First Time, Right Time: The Power of Pension Outsourcing

First Time, Right Time: The Power of Pension Outsourcing Mercer and Chatham Partners Pension Administration Survey 2011

Contents Key findings... 2 About the research... 3 Pressing issues... 4 Barriers to adoption... 5 Outsourcing drivers... 6 Interest in outsourcing... 7 Key benefits... 9 Case studies... 11 Provider selection... 12 Conclusion... 12

Key findings Better service and cost savings are cited among the top benefits of outsourcing, with respondents looking for better technology, access to best practices and ease of compliance. Regulatory changes drive the need for compliance and technology investment, further escalating the costs of internal administration. These factors are among the top drivers for outsourcing and are common across the countries surveyed. As a result, 45% of survey respondents who are currently using an in-house pension administration function expressed an interest in considering pension outsourcing within the next three years. Interest in first-time pension outsourcing among survey respondents is stronger in Europe than in the UK, reflecting different phases of outsourcing market maturity. Smaller schemes express a stronger interest in outsourcing than the larger ones, as they are more affected by increasing costs of compliance and technology investment. Respondents in the HR function showed more interest in outsourcing than their colleagues in Finance and the Executive/Board functions, as HR is more affected by increasing regulatory and compliance burdens. The main barriers to outsourcing include the perception that cost savings from outsourcing are not easily discernible and that internal administration can deliver a better service. However, it is a challenge for companies to accurately estimate the costs of internal administration and, therefore, the level of cost savings that outsourcing can deliver. Moreover, only 55 have considered outsourcing in the past and, as a result, may not be familiar with the full spectrum of the latest outsourcing capabilities. Providers of outsourced services can help companies understand the true costs of internal administration and create a broader awareness of outsourcing services. 2

About the research This research is a joint project between Mercer and Chatham Partners, an independent market research firm, to assess the need and interest in first-time pension outsourcing in the UK and Continental Europe. In this report, we examine the most pressing issues in pension scheme administration, evolving needs and priorities of companies administering pensions internally, and key triggers for first-time pension outsourcing. We present the survey results and interview findings along with a commentary that provides Mercer s interpretations and perspective on this subject matter. Chatham Partners conducted the online survey and phone interviews in February and March 2011. There were 87 responses to the online survey and 15 follow-up telephone interviews. Not all respondents answered each question. Forty-three percent of the survey respondents are companies in the UK and the remaining 57% are based in Europe, including Germany, the Netherlands, Switzerland and Belgium. This research focused on large companies, and consequently, 90% of survey respondents have more than 1,000 members in their pension schemes. The survey respondents are a fair representation of Finance, Executive/Board and HR job functions. By design, all companies included in this survey currently use an in-house pension administration function. We are enormously grateful to all respondents, and we would like to thank them for their valuable input and participation. Respondents by function Respondents by number of pension scheme members Other* 22% Finance 30% 500 1,000 10% HR 22% Executive/Board 26% 1,000 10,000 35% >10,000 55% Total: 87 Total: 87 * Other includes pension committee members, compliance managers and independent trustees 3

Pressing issues When asked about the most pressing issues surrounding their pension schemes, most respondents cited funding pension liabilities and meeting regulatory requirements. Both of those issues are more urgent for UK respondents. Funding pension liabilities is a pressing issue for 82 in the UK versus 54% of those in Europe. In addition, 64 in the UK versus 42% of those in Europe indicate that meeting regulatory requirements is a pressing issue. A number of those issues are interconnected. For example, difficulty in funding pension liabilities creates the need to change plan design, while meeting regulatory and compliance requirements leads to further increases in administrative costs. Pressing issues surrounding pension schemes Funding pension liabilities 54% Meeting regulatory/compliance requirements 42% 64% Servicing active and retired scheme members 38% 39% 48% Changing plan design to limit liability growth 44% 82% Rising administration costs 27% 26% UK Europe End-to-end outsourcing solution Plan sponsors and fiduciaries, already overburdened with compliance requirements, have limited time and resources to deal with a fast-moving market. Employers that have closed or frozen their schemes and are targeting an eventual end game, which may include scheme discontinuance, are being forced to wrestle with the strategic, operational and re-sourcing challenges associated with this complex task. The Mercer Dynamic De-risking Solution (MDDS) is an end-to-end outsourcing solution for sponsors and fiduciaries who wish to manage their plans investments and move to de-risk their plans. It offers a tailored governance framework that seeks to lock in market gains and provide a degree of protection against downside equity risk. Mercer s experts will work with clients to define their pension risks, budgets, priority markets, target funding levels and timeframe. Once these parameters are agreed, a holistic de-risking roadmap will be developed to move the pension plan towards the required funding level while progressively reducing risk. 4

Barriers to adoption Only 55% of survey respondents have considered outsourcing at some point in the past. The main barriers to outsourcing include the perception that internal administration can deliver a better service and that cost savings from outsourcing are not easily discernible. The respondents who have never considered outsourcing are more likely to believe that they can deliver a better service in-house compared to those who have reviewed outsourcing options in the past. In contrast, those respondents who have considered outsourcing view their limited ability to commit internal resources as a barrier to adoption, more so than those who have not considered outsourcing in the past. In contrast to Europe, respondents in the UK are twice as likely to believe that they can deliver a better service internally. Yet, only 43% of the UK respondents have considered outsourcing in the past. Considered outsourcing in the past 55% Considered outsourcing in the past 64% 45% 43% Not considered outsourcing Considered outsourcing UK Europe Barriers to adoption We can deliver a better service 46% 61% Cost savings are not easily discernible 58% 52% Culturally, not a good fit 34% 29% Not considered outsourcing Considered outsourcing Could not commit resources due to other pressing issues 21% 40% Barriers to adoption We can deliver a better service 36% Cost savings are not easily discernible Culturally, not a good fit 31% 32% 46% 67% Could not commit resources due to other pressing issues 22% 38% UK Europe 75% 5

Outsourcing drivers Regulatory changes drive the need for compliance and better technology, further escalating the costs of internal administration. These factors are among the top drivers for outsourcing and are common across the countries surveyed. Changes in international and mark-to-market accounting standards have highlighted the threat of defined benefit pension liabilities on a company s credit rating, which, along with the worsening economic climate, have encouraged companies to outsource their pension administration. Some factors, however, are unique to each country s market and regulatory environment. In the UK, scheme closure, accelerated by liability growth and the burden of regulatory requirements, is the top driver for outsourcing. Improved administration can provide greater control of data and processes, making the preparation for closure and de-risking more efficient. In Europe, however, HR transformation rather than scheme closure contributes to pension outsourcing, going beyond cost savings, with the focus on improving the provision of HR services to employees. Additionally, in Europe, increasing regulatory complexity and changes in plan design become reasons for outsourcing, as such expertise is usually not available in-house. As a result, companies turn to outsourcing providers, looking for their best-in-class technology, enhanced member services, and pension and compliance expertise. Top 5 factors that would lead to outsourcing Average weights* UK Europe Factor % Weight Factor % Weight Scheme closure/wind-up 20 Escalating costs 14 Escalating costs 16 Regulatory changes 14 Regulatory changes 12 HR transformation 13 Access to better technology 9 Changes in plan design 13 Transition from defined benefit to defined contribution 9 Access to better technology 12 * Average weights of all responses to the following question: Which of the following would cause you to outsource the administration of your pension scheme? Please allocate a weighting percentage across these categories. Your total should add up to 100. 6

Interest in outsourcing Overall, 55% of survey respondents expressed an interest in pension outsourcing, with 45% expecting to outsource within the next three years and an additional 10% expecting to do so in the long term. Interest in outsourcing by scheme status, UK only The interest in first-time pension outsourcing is stronger in Europe than in the UK: 58 in Europe versus 27 in the UK expect to consider outsourcing in the next three years. 76% 31% 25% These results correspond to each country s market characteristics and regulatory environment. While the pension outsourcing market in the UK is mature and saturated, in Germany, for example, 70% of companies continue to administer pensions internally. 10% 14% Active 44% Closed Interest in pension outsourcing by country Interested within three years Interested long term Will not outsource 57% 16% 36% 6% 58% Scheme closure is a stepping stone in the evolution of plan design that frequently leads to outsourcing both administration and investment management, as companies continue to look for ways to limit their pension liabilities. Companies look for compliance expertise and the certainty of fixed fees to minimise their exposure to new regulatory risks and the rising costs of internal administration. 27% UK Interested within three years Interested long term Europe Will not outsource In the UK, closed schemes are more interested in outsourcing than are active schemes: 44% of respondents with closed schemes versus 14% of respondents with active schemes expect to consider outsourcing in the next three years. In addition, scheme closure is often the first step towards the wind-up process, which can take several years to complete and includes asset value assessment, data cleansing and other timeconsuming administrative activities. As a result, closed schemes look at outsourcing alternatives, anticipating the future work involved in winding up a scheme. 7

Survey findings indicate that smaller schemes are more likely to outsource than larger schemes. Sixty-seven percent of respondents with 500 1,000 members versus 36 with more than 10,000 members expect to consider outsourcing in the next three years. It is likely that the smaller schemes are disproportionately affected by the increasing costs of compliance and technology investment. In addition, transition to outsourcing is simpler and faster for smaller schemes. Interest in pension outsourcing by function 21% 21% 58% 46% 12% 42% 52% 4% 44% Interest in pension outsourcing by scheme size HR Approval flows Finance Executive/Board 54% 10% 36% >10,000 Interested within three years 37% 10% 53% 22% 11% 67% 1,000 10,000 500 1,000 Interested long term Will not outsource Respondents in the HR function are more interested in outsourcing than their colleagues in the Finance and Executive/Board functions. HR is more likely to be affected by the increasing regulatory and compliance burden than any other function in the organisation. Interested within three years Interested long term Will not outsource HR, however, needs approval to proceed with outsourcing from Finance and the Executive/ Board function. Finance tends to focus on ROI and financial risk and needs to be convinced of cost savings. In turn, the Executive/Board function is most concerned with ensuring a cultural fit while trying to weather regulatory turmoil and limit the company s risk exposure. HR, therefore, needs to help colleagues in Finance and the Executive/Board function to understand the full scope and value of outsourcing services, from cost improvement and quality control to compliance and regulatory support. 8

Key benefits Survey respondents cited better service and cost savings among the top benefits of outsourcing. While reducing ongoing administrative costs is important, the research shows that the key benefits of outsourcing extend far beyond cost savings to improving quality with respect to member services, data and compliance. Top benefits of pension outsourcing Better technology Cost savings Better service 43% Cost savings With regard to cost reduction, 40 would like to achieve more than 15% in annual cost savings from outsourcing. Today, however, there is no standard methodology for calculating the costs of internal administration. Cost savings that will encourage outsourcing 23% 23% Cost savings 42% 17% Best practices 40% 13% Greater accountability Improved quality of planned services 29% 34% 6% <5% 5% 10% 11% 15% 16% 20% >20% Level of cost savings Activity-based costing tool An activity-based costing tool, such as Mercer's Operations Scanner, helps companies better understand the costs associated with in-house pension administration and identify more efficient ways of delivering the services. The tool examines operations from every angle, including core HR functions, cross-functional roles, mission-critical activities, job complexity and work process effectiveness. In addition, the quantitative tool models future costs, staffing levels and scenarios for in-house pension administration versus outsourcing. Subsequently, companies are in a better position to quantify the value of technology, streamlined processes and greater levels of automation and hence ascertain to what extent outsourcing can help them reduce the cost of pension administration. 9

While companies generally account for the HR staff dedicated to pension administration, the respondents cited any combination of other direct and indirect costs, including IT support, legal services, investment management, actuarial valuations, floor space, as well as travel and printing expenses. With such wide differences in methodologies to estimate internal administration costs, it is a challenge to establish a consistent baseline for fee comparison between outsourcing providers. Moreover, a large share of respondents acknowledged that they did not track the costs of internal administration at all. Better service Respondents described better service as access to improved technology, best practices and ease of compliance. Improved technology Respondents cited the need for employee self-service, increased online functionality and enhanced reporting capabilities. Introducing online self-service gives members greater control and can offer potential cost savings on internal administration resources. In turn, scheme sponsors would benefit from data-mining tools and reporting capabilities to obtain better visibility into the pension scheme s performance. Companies look at outsourcing providers to deliver both service quality and cost improvements that best-in-class technology can bring to scheme administration. Best practices The survey respondents defined best practices as process automation and improved data quality. We need improved technology on the employer side, with better access to reporting and data mining. Best practices would include processes that improve data quality and efficiency. The Pensions Regulator in the UK has set targets for the standards of data and recordkeeping expected of pension schemes and is planning to conduct audits in order to ensure compliance. The governmental guidelines indicate the need for data integrity, data definition, exception management and a testing schedule. In the UK, the need for improved data quality is also compounded by the duties of auto-enrolment, which starts in October 2012. Many organisations have yet to grapple with what is required to comply with the 2012 legislation and often find the process around eligibility of employees for enrolment, opt-in and opt-out confusing. Today, many schemes lack both technology and internal resources to ensure that their data are clean and compliant. The outsourcing providers, however, with dedicated focus and investment in technology and process automation, are well positioned to comply with the new data regulation guidelines. Ease of compliance Increasingly complex and an ever-changing regulatory environment raises compliance risk and requires due diligence on the part of employers. Companies We want administration to help us simplify the complexity of pension in such areas as the regulatory environment and governance processes. struggle to keep up to date with regulatory changes and maintain good governance while keeping the costs and efforts of dealing with their scheme s administration under control. Pension scheme sponsors turn to outsourcing providers for their compliance and risk management expertise as well as the technology that seamlessly incorporates and addresses new legislative mandates. By outsourcing their pension scheme administration to a third party, companies ensure that they maintain a well-governed and compliant pension scheme that provides their members with an accurate and efficient service. 10

Case studies Migration to modern administration platform Saddled with a client's antiquated legacy system for pension calculations and processes, and mindful that its client was missing out on the benefits of more modern pension technology, the trustees of a large utility industry client requested that Mercer migrate all the administration data from the client's legacy system to Mercer's modern administration platform. Mercer quickly mobilised a project team to collaborate with the client's pension function, migrating the data and implementing calculation automation well before the agreed deadline. Having demonstrated a substantial (15%+) cost saving in administration, Mercer is now moving the client onto Mercer OneView, a self-service technology platform that gives members more control and can offer additional potential savings on administration resources. Wind-up brings cost savings The trustees of a manufacturing industry client with 3,000 members appointed Mercer to administer a legacy scheme as well as its currently outsourced trust-based defined contribution scheme. Beset by numerous data issues, the legacy system would impose too many risks for the trustees' proposed scheme wind-up. After forming a project team to move the scheme from in-house administration and prepare for wind-up, Mercer employed a rulebased data integrity application to enable rigorous reporting, cleansing and migration of the scheme data. After data tracing all members, an accurate picture of member addresses and other personal data was achieved, removing the data risks. Mercer is now assisting the client through the wind-up process, which will provide the benefit of substantial wind-up cost savings due to the project's success. Auto-enrolment preparation underway A large Mercer administration client required clarification around UK auto-enrolment duties. Engaging with the client's HR function, Mercer's Outsourcing business helped HR through the process, clarifying how the legislation would affect the scheme in terms of the scale of new membership numbers, contributions, data integrity and communication. Providing much-needed assurance to the client, Mercer's review proved that the current trust-based defined contribution scheme was an eligible and cost-suitable vehicle for auto-enrolment. The scheme will provide the enhanced governance of a trust-based scheme and will be as efficient as a contract-based scheme, in terms of cost, over a 10-year period. Mercer is now working with the client on planning for auto-enrolment in 2012 and the introduction of an online data tool for managing autoenrolment eligibility. 11

Provider selection Respondents consider financial stability, commitment to outsourcing business, and competitive fees in making decisions about the outsourcing provider. Factors considered in selecting company for pension administration % respondents Financial stability Commitment to outsourcing business Competitiveness of fees Online service capabilities Investment in technology Breadth of member services Conclusion 48% 48% 55% 69% 69% The Mercer/Chatham Partners survey underscores concerns about pension liabilities, regulatory changes and the escalating costs of internal administration that are causing companies to consider outsourcing options going forward. 77% While survey respondents cited the need for improvement in the areas of employee self-service, reporting capabilities, process automation, data quality and regulatory compliance, some barriers to adopting an outsourced solution remain, and these are often based on deeply rooted perceptions. These perceptions can be dispelled by helping companies understand the true cost of internal administration and by creating a broader awareness of outsourcing capabilities. One of the cited barriers to outsourcing is that the cost savings are not always clear. Without a standard methodology for calculating internal administrative costs, it can be a challenge for companies to estimate the level of cost savings that outsourcing can deliver. But a number of tools can help companies determine the true magnitude of their internal costs and, therefore, establish an accurate ROI of outsourcing. For example, an administration review can pinpoint cost savings that result from automation, employee web access and streamlined processes. Another frequently cited barrier to adoption is that the companies can provide a better pension administration service internally. However, almost half of the survey respondents have not considered outsourcing alternatives in the past and may not be familiar with the full spectrum of the latest outsourcing capabilities, including online access, data management, integrated reporting and dedicated legal and regulatory compliance support. Outsourcing providers will need to ensure that they are fully communicating the value and scope of their services. By making the connection between the perception and the reality of outsourcing, companies can then make more informed choices when considering whether to outsource their pension administration to an external supplier. Ultimately, the right decision can make all the difference between costly and inefficient internal administration and the streamlined power and comprehensive support of an outsourced solution. Learn more If you would like to hear more about the findings of this study or learn more about Mercer s services in pension administration, please contact the author, Julia Velixon, at julia.velixon@mercer.com. 12

About Mercer Mercer is a global leader in human resource consulting, outsourcing and investment services, with more than 25,000 clients worldwide. Mercer consultants help clients design and manage health, retirement and other benefits and optimise human capital. The firm also provides customised administration, technology and total benefit outsourcing solutions. Mercer s investment services include global leadership in investment consulting and multimanager investment management. Mercer s global network of more than 20,000 employees, based in over 40 countries, helps ensure integrated, worldwide solutions. Our consultants work with clients to develop solutions that address global and country-specific challenges and opportunities. Mercer is experienced in assisting both major and growing, midsize companies.

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