What do we mean by outsourcing pensions administration? At the basic level it means placing a service with a provider who is independent of the trustees or sponsoring employer. There are many degrees and many ways of outsourcing:
o Partial: where only part of a service is outsourced, eg, payroll or transfer casework, the rest of the service remaining in-house;
o Full: where all elements of the service, except contract management and staff, are passed to an external supplier;
o Contractorisation: where an external supplier is given a contract to take over an entire service, inclusive of staff, often in situ; and
o Partial contractorisation: where an external supplier is appointed to take over the management of a service, the staff remaining employed by the sponsor and, most likely, in situ. Outsourcing is never so black and white; various shades of grey exist in between. Contractorisation most often occurs in very large scheme cases where the administration function is also large.
The most common reasons for outsourcing are:
o Fundamental redesign of the pension arrangements – causes a redesign of service delivery;
o Introduction of a DC scheme – if there are no existing DC skills in-house and a need to outsource one aspect of the service therefore the whole service is outsourced;
o Major IT problems – need to implement new systems but prefer not to bear the disruption, time and costs;
o Loss of key staff - recruitment difficulties;
o Major company re-organisation;
o Volatile active membership;
o Dissatisfaction with the in-house service and inability to effect change satisfactorily; and
o Corporate philosophy.
These days, cost rarely features in this list because in most cases outsourcing costs more. It is not usually one reason that drives the decision to outsource but a combination. It is important to note that the decision to outsource must be based on sound reasons with precise objectives; in this way, the sponsor is more likely to be pleased with the outcome.
Hindsight is invaluable. Potential outsourcers should draw upon the many hard lessons which have been learned – both by the providers and the sponsors – and some of the early outsourcing exercises have now been through contract novation, re-broking and switching of providers. Many trustees are nervous about rebroking and put up with very poor services instead. Why is this? Possibly because the original outsourcing exercise was such a painful and lengthy experience that they cannot face a repetition with another provider. The good news is that some organisations have moved their services to other providers successfully and with much less pain than the original outsourcing exercise.
Whether you are outsourcing your pensions administration for the first time or re-broking an existing third party service, the pitfalls are very similar. The most common reasons why services fail are:
o They were poorly specified – the provider fails to deliver to expectations because too much was assumed or overlooked by both sides during the selection process often resulting in increased costs and disappointment;
o Neither party had been open and honest about their starting situation – the provider failed to recognise and report its limitations, the sponsor hid essential information about data quality, staff issues, etc, resulting in overruns, service deterioration, poor staff morale and increased costs;
o The relationship between sponsor and provider breaks down – there is little dialogue between parties, contract management skills are poor and afforded low priority, both parties get nasty shocks, an “us and them” blame culture develops and everyone suffers. Strong contract management will avoid this;
o The contract does not recognise the need for partnership – the contract fails to accommodate change, it may be too prescriptive in some areas thus handcuffing the provider and too vague in others affording no automatic contingencies when there are problems. A balance has to be struck between protecting the interests of the members and recognising the sometimes unpredictable nature of the services required;
o Performance measurement – too much reliance on hard statistical targets which are a poor measure of quality on their own. A more holistic approach to performance measurement is required which recognises the partnership between sponsor and provider. Detailed penalty clauses give the sponsor a big stick with which to beat the provider but strong contract management seeks to recognise the problems of all parties through consistent dialogue and investigation;
o The biggest mistake in re-broking services is to recycle the original outsourcing documents which will be out of date and fail to realise the opportunities afforded by a new provider. This list is not exhaustive.
What are the advantages of out
sourcing? In summary, the main advantages are:
transfer of risk, but not responsibility, to a professional provider:
o Provider gives access to a wider pool of resources and skills;
o Provider takes responsibility for recruitment;
o Immediate access to a range of technology based services; and
o Immediate access to quality management systems.
Disadvantages in-clude: o Costs may be more difficult for trustees to control – activities falling outside the service agreement, or increased volumes will incur additional fees. Project work likely to be time costed;
o There may be potential for conflicts in client service priorities – trustees are no longer the sole customer;
o Loss of ‘drop in’ opportunities for customers, new team may be remote;
o Trustees need to develop new external interfaces and closely regulate the flow of information;
o Leading providers may not bid for smaller scheme business.
The transition of services will require careful management and success is not guaranteed.
Outsourcing models: There are many outsourcing models which may be considered. Some sponsors are going to market for pensions, payroll and HR administration services, sometimes from one provider. Others split the services going to specialists for each area. There is no one answer for all; the sponsor has to decide the best fit for his organisation.
Tripartite approach: If you decide to outsource payroll, HR and pensions administration it makes sense to maintain one central database for all basic employee information and use this to supply all other specialist service applications. Tripartite services encourage efficiencies and enable wider access to e business tools. However, it is important to be certain that the chosen provider has the ability to provide an integrated service and is equally skilled in all service areas.
Sponsor front office/provider
back office: This model, usually using web enabled solutions, allows the sponsor to ‘front’ the service and use the provider to handle the processing in the back office. This gives the sponsor a hands-on feel but largely removes the administrative burden. It also gives the sponsor more of a management role across the whole service.
Strategic partnership: This model, which applies mainly in a DC pensions environment but could be adapted for DB, uses a provider’s system under licence with the chosen provider. It usually gives control of the administration to the sponsor in a similar way to an in-house service but removes the IT burden. This means that the sponsor does not incur of IT selection, implementation and support.
Lorraine Harper is a director in KPMG’s People Services Group in London, with responsibility for giving advice to trustees, pensions, payroll and HR managers