Already, 2024 is shaping up to be unprecedented in terms of deals – both announced and those reputed to be in the works – to outsource the management of employee pension plans. As with many things relating to our retirement system, these outsourced chief investment officer (OCIO) deals have their supporters as well as their critics. The Committee on Investment of Employee Benefit Assets (CIEBA) has published a position paper, Challenging the OCIO Hype: Debunking the Myths, that does exactly what the title says and challenges the perception that OCIO arrangements deliver the benefits they claim. Further, CIEBA argues, senior leadership – and ultimately a company’s shareholders – may be left bearing the consequences.
That argument is based upon the position that the OCIO model does not in fact lessen the burdens on senior leadership since under federal law (ERISA), employers are always ultimately responsible for the prudent management and administration of their benefit plans. And even where a company has delegated some fiduciary responsibility, to an OCIO provider, the firm remains liable for the prudent selection and monitoring of that provider. Further, OCIO deals may present potential conflicts and administrative problems for the employer.
Read more about CIEBA’s position in the group’s paper published below.
Two large employers recently decided to strike deals to outsource the management of their multi-billion-dollar pension funds, replacing the in-house investment team with a for-profit financial institution. In contrast, several employers over the past decade have reversed this type of “outsourced chief investment officer” (“OCIO”) decision and brought pension investment management back in house.
OCIO arrangements are marketed as turnkey, low-cost alternatives to managing corporate and pension assets, which claim to also reduce fiduciary responsibility. However, as evidenced by firms who have brought management back in house, the reality is that the OCIO benefits rarely materialize, and senior leadership -- and ultimately the company’s shareholders -- may be left bearing the consequences.
Fiduciary responsibility – never fully “outsourced”
In-house Chief Investment Officers (“CIOs”) play a critical fiduciary role in helping corporations manage their pension assets and liabilities because they can leverage in-depth knowledge of the company to help the leadership team and the plan achieve their long-term goals. Despite this, some companies have considered eliminating the CIO role based on the short-term assumption that the change will reduce fiduciary burdens and plan costs.
Despite claims to the contrary, the OCIO model does not actually lessen the burdens on senior leadership. Under federal law (ERISA), employers are always ultimately responsible for the prudent management and administration of their benefit plans. Even where a company has delegated some fiduciary responsibility to an OCIO provider, the company remains liable for the prudent selection and monitoring of that provider.
Thus, senior leadership is responsible for actively monitoring the OCIO to ensure that they are acting in the exclusive best interest of plan participants and in a manner consistent with the plan’s objectives. This involves considerably more than just attending a few meetings, and that can be difficult – if not impossible – without the day-to-day assistance of dedicated in-house professionals experienced in overseeing investment managers.
Cost reductions for the plan – not always realized
The sales pitch for an OCIO model often promises cost reductions, too, but these savings rarely materialize in the long run. As for-profit enterprises, OCIO providers have an incentive to maximize their own revenue, typically resulting in higher fees over time. Moreover, once a company has terminated its in-house talent, it can be difficult and costly to escape escalating fees and costs of an OCIO down the road.
In practice, in-house CIOs are also instrumental in developing and executing strategies to effectively manage not only the pension assets, but also other retiree benefit program assets, all in the best interests of plan participants. In doing this, not only does the in-house CIO provide dedicated investment management expertise, but there is also a wealth of data demonstrating that in-house CIOs can negotiate for their plans some of the lowest investment management fees in the asset management business.
Potential conflicts of interest for OCIOs
OCIO providers often have material conflicts of interest that can affect investment selection and, ultimately, performance. For example, OCIO providers frequently steer clients toward affiliated funds and managers. This helps maximize profits for the OCIO provider, but it robs the company of the opportunity to select from the broader array of diverse funds and managers available in the open market.
In fact, OCIO providers are often so hamstrung by conflicts that they are incapable of providing objective advice that would negatively affect their profits. For example, OCIO providers might be incented to avoid making strategy recommendations to address pension liabilities (e.g., de-risking or pension risk transfers) because that would reduce their asset-based fees, even if those strategies might be in the best interest of the company and the plan participants.
Administrative, compliance and strategic challenges presented by the OCIO model
The OCIO model creates a host of administrative and compliance challenges for companies. OCIO providers typically do not have the same in-depth knowledge of a company as an in-house investment team, and this can lead to a disconnect between the company’s long-term goals and the OCIO provider’s management strategy.
Additionally, without an in-house team focused solely and continually on the company’s needs, compliance and operations often suffer, leading to a gradual decline in performance and an increase in risk as the employer retains less control over establishing investment policies. It is also difficult for companies to truly integrate an OCIO provider because there are almost always substantial challenges sharing sensitive corporate information – particularly where the OCIO provider is also a potential investor in the company – making it difficult to set up the systems necessary to responsibly transfer information among the company, the OCIO provider, and the plan’s auditors.
Several firms have moved away from the OCIO approach in recent years
Given the challenges, it’s no surprise that several companies who have thoughtfully tried the OCIO model, including several large multinational companies, have found that moving back to in-house fiduciary management was the right long-term solution. Again, challenges firms may encounter with the OCIO model include less-than-satisfactory investment performance, blurred fiduciary lines, concerns about diversification, and an overall decline in control.
Given these challenges, we strongly encourage senior management at firms considering going to an OCIO model to carefully weigh all aspects of the equation and be sure to consider the longer-term implications of the decision.
Dennis Simmons is executive director of CIEBA and can be reached at dennis_simmons@cieba.org.
