The administration outsourcing conundrum
Deciding when to outsource administration and who to outsource to is never easy. If you look at the costs involved, it becomes harder still.
Some pension funds have dealt with the issue by pooling in their resources. Three Danish pension groups, PKA, which administers eight pension funds, PBU, and Laerernes Pension, are forming a joint venture company to offer member services, actuarial services, financial services, and IT to other Danish labour market pension funds. Together they have more than 410,000 members, and the eight PKA funds will be the company’s first clients. Service to PBU will follow in mid-2007 (the company hopes to get off the ground in September this year) and to Laerernes Pension in early 2008.
But not every pension fund wants a joint venture. For those who want to outsource administration, there is a great deal to consider. The 2005 Pension Scheme Administration Survey of UK funds by Capita Hartshead reveals that third party administration cost inflation has ranged between increases of 4.4% to 6.2%. In-house administration schemes ranged from 4.2% to 5.8%. Across the range of schemes, third-party administration costs are on average some 8% less than in-house schemes.
Still, costs are not the biggest concern for UK pension funds when choosing a third-party administrator. The quality standards of the administrator was most important, followed by technical skills. “You need to have an IT platform, and if you maintain that in-house you need to train your staff and be up to date and design your own system. Then, when new regulations come in, you’ll have to change your procedures,” explains Stuart Heatley, marketing director of Capita Hartshead.
UK pension funds rate costs as their third biggest concern. And Allan Course, head of administration consulting at Watson Wyatt, believes that there is not enough empirical evidence one way or another about whether it’s cheaper to keep administration in-house or not.
Last year, the Pensioensfonds Horeca & Catering (PH&C) scheme in the Netherlands decided to pull away administration from third party provider PVF Achmea and bring it back in-house. “We have more than 35,000 employers and 200,000 active employees and 600,000 all together with retired people. With that kind of size we must look very carefully what we do,” says Eric Uijen, head of the scheme. At the time, the fund estimated that it could save up to 35%, with the profit margin and the value added tax it was paying. Now, says Uijen, the difference between outsourcing and doing it in-house is about 10%.
The fund decided it was best to do administration itself. “PVF Achmea is quite a good administration organisation but they have hundreds of clients, so if you want to do things that aren’t standard, they have a problem.” He wants to both reduce the costs of the overall scheme, and increase the quality of services. “I know this is very tough to do, but we are quite sure we can do it, given our infrastructure, communications, and technology capabilities,” he argues.
Consultants say that pension funds will have to consider their options carefully. For one thing, they must not assume that they can give up monitoring their administration the minute they have outsourced it, explains Georg Inderst, pension fund consultant. “At the end of the day, the employee will always go back to the company and you need to have some resources in-house,” he says.
Inderst identifies a range of activities that the administrator must be able to handle. They must handle membership database and administration, pension payroll and benefit payments, bank accounts and cash flow management, contributions, and financial accounting and reporting. They must also provide secretarial services, regulatory reporting, communication, and for defined benefit plans, investment and custody administration. For defined contribution plans, they must provide member accounts and individual transactions. Finally, administrators must be responsible for operational risk control, complaint and disputes.
Not all these tasks must be handed to one provider, of course.
“There’s no right or wrong answer about when to outsource. It depends on a huge number of factors. We always ask people what they are trying to achieve, and what they are most worried about,” says Watson Wyatt’s Course. The most important thing pension funds need to realise is that not all administrators are as good as each other, he says. “There are some that don’t do the basics well, and make mistakes.”
Pension funds have to realise that not all providers are equally competent. Then you have to ask yourself, what are you look for in your administrator. Do you want them to be proactive, or do you have a pensions manager who can instruct them and watch over them?”
Aside from costs and quality, Inderst also points out that efficiency, and transition, the process of moving from in-house to external administration, is important. As difficult as it is to transition to an administrator, it is even harder to bring administration back in-house. Course agrees. “Changing administrators means changing maybe 20,000 records and maybe calculation routines,” he points out. And, he says, changing administrators is “a heck of a lot of work. You don’t want to get it wrong and have to do it twice!”