PENSIONS/RETIREMENT PLANS: OUTSOURCING DEFINED BENEFITS YIELDING EMPLOYER SAVINGS

Do-it-yourself might make sense around the house, but it's rapidly making less and less sense for employers that administer defined benefit pension plans.

Employers, which have long outsourced the administration of their defined contribution plans, are discovering that they can reduce overhead and enhance quality by doing the same with their defined benefit plans. While the process is not without some potential pitfalls, outsourcing defined benefit plan administration appears likely to grow only more popular in the near future, say experts.

"The main reason for wanting to outsource the work is that outsourcing allows economies of scale," such as heavy investments in new technology, said Priscilla Craven, benefit vendor and communications manager for Digital Equipment Corp. in Maynard, Mass., which outsources administration of its defined benefit plan covering 67,000 participants to Hewitt Associates L.L.C. "It enables us basically to buy expertise," she said.

She said excellent customer service and participant satisfaction at being able to get many services from one place are among the top benefits Digital has realized from outsourcing. As a result, the company has not had to invest in infrastructure, such as systems, phone lines, additional staff and training, to administer its defined benefit plan, said Ms. Craven.

Morristown, N.J.-based communications research facility Bellcore is in the process of outsourcing its defined benefit plan, noted Bruce R. Lasko, manager-retirement programs. The first stage, involving the outsourcing the administration of retiree benefits, began last week, with the outsourcing of administration for active employees slated to take place July 1. The outsourcing is being handled by The Kwasha Lipton Group of Fort Lee, N.J.

Mr. Lasko noted that "growing population" was a key reason for choosing to outsource. "When Bellcore was formed in 1984, we had no retirees. In the last 13 years, we have grown to over 1,500 retirees," with an additional 3,000 deferred vested pension participants.

"Our systems were basically antiquated, and we decided rather than rebuilding them to buy from a vendor," he said.

"The calculation of the defined benefit is really a complicated process right now, and we believed there were companies and resources out there that could do it in a more accurate and more efficient basis than we could in-house," said Charlie Kamen, executive director-human resources for US West Inc. in Englewood, Colo.

"We started the process with our savings plan in the late '80s, and it's evolved since that time, and more and more effort was directed toward outsourcing the defined benefit plan since the early 1990s," said Mr. Kamen, who said US West's outsourcing is being handled by a joint venture between Bankers Trust Co. and Towers Perrin. He noted, though, that US West continues to use in-house staff to handle much of the claims, correspondence and interaction with retirees and also explanation of benefits to active employees. Plan design and future strategy also is carried out in-house.

The US West defined benefit plan covers about 60,000 active participants, 39,000 retirees and about another 10,000 deferred vested pensioners, he said.

Consultants note that outsourcing administration of defined contribution plans has been standard practice for years. In fact, "Today, it's the unusual employer that is still doing its own 401(k) administration," said Dave Thompson, a principal in Towers Perrin's Philadelphia office.

"Very few companies still perform defined contribution administration in-house. In defined benefit, when there's a plan change or systems change at the employer, that's when they begin to ask the question whether it makes sense to keep the administrative function in-house," said Curt Morgan, a principal with The Kwasha Lipton Group in Fort Lee, N.J.

Outsourcing defined benefit plan administration lagged behind outsourcing defined contribution plan functions for a variety of reasons, noted E. Scott Peterson, a Hewitt Associates outsourcing consultant in Lincolnshire, Ill. Plans are complex, and there "was a sense that defined benefits was not something you could easily automate," he said.

Handling defined benefit plans in-house is a "huge job," he said. Companies find that the data management work and the benefits calculation process are functions they want to stop doing themselves and are more than willing to outsource.

"These days, people are looking at outsourcing the entire process. The largest growth is in the employee service area," said Mr. Peterson. This includes fielding participants' questions, providing benefit estimates and the like, he said.

"There are two reasons for outsourcing that run hand-in-hand: the administrative complexity of retirement plans today, and the costs associated with them," said Fred Schick, vp and managing consultant with Sedgwick Noble Lowndes in Chicago.

"Every corporation today is lean and mean. There's no one sitting around with nothing to do," he said.

"Sponsors are looking for ways to divest themselves of day-to-day functions. They're trying to concentrate more on strategic benefits and human resources functions," said Jeff Lanzet, a managing consultant with A. Foster Higgins & Co. Inc. in Princeton, N.J.

The defined benefit plan "traditionally has not been an area that has been outsourced a lot," said Mr. Lanzet. But "defined benefits plans never get easier" to administer because of regulations and growing complexity as employers acquire other companies with different plans, he said. Outsourcing provides significant advantages in terms of quality, consistency of administration, and the ability to access retirement experts, he added.

Outsourcing also has a risk management advantage, helping employers manage the risk of changing regulatory and technological environments. "As a provider, I need to stay abreast of either current changes in technology or changes in the law," he said.

"We're under a mandate to reduce staffing," said Richard D. Quinn, director-performance and rewards for Public Service Enterprise Group, a Newark, N.J.-based energy company. The company found it wasn't practical to make a heavy investment in new technology as its plan grew more and more complicated.

The company completely outsourced its two 401(k) plans, one for unionized employees and one for the rest of workforce, to Hewitt in 1993. Last year, the company followed suit by outsourcing its cash balance defined benefit plan to Hewitt and is in the process of doing so with its traditional plan, Mr. Quinn said. He said he has asked Hewitt to build a completely new calculation system to replace a 20-year-old in-house system "that's completely outlived its usefulness."

He said PSEG will be transferring a voice response system to Hewitt that allows any participant to get an up-to-date benefit calculation.

Since it began the process of outsourcing in 1992, the company's human resources department has shrunk to 11 employees from 35, he said.

In addition to achieving staff reduction, "one unexpected benefit was we've been able to identify a lot of things in our own systems where we thought we had some checks and balances" but didn't, said Mr. Quinn. This included calculating vesting dates, and other "administrative things that we thought we running smoothly," he said.

"We weren't really sure we could outsource defined benefits at first," thinking that vendors might be able to do only some basic functions, said John Stradinski, U.S. retirement program services manager for Digital. Instead, Digital "found that they could do a full soup to nuts."

Making the best use of technology is a key to successful outsourcing, said John McGlone, principal and director of participant services for Buck Consultants Inc. in Secaucus, N.J.

Some of the most common technological applications are 24-hour-a-day, seven-days-a-week interactive voice response systems; participant service centers with live operators fielding participants' questions for 12 to 16 hours every weekday; and the use of intranet communications within a company, he said.

Mr. McGlone warned, though, that "you have to apply technology to the right end user."

For example, retirees, who generally prefer talking to customer service representatives, often bypass voice response systems.

But "by and large, participants like both services because they get it on expanded hours and they like the anonymity involved," he said.

A lot of times, employers may have to really hold employees' hands throughout the process of outsourcing, said Kwasha's Mr. Morgan. "It's an educational and communications challenge."

The education is typically carried out by an employer-consultant team, and "it is critical that all the parties be at the table to talk through this," he said.

Mr. Morgan said Kwasha handles all needs of the participants. It enables participants-both employees and former employees-to call any time and receive projections about pension benefits under various economic and personal employment scenarios. They can do so using a touch-tone telephone and will soon be using the Internet or company intranet to access the same information, he said.

The outsourcing service can build upon traditional human resources practices and expand on them, noted Tony Herron, a vp with Wellspring Resources L.L.P. in Minneapolis. Wellspring is a Jacksonville, Fla.-based joint venture of Watson Wyatt Worldwide and State Street Bank & Trust.

"Today, when employers are making the decision to outsource the pensions, it's essentially the full scope of services involving defined benefits," said Mr. Herron. This includes data management, estimated and final pension calculations, qualified domestic relations orders, non-qualified plan administration-all interaction with active, retired and terminated vested participants, he said.

Wellspring's Mr. Herron said that while employers used to think that retirement counseling was a function that should not be outsourced, in reality it has become one of the outsourcing success stories. It provides improved access to information, real-time modeling and more consistent information, he said.

Overall customer service has improved dramatically, and the counseling is at more of an arm's length, which many participants appreciate because the anonymity makes them more comfortable when asking questions they fear some people might consider stupid, he said.

While there is agreement among consultants and employers that outsourcing makes economic sense, there is no universal agreement on how best to go about outsourcing, with some experts advocating a phased approach while others say to do as much as possible at once.

"A phased implementation is perhaps easier to do," said Foster Higgins' Mr. Lanzet. He added that if it becomes apparent that an employer is going to outsource a function in the future, staff retention becomes an issue.

But outsourcing all at once means having to manage a lot of change at one time, and it requires a lot of resources. That does have the advantage of being a clean transition, he said.

"Avoid the big bang theory" of outsourcing, said Buck's Mr. McGlone. "I recommend an evolutionary staged process," with the employer making sure it's a phased approach and handled properly through education, he said.

"It's difficult to do it in pieces because you get into the problem that you never really get those pieces outsourced. It's better to make a clean break," said Towers Perrin's Mr. Thompson.

"Do the whole thing," said Mr. Herron of Wellspring. He said there are not "a lot of advantages to doing it in pieces" and added that it is more effective to re-engineer the process if it is done all at once.

There is also some disagreement over what downsides-if any-an employer can expect while attempting to reap the benefits of outsourcing.

"I can't think of any real downside to it," said Mr. Quinn of PSEG. There were "heavy start-up costs," he noted and added that start-up costs typically outstrip the first year's savings.

"I think people don't tend to look at it as an immediate cost savings. We looked at it as where is our core business? We concluded that there were other people who could do it better than we could on an ongoing basis. It also gives you access to the latest technology without a lot of new expenses," said Mr. Quinn.

He added that participants are happy with the outsourcing arrangement-in a survey taken last year, more than 80% said they were very satisfied with the program, he said.

"I actually think the quality is better when you outsource," said Wellspring's Mr. Herron. Data is cleaned up, there's "more automation around it," there are internal audit controls, and the entities doing the outsourcing are "focused exclusively on these services," he said.

"The closest thing to a downside as employers are considering outsourcing is that they worry they will lose contact with their employees," said Hewitt's Mr. Peterson.

"Control is an issue. Basically, there is the opportunity to lose control. A plan sponsor needs to assure that adequate controls are in place," said Mr. Lanzet of Foster Higgins.

"The major downside is that without a clean definition of roles and a clean break, the client will end up not only paying for outsourcing but still have the HR/benefits people," said Towers Perrin's Mr. Thompson. As a result, employers have to change procedures and eliminate access to data to achieve the clean break.

"One of the areas for improvement has to do with really understanding that the outsourcing provider has to be willing to step into the shoes of US West and have the interaction with active employees and retirees that we would have as in-house staff," said US West's Mr. Kamen. He said that process is continuing.

Employers face quality control questions as well, and for defined benefit plans, these questions often involve the quality of data, said Buck's Mr. McGlone. Most companies have a large portion of their data on paper files, and even the data stored in computers has to be cleaned up, he said. Cleaning up data is one of the biggest expenses in outsourcing, he said.

"It is a new field," said Buck's Mr. McGlone. He said that five years ago, it took two years to get a client "up to speed" on outsourcing. Now, getting a client to the same level takes six to nine months, he said. Vendors have learned to carry out the process better, and have learned to manage expectations better, he said. Many employers consider outsourcing a "panacea, that they would be absolved of all day-to-day" responsibilities, he said. That is not the case.

Digital's Ms. Craven said she thinks some employers follow "myths connected with outsourcing."

Some people think it means total staff reduction, and that's not true, she said. Also, there is a belief that work will go away, which it doesn't, she said. Instead, the nature of the work changes.

Ms. Craven said Digital holds formal quarterly reviews with Hewitt to discuss the outsourcing and measure progress against the written objectives for the retirement plan. The company has "very explicit goals and expectations of the services that will be performed."

Another quality issue is the performance standards involved, said Mr. McGlone. Buck recommends that the client negotiate performance standards going into the contract and have vendors put fees at risk if standards aren't met.

"Quality control is a big issue," agreed Sedgwick Noble Lowndes' Mr. Schick.

But outsourcing is here to stay, agreed consultants and employers. As Towers Perrin's Mr. Thompson put it: "Where it ends up is anybody's guess. But some of the outsourcing that's going on right now is irreversible, because more and more outsourcing is tied to the technology, and as vendors vie with one another to improve their technologies, the cost of entry gets higher and higher for a new provider or for a company to do it themselves."