Article | 10/07/2017

To outsource or not to outsource

 To outsource or not to outsource

Two key features characterised the first half of 2017. First, trustees looking for a new supplier because their current administrator is retreating from the market; and second, in-house administrators looking to outsource for the first time.

The first is inevitable in a market still in flux, with many providers withdrawing from the market or deselecting themselves from new opportunities.

The second feature is an interesting and broadly unpredicted change from previous years - a steady flow of first-time outsourcing projects, driven by the maturing defined benefit (DB) market and sponsors looking to lower operating costs.

The third-party administration market maintains that the case for outsourcing is solid. However, outsourcing isn't the magic bullet for all schemes and I have provided this advice to many operations, highlighting three features of successful in-house operations.

Scale

Scale is an essential characteristic of any administration department and the most important factor for long-term sustainability.

Through scale you unlock process efficiency, lower marginal operating costs and, importantly, build in redundancy. Redundancy is the ability to duplicate an operation's critical functions, thereby increasing resilience and reliability. This most commonly manifests itself in the number of people available to complete business-critical tasks. Without scale there might be only one person who runs a payroll, produces accounts or knows how to run calculations for certain members.

Having enough people is critical to mitigate risks across essential processes and support highly specialist administration demands. Analysts, programmers, change and project managers are specialist functions required by maturing schemes. If the service lacks the scale to support these roles long-term, then in-house teams should have resourcing plans and contacts that can be accessed when needed.

It's hard to quantify the optimum scale to support a resilient, well-resourced administration function, but any operation providing services to fewer than 15,000 members should consider if it has the redundancy required to mitigate operational risk.

Investment

High-quality administration also demands sustained investment - not only in good quality systems, but also training, communications, process and assurance. Systems are key to promoting low-risk efficient services but are just one function that must be continually developed. Investing in systems is useless without the scale to sustain specialist personnel who can maintain and develop it.

Strategy

In-house operations must additionally have an overarching strategic reason to exist. This can take many forms and be driven by the sponsor or trustees, but the strategy and business case must be sound and clearly communicated. Two examples from the sponsor and trustee side are as follows:

  1. The sponsor having multiple pension arrangements that are being consolidated into a single in-house operation, and the sponsor is growing through planned acquisition that will add further scale and opportunity to the in-house team over the long term.

  2. The trustees having many high-intensity administration projects that require dedicated support over the medium term.

Managing complexity is not a strategic requirement but a business function and not overwhelmingly unique or insurmountable for any pension scheme. Complexity is a given, especially in very mature DB arrangements, so any credible administrator, in-house or third-party, must be able to handle it.

Like commercial businesses, administrators need a business plan that sets out its strategic purposes, plus development and investment plans. Trustees should have a robust and ambitious service agreement in place with their in-house team to ensure strategy and focus is fully aligned.

Outsourcing of all administration shouldn't be regarded as inevitable. Many high-quality in-house operations have achieved - even exceeded - these three key indicators on long-term sustainability. Where conditions are met, in-house teams deliver services to members and trustees far exceeding comparable standards in the third-party sector.

However if sponsors and trustees are wrestling with whether to maintain an in-house operation, I urge them to consider these three key factors. If your current operation does not meet all three, it's time for a change.

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