Today, investment outsourcing is so much a part of pension fund management, that it is hard to imagine it any other way. But handing administration to an outsider is now common practice too, particularly in the Netherlands.

Increasingly complex demands from the regulatory and accounting sides have turned administration into a job that external specialists can often do more cost-effectively.

More pension funds in the Netherlands are turning to outside agencies for help with administration and investment, says Rudolf Hagendijk, chairman of the executive board at Dutch independent pensions administration organisation Mn Services.

“As regulations become more complex and regulatory pressures grow and with qualified staff in short supply, it is becoming more difficult for pension funds to meet all the requirements placed on them,” he says. “Outsourcing provides the solution.”

Outsourcing administration is a trend for UK pension funds too, says Carole Ward, administrative partner in the Cheltenham office of consultancy Barnett Waddingham LLP - and one that she cannot see reversing. “Cost is usually cited, but there are lots of other reasons,” she says. “Pensions regulation is becoming so complicated and pensions administration is not just a processing job.” Any administrator - whether in-house or external - should be able to explain some complex issues to scheme members.

Changes in pensions law in the Netherlands have made the overall costs of pension fund management more expensive, in particular, for some of the smaller pension funds. The new regulations, fund supervision requirements and fiscal challenges have meant that there is little alternative to outsourcing for some funds.Pension fund management groups, such as AZL Group, have been taking on new business as result of the new environment.

While outsourcing investment management piecemeal - mandating external managers for individual funds or asset classes - is the norm in the pension fund industry, some pension funds are choosing to use outside investment specialists more broadly.

Particularly in the Netherlands, many pension funds have awarded fiduciary mandates, passing on much of the complexity of asset allocation as well as complying with accounting and supervision regulations. Last year, Pensioenfonds Vervoer gave Goldman Sachs Asset Management a fiduciary management mandate across all of its assets.

According to research by Dutch consultancy Bureau Bosch, outsourcing has increased dramatically in the Netherlands.

Total Dutch institutional assets managed externally were €502bn at the end of the first quarter of 2006, up from €353bn a year earlier, which means an increase of 42%. Going
back to 1993, only €95bn of assets were managed externally.

This increase, the company’s director Frits Bosch has said, is strongly related to the introduction of the new financial assessment framework (nFTK).

Although it can make sense for a scheme to contract a specialist firm to take over its administration, one of the barriers to doing this is that trustees want a bespoke service, says Ward. “This ‘one size fits all’ approach may not be attractive to everyone,” she says. Barnett Waddingham, on the other hand, offers a tailored administration service and often a dedicated helpline for members to access, she says. Some schemes want their third party administrator to be able to deal directly with their members, she says, and this can be incorporated into the service.

Where the third-party administrator handles correspondence, this can be tailored for the particular scheme and, for example, use its own pension scheme letterhead. “We could also incorporate pensions communications into a company newsletter, or design a newsletter specifically from the trustees,” says Ward. Service features such as the helpline are important, not least for easing the often uncomfortable transition. “When an in-house scheme outsources, there is a certain feeling of loss of control,” she says. Company staff are used to being able to walk along to their HR department to ask questions, she says.

“It’s important that they do not then find themselves calling a remote call centre,” she says. “The people who answer the phone must be the people who are dealing with the scheme. Members definitely need that personal touch if they’re going to third-party administration,”
she says.

Most of the work involved in pensions administration - collecting contributions, paying benefits, keeping membership records - requires good IT systems, which can be costly when the time comes to upgrade them.

Smaller schemes are more expensive, per member, to administer than larger schemes.

IT is an important part of the whole outsourcing debate, says Ward. “Web access is particularly popular, and the in-house systems often cannot do all that the scheme requires,” she says. “That makes them question whether they should be outsourcing,” she says.

Last Summer, Mercer Human Resource Consulting responded to the growing interest in outsourcing by launching a new service for pension schemes. Called ‘Mercer Retirement Solutions’, it gives schemes administration, pension scheme management, asset management and member communications for a fixed fee.
It saw this as the single largest growth area in UK pensions over the next
five years.

The trend in the UK for entire pension schemes to be outsourced to
specialist pensions buy-out firms, such as Paternoster and Synesis, continues. In most cases, the sponsor’s decision to offload a pension scheme in this wholesale way is less about cost savings than removing the liability risk from its own balance sheet.

In November, Paternoster, which was created by the former UK chief executive of Prudential Mark Wood, said it was taking on five pensions outsourcing deals, including £11.5m (€17.1m)in assets and around £14m in liabilities of underwriting agency Cuthbert Heath’s final salary scheme.

But the economy of scale argument still lies at the heart of the pensions buy-out business. By bringing together several pension schemes, Paternoster can get better deals with asset managers and better terms for the management of the money within the fund, Wood has said.

But whatever the benefits, there are also potential pitfalls in outsourcing, says Peter Damgaard Jensen, CEO of Danish pensions organisation PKA. “Outsourcing in its purest definition means losing competences and hands-on expertise in the long run,” he says.

A pension fund must decide whether they are willing to risk that, he says. If not, then the best solution may be to join forces in the way that PKA has created pensions services company Forca, he says.

“It is very important that you ensure an ongoing process to monitor the outsourcing process and the quality in the business outsourced,” he says. “You need to ensure daily insight in basic business demands in order to ‘keep in touch’.”