Well established trend
The move to pass pension fund administration to third party operators rather than do it in-house is now a well established trend in the UK pensions market, as in a number of other countries.
In an annual survey of pension funds’ attitudes to outsourcing, published earlier this year, administration specialists, Capita Group reckons that just over a third of UK funds have outsourced their administration, based on a sample of 22 funds, with assets of £111bn (E174bn) and membership of 3.2m, around one third of total occupational scheme membership.
A more recent analysis by consultants Jardine Reeves Brown found that of a sample of 216 plans, with £153bn of assets, found that some 58% of funds still did their own administration, around 39% used a third party provider. But 18% of the schemes administered internally have studied outsourcing. “Plans are act-ively considering this as an option,” comments the consultancy firm.
The schemes in the Capita survey were mainly the larger defined benefit (DB) schemes. These said they retained the activity in-house, as it gave them “better administrative control”. But Capita counterbalances this with the survey finding that nearly 70% of all schemes reckon that there will be a continued move in favour of third party administration in future.
Since the merger of William M Mercer and Sedgwick Nobel Lowndes, the combined group is now the biggest UK pensions administrator by far, says Philip Brentnall, who comments that the trend to outsourcing DB schemes may not be quite as pronounced as before. One reason may be that the changes brought about by the Pensions Act caused problems.
“Some of the administration providers had problems with their systems as a result and had to do work manually.” And of course, currently, the worries about Y2K failures may persuade some funds to defer any decisions until the turn of the millennium is well behind them.
Brentnall points to the pressures often being exercised with the finance departments of corporates anxious to pass the ball to third party administrators because of Pensions Act, with the move to defined contribution (DC) likely to be the main challenge to in-house administration. “You need very slick systems if you can to administer your own DC schemes,” he warns.
UK pensions schemes are increasingly turning their minds to this, but no wholesale switch is underway. According to the Capita survey, over 10% of the larger schemes have or are introducing DC or hybrid schemes. “There are certainly administrative issues in getting to grips with such moves,” says Brentnall of Mercer. Not only is DC more costly to run than DB as it is more complicated, this also makes it more prone to mistakes. “You do expose yourself to the risks if you insource and there is no one to sue if it goes wrong!”
On the cost issues, the Capita survey found that in 1998, third party administration costs increased by between 3 to 8.5%, well ahead of in-house administered schemes, where increase were in the 2.3 to 4.8% range. The lower in-house costs were attributed to the current low inflation levels and that the costs associated with the Pensions Act implementation had been absorbed at last. But Capita points out third party administration costs are “on average still some 18% lower than in-house run schemes”.
One surprising result was that over 30% of in-house administered schemes did not know the cost of their own administration service.
But cost is not everything and the implications of passing administration to third parties needs to be viewed much more deeply, says Trevor Cook of consultants Specialist Pensions Services. “Frequently, companies’ finance directors say ‘We are here to run the company and to get rid of non-essential activities, so we will outsource pensions administration’”.
But too often in this scenario, the role the pensions manager has of advising the board and trustees on pensions policy and issues is overlooked. “People think that without the administration function they do not need such a high-powered person anymore, in particular, they do not need to pay so much money. So the job becomes devalued, and the question of advising the company on best value in pension matters or the implications of mergers and acquisitions from a pensions perspective more or less disappears, as well as does the source of advice to the trustees.”
In a well organised company, this would not happen as the advice and contribution of the pensions manager, with “an almost board or just sub-board role” is appreciated, says Cook. “In UK and Irish companies, boards do not have sufficient understanding of the role of a good pensions manager.” The end result is that the employer often has to end up paying for very expensive actuarial consultancy and advice.
Pointing to the Netherlands, he says that when outsourcing takes place it can mean that both administration and investment go out together- “they often hand out everything to one group”. “Can they be sure that the person who is the best administrator is also the best on the investment side?”
He adds: “Outsourcing can be beneficial, if it is done properly, but otherwise, you are in danger of devaluing an important job, and policy matters tend to get over-ridden.” But companies only learn this when they have to pay costs of merger and acquisitions, when the consultants benefit enormously. “They could end up paying a lot more in consultancy fees than they could ever gain from the saving in outsourcing.”
In the Netherlands, the consultants on the ground see some trend to outsourcing administration, but it is not very pronounced. As Nico Top, who runs Practis, the software systems consultancy , puts it:”Management s of pension funds still want to keep track of their own activities, so there is still a small mountain to be got over before they go to outsourcing. Even the smaller schemes want to do their own”
The growth in the capability to provide outsourcing has come from insurance companies, who are moving into selling administration services. “Most of the clients for our administrative systems are insurance companies,” says Top.
The realignment activity has been intensive in the Dutch market, with PVF, a major pensions administrative and investment group, joining up with insurer Achmea, while Robeco, Rabobank and Interpolis group have announced their merger with van Spaendonck, an independent pensions administrator. “That will be very powerful, as they also have Beon, the Groningen-based administrator, in the group,” Top adds.
Watson Wyatt Brans, the Amsterdam- based firm of the international consultants, who are also active in supplying software systems to pensions funds, says there is tremendous demand for systems among the larger funds. “Many funds are renewing their systems, especially as company pension funds have to provide new individual arrangements. Our pension system section is growing and is hampered by lack of personnel, otherwise we could market many more,” says partner Arjan van de Griend.
A recent development both he and Top note is the move by a number of larger funds to get together to see if they could share the costs of developing pensions software, supported by international software groups keen to get into the market.
In Switzerland, Europe’s next biggest pensions market in terms of assets, administration services market is dominated by the pensions consultants, though there are signs of new players emerging. While the smallest funds will buy integrated pension packages from the insurance companies and the banks, the largest will do their own thing.
Outsourcing is seen to be a middle market activity, though according to Mike McShee of Buck Consultants in Geneva “the threshold below which people will think of outsourcing has become higher and schemes with a 100 to 2,000 members are candidates for the consultants’ services.
“Underlying the move is the DB /DC decision consideration.” The legal requirements have made the administration task more demanding, especially. “In the last five years, the elements in the administration task has got worse and more complex, which has made people more interested in delegating responsibility and the work.”
Buck see the area as a priority one and have developed a total payroll system in their drive for business, says MacShee. In addition to the other major consultants competition is not likely to come so much from the insurers or the banks, but from initiatives like that of ABB Vorsorge which has entered the third party business for both pensions investment and administration business.
There are signs that the structures might be changing and that new providers might be emerging. In the Netherlands, Watson partner van den Griend would not be surprised if the custodians moved in the direction of pensions administration. He notes the decision of ABN Amro to acquire an administration specialist. At global custodian State Street Bank’s headquarters in Boston, Ron Logue sees pensions administration developing as a possible offshoot from the pooled funds administration business they are building up in the UK and elsewhere. The rise of DC could drive this forward, though he notes that his group was only likely to become involved in DC administration, where there was an investment element as well to help offset the heavy costs in DC servicing. Fidelity’s drive to build up a DC business with investment and administration has become cautionary tale for international adventurers.
But cross border incursions on the administration side is already on the cards from the technology suppliers. Mercer’s Bretnall says: “We are looking to see where we can leverage our good IT in different European markets. Every complication that the continentals are thinking of in terms of lifestyle investments and so on, which we have tried in the UK. The best systems here can cope with those tricks.” He adds that the group has already designed systems to meet German requirements based on UK DC software. “Everywhere we look in Europe, most of what is required can be handled by a UK system, with a little bit of adaptation.”
The consultants are actively exploring what can be done to support the market in Europe and that pensions investors are prepared to talk to UK providers about their need. Bretnall also points to the success Mercer is having with developing sizeable schemes for international groups. “Multinational clients are setting up international pension plans for their workforce around the world, perhaps, using Jersey trusts to achieve this. I have seen one scheme grow from 200 to over 2,000 members, as people join from all around the world.” These plans used to be small offshore schemes for senior employees, but now they are being used down the line in corporates. “If the trust rules are drawn sufficiently broadly, it is possible to have different sections for different groups of people,” he says. The administration can usually be located in a choice of places. Even the UK is possible nowadays, as the tax authorities have accepted that to do the re-cord keeping and administration does not turn it into a UK pension scheme.
This has now led multinationals to consider their other schemes and ask if on the administration side whether it is possible to run some kind of administration for all their pensions activities located worldwide. “This is not a storm yet, but just a number of gathering enquiries,” says Brentnall.
Multinationals are also catching onto the idea of using the multi-manager structures, according the David Duncan of Global Asset Management, the specialist manager, which has recently been bought by UBS. This gives the multinational the option of dealing with one central point. “They can allow their subsidiaries the flexibility of investment choice, provided they pick from the stable of funds. The local trustees can be seen to be in charge of determining their asset allocation within the structure.” But Duncan does point out that the GAM funds are located offshore so will not meet everyone’s needs. “People who think they may never be able to achieve their own central pool, are turning to multi-manager funds,” he maintains.
Another who thinks the quest to find a vehicle to hold the assets of funds seem to be losing steam is Michael O’ Brian, an investment consultant with Towers Perrin in London. He says that the hopes for the Pension Fund Pooling Vehicle (PFPV) getting anywhere quickly enough have waned. The idea of setting up a Sicav in Luxembourg or elsewhere seems to have petered out as a serious runner, due to tax considerations. There is some interest in setting up a captive insurer and then reinsuring European pensions assets into this, but even that is not without its difficulties. “In some countries, an insurance wrapper or some arrangement may be necessary,” says O’Brian.
He appears to have reached much the same conclusions as Nestle has on pooling (see box): “If a client has assets in a number of countries, we have them aggregated for investment charges, so if you have 20 portfolios of $10m, then you pay fees based on the $200m and not the smaller individual sums. You can now get the economies of scale by aggregating. At American Express Asset Management in London, Peter Lamaison says the group is seeing these types of mandates increasingly. “We charge on the overall basis, but can add something for the additional administration.”
But O’Brian sees potential in the multi-manager approach. “There is interest here and I think this will really open up whet the big managers with integrated administration will open this up to a second stable of managers.” He is certain that things will go this way. “You will have a situation where say Mercury opens up their administration and allows Putnam or Capital International in there alongside themselves. I cannot see why you cannot get to the stage that you have more and more managers there through an administration system facilitated by one of the investment managers.”
As the banks in continental Europe move into the administration business and develop the infrastructure software for this. “They will offer links though their system to other investment houses, provided they get a slice of the mandate themselves.” More clients are coming over to the multi-manager concept. “What clients are saying is that instead of suffering with the vagaries of a particular investment house, they will try to neutralise with a complementary style,” says O’Brian. “They try not to fish in just one part of the river.”
One group that has tried to address the pooling demands of international is State Street Global Advisors. Jean-François Schock, who runs the Belgian operation of the group says: “People are looking for a common denominator, but there is no ideal solution.”
He adds: “We offer pooling structures and the best ones and the ones we have had most success with is our series of Balzac French-domiciled country indexed funds.” Already 30 of these have been formed and bond and cash funds are being added to the range, he says. The advantages of France are the transparent cost structure, where the quoted management fee is the same as the total expense ration. These funds are available to the public in France, as a total 50bp fee, which can be rebated in part to institutional investors. “They are efficient from a withholding tax viewpoint. We have been successful in the assets we have collected of over $1bn, coming mainly from internationally operating groups. “We believe this is the most efficient way of delivery to investors,” says Schock.
In the discussion as to how best to outsource and manage their international schemes, Anthony Ashton at consultants Callan Bacon Woodrow in London thinks international groups often put the cart before the horse. “If we physically pool funds into a Sicav, a unit trust or whatever vehicle the savings from the pool are administrative savings, which could be around five or 10bps. I would be surprised if it were 10bps. That is the potential cost savings in the physical poling of assets.”
On the other hand the cost savings that are available to groups from ensuring global best practice in how it determines its strategy, structure and manager selection could be “hundreds of BPs”, he says. “Far more is to be gained by ensuring a sensible process is being gone through than by trying to pool assets.” That does not mean that there is an ideal investment structure that works for everyone, just a process to be gone through by each local operation to implement an investment structure.”
Doing this properly can save a good sum of money, much more than the meagre picking on the administration side. “Our message to clients is get the big things right first in terms of choosing good managers, hiring and firing at the right time, all this saves money. If then an opportunity to pool comes along, then take this as icing on the cake.”
Ashton sees increasing outsourcing on the investment side by European pension funds, for pragmatic reasons. “There is more money to be made in fund management than in most other businesses, enabling managers to pay for the brightest and best. They can pay significantly above what internally managed pension funds can pay. We have seen in the Netherlands, the younger generation recruits to the pension fund being sucked out into fund management, attracted by higher pay and better career pros-pects.” This makes it harder for internal funds to get the best staff. “You have to have good people or you will not obtain the best results. The pattern will be the same there as in the UK, with a decline in the number of funds run internally.”
The problem with any of the current pooling structures are the tax implications, he maintains. “Pooled vehicles run the danger of being tax inefficient.” Eventually, that will be solved with tax harmonisation in Europe, which could take several years.
However he is hopeful for progress on the pensions taxation, as a result of the recent EC communication on pensions tax. “This is going on the right lines as it aims to achieve mutual recognition of pension funds. This just says that authorities should treat membership of a pension fund in one member state the same as in own member state.” So a German in a Luxembourg pension fund would obtain the same tax benefit as when he is in a domestic pensions arrangement. “This makes it difficult for the Germans to argue that they must protect their tax base as there is no tax difference.”
He predicts that the multinationals will lead the way to very rapid consolidation of pension fund administration or asset management into European centres such as Luxembourg, which is gearing up for this. “That is where groups are going to gain those additional five or 10 basis points. All we need to achieve this is mutual recognition of schemes, not tax harmonisation. Mutual recognition is the key to pan European pensions.”