Pension Funds Online

Spend if You Can See a Return

What can you buy for £5,000? Well, you could get 5% of an Aston Martin Vantage. How about 2.5% of an average priced UK house; not grabbing you? Well, at least it will pay for a term at a private school. Or maybe you fancy 4.5% of a house in Provence?

Let’s put that £5,000 into more realistic business terms. How much of your rent, lease or rates would it cover; or your IT expenditure in a year? Would it make much of a dent in your pension scheme costs, and once spent, what return do you get for your investment?

For example, would another £5,000 really make a difference to your DB or DC pension scheme liability - how much is that costing the business? What about the actuarial, consulting or administration costs of running your pension scheme?

I heard a comment the other day that frankly didn’t surprise me; “all the scheme Trustees ever seem to do is come back cap in hand to the business for more funding,” said the rather despondent finance director, “I want to keep our scheme, but we can’t keep shoring it up without seeing some efforts to reduce costs.”

As I say, I wasn’t surprised. The budget pressure on sponsoring employers of pension schemes, of any size, has never been so high. Reducing interest rates, poor stock market performance and increases in longevity (and yes, I know you’ve seen those three sisters of woe paraded many times) combined with ever more complex legislation, Pension Protection Fund (PPF) demands and increasing Trustee powers, have left FD’s in an almost ‘blank cheque’ position.

What if you could take a proposal to the scheme Trustees showing that £5,000 spent on undertaking an audit of the member data held in the pension scheme administration records could reduce any DB funding deficit you may have by many multiples of that initial spend; could reduce your actuarial valuation costs by a third or even reduce your ongoing administration costs by many thousands of pounds. This can be done simply by using technology to take the guesswork out of assumptions regarding data. Now, I’d call that a difference.

You might say that with all the other prevailing factors surrounding scheme administration is it right to focus on technology, or rather the perceived lack of it? Well I believe it is - then I would say that! But ask yourself if you really are seeking out the best technology and processes, and if you are, are they implemented well enough to be as efficient as possible in cutting pension scheme costs?

The nirvana for any scheme is ‘push button administration’ with quotation or benefit statements produced automatically, taking half an hour at most. Some pension schemes have reached this nirvana - most haven’t. But why is this? Is it because we don’t invest enough in IT systems, employ administrators or IT professionals who are incapable; or perhaps it’s because we just don’t care! Obviously none of the above is true - so what is happening?

Well, there is a sneaking suspicion that the foundations on which all the major costs of a pension scheme are based are not that secure. This foundation is data. Data underlies the costing principles of any pension scheme - investment decisions, funding levels,

actuarial and day to day administration costs. However, despite the best efforts of administrators and pension managers alike, the Trustees rarely have any knowledge of the quality of the data - it simply never gets the attention it needs. Even if it does reach the Trustee meeting agenda, there’s always something else to sort out before confronting data.

Ongoing data management

What has sorting scheme data got to do with best use of technology, value for money and efficiency? Well, everything actually. Using technology to deliver visible and auditable proof of ongoing data management is the key to straight through processing, ensuring every single member (existing or deferred) gets exactly the right benefit to which they are legally entitled and most importantly, a reduction in overall costs.

Most schemes throughout their life undergo major data change - either through change of administrator, change of system or a total scheme revamp (switch from DB to DC). At this stage it is common practice to ensure that the data is in reasonable shape and testing is done to ensure that data held on one system is transferred to another. If time or technology allows, a more robust analysis is undertaken with evidence (in some shape or form) that this is the case but only at this single point in time. Thereafter Trustees tend to ignore data and its upkeep until the next major change takes place.

Where is the proof that data is managed properly, member movements are being correctly recorded and all post change work has been carried out? The technology exists to do it; and it isn’t expensive. In fact compared to the potential costs of ongoing and worsening data - it’s positively cheap. By insisting that Trustees invest in simple technology for ongoing data management, tangible evidence of seeking to reduce scheme costs - year on year – can, and should, be provided.

I’ll show you mine, if you show me yours

Regular covenant reviews; the process whereby Trustees measure the financial standing of the sponsoring employer, are now standard practice. At this time Trustees gauge the financial fitness of the business, assess its future plans and can actually stop any strategic business proposals that in the mind of the Trustees potentially affect the ability of the business to meet its ongoing pension liabilities.

During a covenant review Trustees can expect sight of any documentation to back up the current and future plans of the business. Whilst this is good practice intended to secure the future of the scheme, it does seem somewhat iniquitous that Trustees can assess the viability of the employer whilst not having to provide tangible evidence of similar prudent management of all aspects of the scheme, including ongoing data management, to the sponsoring employer.

I believe this is set to change. Sponsoring employers will start to insist on independent written, auditable evidence that the scheme Trustees undertake an annual data review that includes;

• The data itself - to ensure the data remains fit for purpose;
• Interfaces to the scheme data - to ensure that regular scheme data updates are sound;
• Scheme calculations - to ensure benefits settled or promised are within ‘reasonableness’ criteria;
• Fraud - to detect early signs of potential;
• Controls - to detect signs that data controls are not in place or being followed;
• Efficiency - to ensure that administration is efficient;
• Cost - to ensure costs for administration are reasonable for the scheme.

The technology to run this simple data analysis is built into the ongoing administration for the scheme and when run annually, provides ongoing evidential reporting that the scheme is managed as efficiently and cost effectively as possible. I mentioned earlier that actuarial and administration costs, both ongoing and at valuations, can be reduced by as much as 50%. This is not wishful thinking; it is based on an actual case study.

There are other benefits too. Using the same technology Trustees and scheme administrators can also ensure they have:

• Access to clean and safe data warehousing ensuring that an up to date set of data is always available;
• Frequent updates of data automatically provided by their administrators (monthly or annually);
• The ability to move quickly and independently of the current administration provider when changing delivery strategy;
• The ability to deliver on data related projects independently of the administration team if there are constraints due to time, resource, skill set or cost.

In addition, in-house administrators, managers or external consultants can use the outputs from the data management analysis to highlight areas within the wider scheme management where costs can be reduced.

What about the future?

The risks inherent in running a pension scheme nowadays are leading more and more to a careful re-evaluation of the most appropriate pension arrangement to be offered to both current and future employees. This has led in many instances to significant pension changes and either:

• Closure of the defined benefit plan for all future employees but existing participants can continue (usually on a reduced level);
• Closure of the defined benefit plan for the future with a new defined contribution proposition instead.

In either case the employer will be interested to learn about what options are available to restrict the potential for the liabilities to become more expensive than current forecasts. These options can include:

• Purchasing annuities (either selectively or in bulk);
• Offering incentives to take transfer values;
• Enhancing the leaving service communications;
• Assessing the viability of buying out some pension increases;
• Maximising Tax Free Cash Sum (TFCS) take up;
• Stopping early retirements (especially those offered on an unreduced basis);
• Modifying past rights to replace a fluctuating liability with a fixed one.

Under virtually all these alternatives it is essential that the administration records held for each member are accurate and sufficiently detailed as it is only possible to properly assess the financial implications with complete information. In many instances administration information is incomplete or inaccurate, preventing the company from proceeding with de-risking options.

Yes, it is a cliché

Treating the cause and not just the symptoms is always best. Spiralling pension scheme costs cannot always be blamed on external factors; and dealing with increased administration costs by going back to an already overburdened sponsoring employer is a short term, symptomatic approach.

So are you going to invest in 5% of an Aston Martin? Well, we’d all like to, but even I have to admit that the £5,000 is better spent reducing your year on year pension scheme costs.