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Strategic Finance

Pensions: trim the cost not the benefit

Written by Julian Webb, Executive Director, DC Business Development, Fidelity International

Monday, 08 September 2008

Where can the biggest real cost savings can be made?

Even firms operating a more cost-effective defined contribution pension (and therefore not carrying the financial burden of paying a fixed final salary to retirees) can find further savings that do not reduce their employees’ retirement prospects.

Two areas of cost saving are often overlooked. First is the structure of the scheme and its administration which is where the biggest real cost savings can be made. The simplest option here is to bundle administration with investment management with one provider.

In the past, this has required numerous compromises as fund managers with adequate admin capacity were limited in number and expensive; a good deal on administration may have led to a compromise in fund management.

But, the emergence of open architecture in the DC fund management industry, which allows a plan to appoint one provider for admin and fund management who offers the funds of many other investment managers, means there is no compromise.

As homeowners know, combining phone and broadband in one package can attract significant discounts; the same applies with pension fund management and administration.

Changing administration provider would be a major decision and not to be taken lightly. But at the same time, other measures can be considered which increase the impact of the changes.

Many schemes still operate with a traditional trustee board with responsibility for the protection of members’ interests. A growing number of plans are now moving to contract-based arrangements where each member contracts directly with the pension provider. The advantage to the employer is that the cost associated with running the trustee board, such as training, legal, professional and administration fees all disappear.

Stewardship can still be offered by a more streamlined employer-appointed committee charged with members’ protection and members come under the wing of the powerful financial regulator the FSA.

Changing the contract relationship also presents a good opportunity to review the balance of active and deferred members. For some schemes, the weight of deferred members drags on the resources available for active members. An immediate solution to this arrives in the form of a buy-out of deferred members.

In this case, the pension provider takes direct responsibility for the deferred members eliminating the cost and responsibility of the former employer.

Another measure encourages greater participation from members. Salary exchange, in certain circumstances, can reduce an employer's overall benefit spend and increase an individual's pension contributions. It works by an employee electing to reduce their salary by a certain amount, and have this sum paid into their pension.

A lower salary means savings can be made by the employer paying less NI, and though we see benevolent employers reinvesting this money into the pension scheme in the form of enhanced employer contributions, salary exchange is proving a popular benefit with both pension scheme member and sponsor. More and more schemes are offering it.

All of these initiatives carry considerable long-term benefit for both employer and employee. And they all go to show that when money is tight, an employer need not be.