Pension funds are redesigning their investment management operating models

During our global industry events, we invite market experts, investment managers, and solution specialists to discuss trends and challenges from an IT perspective. In this article, I share important takeaways from a recent Pension Fund Roundtable I hosted at SimCorp Headquarters, where senior executives from leading global pension funds gathered to discuss key challenges and strategic priorities in the pension fund industry. Find out what they see as a main challenge facing the industry and how they plan to tackle it.

The pension firms gathered all share a dedication to creating long-term financial plans that provide security for their customers and their families. However, they also discovered that they share a key challenge: Tackling the impact of the pension fund industry’s gradual shift from defined benefit (DB) to defined contribution (DC) pension plans.

Moving from DB to DC plans implies that the pension fund no longer guarantees the customer a specified payment amount in retirement (the idea behind DB plans). Instead, the payment will be a function of investment returns. Consequently, the investment strategies look much different and are more complex compared to those designed exclusively to meet minimum requirements as will be further explored below.

DC implications for pension funds’ operating model

As DC plans’ focus on investment returns lead to more complex investment strategies, this has far-reaching implications for the operating model and supporting IT systems, including:

• the cost and challenge of onboarding and supporting new asset classes;
• the necessity to redefine the business and IT architecture; and
• the need for data standardization and consolidation.

Before looking more at the IT-related implications, we will briefly review the background for the shift from DB to DC.

DC is becoming the dominant pension plan model globally

Over the past few decades, the industry has seen a shift towards DC pension plans, which has been accelerated by various external factors, most crucially: regulatory changes favoring DC plans relative to DB plans, changes in accounting requirements, and macroeconomic shifts. The impact of these factors has varied across the globe over time, resulting in DC assets today representing 49% of total pension assets across the world’s seven largest pension markets, after growing 5.6% pa during the last ten years. Meanwhile, DB assets have grown 3.1% pa, confirming that DC is gradually becoming the dominant global model.¹

Many of the pension funds gathered at the roundtable have started their journey towards DC plans, among these leading pension funds in the Netherlands, where DC now accounts for 6%², slightly ahead of Canada and Japan. Meanwhile, the UK pension industry has 19% allocated to DC assets whereas the proportion is significantly higher in Australia and the US, where DC accounts for most of the pension assets (87% and 60%, respectively).

DB/DC spilt in 2017

Source: Willis Tower Watson, 2018.

DC trend causes a more complex investment setup

Henrik Olejasz Larsen, Chief Investment Officer at Sampension, the third largest pension fund in Denmark measured by AUM, explained that moving to DC plans had required the pension fund to move from a very simple to a much more complex investment setup, adding more investment strategies and asset classes to its portfolio. As an example, lifecycle investment strategies, the process of adjusting pension fund members’ asset allocation over time to reflect their changing risk profile and age, have become a well-established part of Sampension’s DC offering. From 2007 to 2017, the pension fund’s lifecycle investment assets grew from zero to nearly DKK 85bn (approx. EUR 11bn). Furthermore, to be able to deliver returns that would meet their pension fund members’ retirement expectations, a multi-asset approach was set up, including an increased allocation to alternatives such as structured credit products and real estate.

Henrik Olejasz Larsen, Chief Investment Officer at Sampension: “Moving to DC plans required the pension fund to move from a very simple to a much more complex investment setup, adding more investment strategies and asset classes to our portfolio.”

Sampension’s increasingly complex investment setup required them to look for a more robust business and IT architecture, which, for instance, could handle more complex risk calculations and analyze higher data volumes. In the beginning of 2017, the company took over the administration of two smaller pension funds, which remain independent but added to the need for systems capable of supporting more diverse investment operations.

A recent survey of 100 Heads of Investment Operations in Europe confirms that private debt and alternative assets are regarded as the most challenging or costly asset classes to support.³ Whereas some pension funds turn to dedicated, best-of-breed solutions to support these more complex assets, some find these less attractive as implementing a new separate system results in costly integration and data consolidation issues.

These considerations also played a key role when Pen-Sam, a Danish labor market pension fund also present at the Roundtable, decided against implementing a separate new system for alternatives and instead chose to become a development partner for their current vendor, SimCorp, who has recently launched a new, integrated alternative investments solution.

Hence, a key concern for many pension funds moving from DB to DC is to find an investment management system that is agile and flexible enough to support their future strategy without the need for large and expensive upgrades to manage the pace of change. However, the people and cultural angle of such a shift should also not be ignored. For example, many front office professionals have become so reliant on their own excel models that it can be hard to convince them to use an integrated system for all their asset classes. This reluctance is often seen despite the obvious benefits implied: knowing your true exposure across the entire portfolio, mitigating operational risk, and spending less time on data validation and processing.

… a key concern for many pension funds moving from DB to DC is to find an investment management system that is agile and flexible enough to support their future strategy without the need for large and expensive upgrades to manage the pace of change.Hans-Otto Engkilde, MD of SimCorp UK & Northern Europe

Redesigning business architecture

At PGGM, the second largest pension fund in the Netherlands and 10^th largest globally⁴, the growth in complexity has also been significant. Back in 2008, the company was solely responsible for the pension administration and asset management of the Dutch Pension Fund for the Healthcare and Welfare sector (PFZW). While PFZW is still its largest client today, PGGM started servicing multiple clients in 2009 and has increasingly customized its services. The complexity associated with moving from “single client, single product” to “multi-client, customized products” and becoming “DC ready”, has led to a full business process redesign, aimed at future-proofing the business to be sufficiently agile in meeting continuous changes in client preferences.

A structured framework is guiding this redesign at PGGM, where the products and added value for the clients are evaluated before translating this back to the business processes and value chain and, first then, linked to IT systems and data. This approach helps reveal and remove duplicate tasks and increases efficiencies. For example, many pension funds externalize part of their investments, while still doing a lot of the related administration in-house, even though the external manager does exactly the same. As Sylvia Butzke, COO of PGGM explained at the Pension Fund Roundtable: “It is not about undoing the complexity of the products, it is about reducing the complexity of the processes, so we can be more agile.” Only once the new business architecture has been established, the data processes and system configuration to support it is added.

Sylvia Butzke, COO of PGGM: “It is not about undoing the complexity of the products, it is about reducing the complexity of the processes, so we can be more agile.”

Pension funds’ data challenge

DC plans’ demands on the operating model are also data-driven. As pension funds’ investment strategies broaden, more data becomes available and also necessary for analysis. Not only does this present a challenge in acquiring new data sets, but also in terms of standardizing and consolidating data.

Returning to the increased exposure to alternative investments, pension funds need to handle data specifics across a diverse range of asset types and investment stages, which often lacks standardization. In addition, the task of consolidating this data with investment data from traditional asset classes makes it difficult to get a true view of exposures across the entire investment portfolio.

Another issue arises when different functional groups within the organization collect similar data from different sources, demonstrating another example of duplicative tasks. Consolidating increasing amounts of data was highlighted by the pension funds present as key to leveraging synergies, becoming more agile, and reducing the cost of ownership.

One shared challenge with many aspects to tackle

The impact of the pension industry’s shift from DB to DC should by no means be underestimated. It is a fundamental change in how the industry operates, how its funds are managed, and how it serves the individual pension savers and meets their changing preferences. Neither should the related impact on pension funds’ operating model and investment management systems be underestimated. The Pension Fund Roundtable showed that this impact has many aspects, which need to be tackled by the individual pension fund.

Choosing the optimal IT setup for tackling DC plans could well be a source of competitive advantage in the future. Whereas the pension funds at the roundtable had chosen different frameworks and approaches, they all shared the view that the workflows, internal processes, IT systems, and data pools need to be agile and flexible enough to cope with ever changing customer requirements.

1. Willis Tower Watson, February 2018: Global pension assets study 2018. P7, the seven largest pension markets, include Australia, Canada, Japan, Netherlands, Switzerland, UK and US.
2. Willis Tower Watson, February 2018: Global pension assets study 2018.
3. ‘Buy-side Operations: Cutting Through Complexity', InvestOps, June 2018
4. 2017 Willis Towers Watson. Ranking as of year-end 2016.