’ to outsourcing pensions administration but there are also serious control, quality, incentive and cost issues that need to be managed well. In fact, some cases of ‘re-insourcing’ are known because of ‘too much pain’.
Selection: Once the decision for outsourcing is made the next question is, where to and how? The general best practice principles of delegation apply to the selection and supervision of administrators.
One important issue is the nature of the pensions administration industry itself. Such operations tend to have low margins and high turnover of staff. They are often ‘by-products’ of other businesses such as pensions consultancy and are subject to frequent corporate change. Trustees need to ask questions in that direction. There are other critical areas to scrutinise. To give a flavour:
q How strong is the commitment by the administrator to hire and retain key people dedicated to the specific plan administration?
q How good are the quality controls?
q What are the investment plans for the development of systems?
q How about interfaces with other data providers and disaster recovery?
q How are non-standard cases dealt with?
q Are member ‘satisfaction surveys’ available?
q How responsive is the administrator to special requests, eg, from the pensions board?
Contract: It is good practice to have a formalised service agreement also with an ‘internal’ administration department. Working out the right administration agreement is more tricky than it might look at first sight. It is easy to sign off some sort of standard administration agreement but you may miss some points that are critical for trustees and sponsors.
For example, are the listed services plan-specific and are clear time limits set? Will data records be reliable, safe for the long-term and in-line with data protection legislation? Will the administrators compensate for losses resulting from their mistakes? Is their insurance cover high enough? Are the termination clauses economic and practicable?
Costs: A key element in the administration contract is the exact definition of charges. Be aware of the setup, transition and termination costs. Most importantly, understand the fee basis (fixed, time, transaction charges). Big fee surprises seem to happen ‘at the margin’, eg, for unlimited telephone queries from members.
Monitoring: The regular administration report needs to include relevant statistics that allow the monitoring of the performance of the administrator. It should also comprise ‘warning signals’ such as the deviation of costs from budget or the number and nature of complaints member.
The future: The world of pensions administration is very much in flux. Plan members increasingly demand internet access to their accounts or even specific on-line investment advice. Administrators require clear direction from pension boards on projects of such scale. Good pensions governance requires more than just the monitoring of the status quo. The pension fund business plan needs to include the wholesale review of the administration arrangements as an important point on the agenda.
Georg Inderst is an independent consultant based in London