Pensions open for outsourcing
One person's threat is another person's opportunity. The Dutch AZL Group, one of the largest providers of pension fund management in The Netherlands, sees the current changes in the regulation of the Dutch pension sector and the new requirements of European Directives, not as constraints or impediments to development but as possible new building blocks.
Until recently, the chief concern for Dutch pension funds has been the uncertainty generated by the provisions of the new Pensions Act, notably the nFTK, the new financial assessment framework, and the mandatory ‘Levensloop' life-course savings scheme. In September, the Dutch House of Representatives approved the new pensions act and voted on its proposed amendments.
Eric Jan Reemers, board adviser at AZL advising on all aspects of the daily management of a pension fund, says the issues currently confronting the members of pension fund boards are mainly Dutch regulations, fiscal challenges and fund supervision. The clients of the AZL Group include several of the ‘smaller' pension funds - those with less than e300m in capital. These pension funds are finding that these new constraints are likely to affect every part of their operations.
For some of the smaller schemes, consolidation will be an option, says Reemers. "If you look at the smaller pension funds in particular, you will see a trend towards mergers in the sector. Pension funds are changing dramatically."
The overall stability of the pension sector has decreased, he suggests, as a result of the increased workload, financial pressures and demands for increased professionalism from members of the pension fund board members. "The boards of pension funds have been confronted by a move towards more active management of the fund," he says. "Board members have also become aware of increased legal pressure due to pension fund governance issues. These changes have raised overall costs of pension fund management."
These political, fiscal and regulatory pressures have made pension funds more willing to open their books to third party advisers. Huub Dumont, the chairman of the AZL board, who has been working for AZL since 1987, says: "Outsourcing has now become a normal way of life." Pension funds that continue to manage in-house are now under pressure to explain to their stakeholders and subscribers why they have decided not to outsource, he says.
AZL is reaping the rewards of these changes in the market, Dumont says. "Service providers such as AZL, are taken on board by pension funds based on the expectation that they are capable of implementing and managing the resources according to requirements. All advice and consultancy provided is being presented within an integrated framework, based on assessments of more than one party."
Dumont says AZL's role is to be outwardly focused; addressing future challenges and strategies in the domestic or international marketplace. There is an increased role for AZL advising not only on the liabilities side but also on asset management issues. Generally, pension funds have become more mature, he says. "Independence has grown."
The distinction between the role of pure adviser and investment manager has also changed, he says. "AZL provides to pension funds not only the liabilities but also asset management in which ever form necessary. We have become multi-disciplinary teams." Increasingly, he says, pension fund trustees are not only concerned about getting the best return on investments or matching liabilities sufficiently, but are also ensuring that they stay in charge. "The issue for pension fund boards is how to stay in control and be able to direct the policy they have chosen."
The main strength of AZL, Dumont says, lies in offering a full service that is capable of providing the total management of all issues confronting a pension fund. "Our palette of services is meant to assist the board of a fund to keep control of all aspects," he says. "The issue of control has become the main driver for all future changes in funds, based on current financial and political situation."
AZL has championed the notion that people who are involved in managing a pension fund should be part of the board. AZL opts to have people who execute the strategy and policies as part of the management and board of the fund. These people should, at the same time, have management responsibilities, which means that they will be held accountable for their actions and results.
"Though we have proposed the participation of third parties in the board, the idea has not been totally new," says Reemers."Increased accountability of board members has been discussed for the last few years. Our proposal is another step forward to support performance of the targeted funds in future." The idea is gaining support, he says. "First reactions of the sector have been overwhelmingly positive. Increased checks and balances are hitting the right nerve of the sector."
Reemers is a strong proponent of the idea that the outsourced manager is a primary manager rather than a secondary partner in the management of the fund. New managers, he says, should only occupy positions in which they can manage issues based on their respective expertise or background.
The issues that are currently at the forefront of managers' attention are cost efficiency and benchmarking. Pension fund subscribers are becoming increasingly aware of the role of cost efficiency on the overall performance of a fund. At the same time, awareness of the role of benchmarking, and the fund's particular position in the sector, has also increased.
To reach a satisfactory level of cost efficiency and benchmarking, a board of a pension fund will need confidence in its outsourcing to third parties. Reemers says the pension funds need to put in place enough checks and balances to control and manage the increased workload.
He also warns that changes in International Financial Reporting Standards (IFRS) that relate to the movement of surpluses or deficits on to the balance sheet of the sponsoring company will demand a new approach. There is a growing need for pension fund boards and managers to consult the accountancy sector on these issues, he says.
The issue of pension fund deficits and surpluses is likely to become a hot topic in the coming years, says Audrey Ringens, head of AZL's actuary department. Ringens believes that the current new regulations are an effective way of tackling risk. "Market value is one of the best ways to counter the former problems of funds", she says.
However, Ringens agrees that some of the issues raised by IFRS about current market value and coverage ratios could have a detrimental effect on the relationship between pension funds and their sponsoring companies. Several companies already have already decided to end the direct relationship with a pension fund because of the expected financial repercussions of IFRS rulings. Some funds are likely to choose the option of reinsuring their liabilities.
Walter Schapendonk, fiduciary risk management director at AZL Investment Management, says that AZL resolves the issue of the accountability and responsibility of pension fund boards for investment management and financial risks by using the right set of tools and instruments:
"We take onboard the leading investment strategy issues of the respective fund, without having to put daily investment decisions and issues on the plate of the board," he says. "The so-called nitty-gritty but very important investment issues we take in our own hands, while keeping the board informed of the larger picture."
Fiduciary risk management is not the same as financial management, Schapendonk emphasises. The emergence of new investment markets and the need to match investment strategies to pension fund liabilities have been the main drivers for fiduciary management, he says. "The total impact of outsourcing of the sector has increased exponentially. Before 2005-2006, smaller pension funds had outsourced in general more than one service component to AZL, such as liabilities and financial reporting. Due to the fact that the pension fund sector has become more diverse and challenging, the pressure on the sector has increased."
Interest in fiduciary management has increased not only because of changes in the market, notably nFTk, but also because of developments of the consultancy sector, Schapendonk says. Additional advisers, such as accountants, are needed for independent certification or control. Yet for most pension funds it is no longer feasible to outsource different operations to different advisers, consultants and managers. A more integral approach of the total issue is needed.
Ringens agrees that there is a growing need for an integral approach, which will result in lower costs overall. She suggests that if a pension fund buys a total package, integrated within the existing AZL services, it can expect advice on any relevant issue. There will be shorter lines of communication between the pension fund and the adviser, which will increase the level of efficiency.
Outsourcing will give added support to the independence of pension funds, AZL maintains. Increased cost structures and workloads mean that there is a growing tendency for Dutch pension funds to merge which is likely to continue over the coming years. Using the integral approach of the total management of a fund, leading to lower costs, could be one of the many ways in which corporate pension funds in particular could retain their independence.
For AZL, success in the Dutch market depends not only on a stable pension fund sector but also on the ability to meet competition. The Dutch pension fund environment has changed dramatically, as EU Directives have opened up the European market to international operators. Dumont is optimistic, however. "Challenges should not always be seen as threats. Most of the time they also represent opportunities," he says. The DNB's supervision rulings and fair value are challenges which have become opportunities for management advisers like AZL. New fiscal changes and requirements by the DNB and the market regulator AFM have forced pension funds to outsource an increased part of their former work.
Further down the road, the opening of the European market will present AZL with new challenges, as new competitors will emerge not only on the European field but also in the Dutch market, Dumont says. "On the investment management market, Anglo-Saxon competitors are playing an increasingly important role. However, on the liabilities sector, the situation is different. The specific Dutch market represents a lot of challenges to international providers, as they have not yet the required insight knowledge and experiences," he says.
Current pension fund knowledge strengthens AZL's ability to internationalise its operations in future, if necessary, he says. "For the foreseeable future the Dutch sector is still to be considered our own home market, with growing competition of course, but largely to be ruled by current service providers. We're all likely to use the same terminology, but we do have our specific nationally orientated interpretation and expertise."