Outsourcing a defined benefit (DB) plan’s administrative tasks could be advantageous for some companies. The process of gathering data, calculating pension amounts, preparing retirement paperwork, and setting up payments may become too cumbersome for in-house personnel to maintain. In addition, the vast array of regulations may be too much for some administrators to keep up with.

In David Benbow’s recent Plan Consultant article, “Replacing Betty: Why DB Plan Outsourcing Makes Sense,” Betty characterizes the sole manager of many plan sponsors’ internal pension administration system.

Here is an excerpt:

As if complicated laws weren’t enough, DB calculations depend on extensive data. Usually, the longer a plan has existed, the more data are needed to calculate the pension and, if the plan has changed hands through mergers or acquisitions, this data may not be centralized or easy to obtain. Companies that have administered their DB plans in-house often have one key person—let’s call her “Betty”—who has been calculating the pensions for 35 years. Betty has all the historical knowledge; she knows which employee groups are special and why; she remembers when she has to go look someone up in the red binder to get the frozen amounts that are listed in it. Betty is friendly, reliable and indispensable. And Betty is 62.

As impossible as it may be to imagine life without Betty, we know her days are numbered and someday she’ll retire. So far, cloning Betty isn’t an option and training others isn’t really Betty’s strong suit, but we have to find a way to take the knowledge out of Betty’s brain and document it for posterity.

Could it be time to think about outsourcing the DB plan? Outsourcing sounds expensive, and our culture has always been to take care of our own employees. Then again, we may be forced to take the plunge.

It’s very common for a pension plan to have some data-related skeletons in the closet, and experienced pension administrators have seen it before. By looking at samples of Betty’s calculations, they can identify the key pieces of data, store them in a central, accessible location, and have the mysterious red binder keypunched so it can be automated. Betty will still be around to use as a resource, but with the processes automated instead of sitting between Betty’s ears, there won’t be any surprises when she retires.

The article also discusses the scope of outsourcing DB plans and provides two examples demonstrating how outsourcing can help streamline administrative tasks.

The Outsourcing Spectrum
There is a lot of grunt work involved in administering a DB plan. Someone has to gather data, calculate pension amounts, prepare retirement paperwork, review election forms, answer participant questions, and set up payments. Virtually all of these tasks can be outsourced or done in-house. However, there are three common places along the spectrum where the tasks are usually divided up.

“Old school” outsourcing. This is where a third party (usually an underling of the plan actuary) performs pension calculations using data provided by the plan sponsor. Typically, the third party will also prepare the election paperwork, but the plan sponsor will mail the packet and process the elections. The advantage to this old-school approach is that it’s less expensive, but has enough actuarial oversight to ensure that the calculations are compliant with current legislation. However, the process may be very slow, depending on the actuary’s workload.

“Co-sourcing.” Often, a third-party administration firm will create and host a DB administration system the client can use to administer pensions in-house. This blend is often called “co-sourcing” because the third-party firm will collect data and maintain the system, while the sponsor does most of the daily tasks. This is advantageous for companies who are reluctant to let go of the daily administration and want to maintain the face-to-face interaction with their own employees. However, it can be slow during periods when the sponsor’s benefit department is very busy (such as open enrollment). Often, this service is nearly as expensive as full outsourcing.

Full outsourcing. Under this approach, a third-party administrator will receive regular payroll data feeds from the plan sponsor and do all the administrative tasks. Usually this will include a call center for fielding participant questions, and many firms will host a website that participants can use to monitor and model their pension benefits.

The cost of outsourcing a pension may deter a plan sponsor, however, it would be cheaper than any legal litigation that could result from an administrative error. Here is some perspective:

Sticker Shock
Let’s face it. DB plan outsourcing isn’t cheap, but as is often the case, you get what you pay for. I know that Betty is reliable, but has she ever made a mistake? She’s human, just like the rest of us. Compare the cost of pension outsourcing with an administrative error (with potential legal implications) and it suddenly seems more reasonable. Betty has a wealth of historical knowledge of your plan, but has she kept up with new legislation, such as PPA benefit restrictions, that could cause the plan to be administered incorrectly? Would Betty’s work stand up to audits by IRS or DOL? Even some firms that provide pension administration services but don’t consider it to be their main focus may be out of step with current laws or plan rules. Sometimes, a third-party administrator may offer to take over the administration so they can manage plan assets or sell some other product. But if their focus isn’t on the administration, it could lead to quality problems.

Milliman’s Jean Smith also discusses the benefits one company experienced by outsourcing its pension administration system here.

Javier Sanabria on Google+