Despite talk in the media of a surge in outsourcing, in reality it’s less than reported. Instead of fully outsourcing administration, many funds are either considering taking the plunge or developing an internet site to accommodate more demanding members. Nevertheless, there remain some very good reasons for outsourcing or for developing an in house intranet or internet system. Administration is more complex today, fund members are more clued up and there is continued pressure to cut costs.
Julius Baer, the Swiss independent bank, became the first continental European institution to outsource when it recently appointed America’s Bank of New York to oversee its fund administration and custody. Europe lags the UK market where many of the funds outsourced administration following the Maxwell fiasco. According to Clive Witherington, a senior consultant at William M Mercer there is a fairly basic check list to gauge whether outsourcing is worthwhile. First up for review if the in-house IT system, often prohibitively expensive to replace. “The need for really good IT and exploitation of IT is absolutely imperative but the problem at an individual pension plan is that there are very few of sufficient size that can afford to make the investment in IT to get the job done well,” says Andrew Dawson, deputy managing director at Gissings consultants in London.
If a pension scheme is mature and there are a great number of pensioners compared with contributors, it makes sense to outsource as you are effectively running an in house department for people no longer at the company. A switch from defined benefit (DB) to defined contribution (DC), so prevalent across Europe, often leads consultants to recommend outsourcing their administration. “DC administration is quite a technical subject and it’s difficult to recruit people who have these skills,” says Witherington.
This shortage leads consultants to check in-house personnel for experience and turnover of staff. A scheme’s size and the number of employees servicing it have a bearing on whether to outsource. For smaller funds it can be risky to run the fund in house. There are likely to be a handful overseeing the scheme and if they leave or are poached, it can leave the scheme exposed. Staff retention is paramount and due to the shortage, it’s often large institutions with deep pockets who can afford skilled administrators. “In a situation where the pensions section is five of six people you’ve got the recruitment and retention problems,” says Jeff Houston, business development manager at the London Pension Fund Authority.
There’s another incentive for experienced administrators to gravitate towards financial institutions and that is career development. Small manufacturing and commerce companies find it harder to lure top personnel. Says Dawson: “The in-house option isn’t that attractive. The next chief executive isn’t going to be picked from the pensions department.” Combined, the above sounds like a death sentence for the-in house administrator. Not so, says Mercers’ Witherington. “If a company has a stable employee base and a decent level of technology there wouldn’t necessarily be any overt reason to look at outsourcing, though we would do cost comparisons.” If the in-house team are efficient and the IT adequate, it’s normally difficult to justify outsourcing on a financial basis.
In the UK though the 1995 Pensions Act has made administrating pension funds more complicated and Dawson says Gissings’ clients have tended to outsource administration. For the last 25 years the British government has pushed through major legislation every five years adding to the complexity. According to Houston members are nowadays more knowledgeable and demanding and this fuels the cost of administration. Outsourcing to an expert team or creating an internet access to the scheme is effective in containing costs.
Such a containment is likely to become more important. Britain’s government has announced that, as of next April, insurers offering stakeholder pensions will have to keep annual investment and administration costs below 1% of the fund’s value. Management consultancy Cap Gemini Ernst & Young recently launched its Silver Bullet solution, an e commerce system aimed at financial services companies planning to offer cheap products like stakeholder pensions. The new service produces a low cost, self service environment where employers and employees can track their pensions and carry out online transactions and fund switches via the internet, WAP phones and interactive TVs.
Alan Walker, vice president of financial services at Cap Gemini, says there’s great potential in the European market: “If you look at Europe they have got a bigger pensions timebomb than we’ve got…when they eventually address it they are going to be pushing people towards private provision.” Insurance company Skandia Life has launched a new online pensions administration system and the BP Amoco pension fund has recently set up an internet site that provides online information including, amongst others, accruals and eventualities for different retirement age of its members.
Dutch airline fund KLM, like other smaller funds, has outsourced management of its E8bn assets. “ABP and PGGM can afford with their amounts of assets under management to hire a group of managers and do it all in house…what seems efficient for the big funds seems less efficient for funds like ours” says Fons Lute, head of investment strategy research. KLM concentrates in attracting, monitoring and evaluating external managers and the outsourcing have enabled the fund to invest in more specialised investment categories including emerging market debt and high yields in the US. “We feel we have a better balanced portfolio now,” says Lute. In 1998 the fund underperformed the benchmark, last year it outperformed marginally.
Other funds have been less enamoured by complete outsourcing. Houston says that many pension funds now give a lot more thought to wholesale outsourcing and many are even sceptical. “The reason they are having second thoughts is that the first bout of outsourcing was driven by cost…people are seeing that possibly this wasn’t the right way to go about it,” he says. Following the first round of outsourcing there was a feeling among members of neglect as there was no one around to service the fund and Houston is adamant there will always be a place for an on-site personnel service.
Cap Gemini’s Walker says that clients are far keener on examining the options but few are willing to make the transition. “If you’re going to outsource strategically, you’ve got to do it for all your products and not many people feel it is right to relinquish such a degree of control for their entire product range,” he says. In the early 1990s there were a lot of people trying to get into the market with the result that some of the bids for administration were unrealistic. Many pension funds were disappointed “Basically the standard of service didn’t come up to scratch,” says one consultant. “Many saw pensions as a purely transactional processing job and they forgot the human side of it.”
PGGM, the Netherlands’ health sector pension fund, outsourced its asset management over 10 years ago, to a number of external managers but since 1998, it has begun to repatriate funds. Alfred Kool, spokesman at PGGM, says Roderick Munsters, PGGM’s chief investment officer appointed two years ago believed in the funds’ ability to manage itself and he led the drive to repatriate the funds. “We were not disappointed but simply the thought that if we did things in house, the yields might be even higher. They weren’t bad but we are always striving for better results,” says Kool. Last year overall return on the fund was 22.7% compared with 18.4% in 1997, the year before they repatriated. PGGM still has some assets externally managed but the percentage managed in house in growing.
Deciding to outsource boils down to chasing economies of scale and naturally larger funds have the wherewithal to outsource administration and asset management. “It’s often difficult for industrial and commercial companies to pay the same sort of remuneration to fund managers that investment management houses would be prepared to do,” says Nick Sykes, senior consultant at Mercers. If the fund runs into billions then often the company is able to pay top managers and this is borne out in that some of the UK’s largest funds, including BP, British Aerospace and British Telecom, run their own funds.

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