The limbo bar is set lower and lower each year for 401(k) record-keepers. Several providers have exited the game, merged or been acquired by larger providers because they haven’t been able to keep pace with “how low can you go?” fees or expanded services that plan sponsors have been demanding.
“Plan sponsors want more,” said Jamie McAllister, vice president of defined contribution practice at Chicago-based consulting firm Callan Associates. “They want more services, more technology and lower pricing. It’s hard for everyone to keep up. It’s resource-intensive and investment-intensive.”
Plan sponsors feel the heat from U.S. Labor Department rules and in turn are continuing to put pressure on their providers for more or better services at lower costs. A few years ago, the Labor Department required plan sponsors to know how much they were spending on their plans, and in turn provide that information to participants. Over the years, participants have brought lawsuits against companies saying the providers they hired were receiving unreasonably high fees.
On top of this, a newly minted rule, which takes effect next year, redefines the definition of fiduciary. Now any service provider that gives investment advice to a plan must put the plan’s best interests ahead of its own.
As a result of plan sponsor demands, fees paid for record-keeping services have been squeezed, hitting record lows each year. The median record-keeping fee was $64 per plan participant in 2015 down from $70 in 2014, according to data from investment consulting firm NEPC. When NEPC started tracking fees 10 years ago, it was $118.
“This erosion in fees leaves little wriggle room for more cost savings,” NEPC’s 2015 October survey on defined contribution plans and fees reported. “Plan record-keepers cannot continue to provide the highest levels of service if profit margins are nonexistent.”
So what happens? Consolidation. Last year’s big deals included John Hancock Financial purchasing New York Life Retirement Plan Services; Transamerica Retirement Solutions acquired Mercer’s defined contribution record-keeping business; and OneAmerica Financial Partners bought BMO Financial Group’s U.S. record-keeping services business. Earlier this year, Xerox Corp. said it would spin off its record-keeping business into a separate public company.
Many of the acquisitions were made so the acquirer could broaden its ability to serve plans of all sizes. By purchasing New York Life’s expertise in the mid- to large-plan market, John Hancock has been able to round out its small-plan capabilities, said Fred Barstein, founder and executive director of The Retirement Advisor University and The Plan Sponsor University.
“As a record-keeper, you have to sell to all” segments of the market, Barstein said. “As plans grow and get more sophisticated, some record-keepers lose out because they either don’t have the right people or the bells and whistles that are now standard.”
Record-keepers are the nuts and bolts of defined contribution plans. They manage the daily operations, like processing enrollments, tracking and handling investment elections, contributions and payouts as well as producing plan statements for employees.
About 10 years ago, record-keepers needed to service 1 million participants to stay alive. Today, providers need 2.5 million to 3 million participants, said Jim O’Shaughnessy, managing partner for Sheridan Road Financial, a Northbrook, Illinois-based consultant and retirement plan advisory firm.
“The industry has changed a lot,” he said. “In the record-keeper industry, we expect to see consolidation continue down to maybe six total providers. That’s probably an aggressive number, but there is still an enormous amount of consolidation to occur.”
Fidelity Investments continues to dominate the field, serving 24,000 plans with 18.9 million participants with $1.5 trillion in assets.
Scale is what these players have in common, industry experts say. Things like mobile apps, automatic features and other online educational tools used to be the specialties that got record-keepers noticed. Today, these providers can’t survive without top-line technology and services. In many ways, record-keeping has become a commoditized service — meaning that there is little that differentiates the options on each providers’ menu.
Because the market is changing so rapidly, plan advisers are working with plan sponsors to evaluate record-keeping services more frequently. Robert Lawton, founder and president of Lawton Retirement Plan Consultants in Hales Corners, Wisconsin, works with midsize to smaller plans. He said plan sponsors that haven’t taken record-keeping services out to bid in three to five years can see fee reductions of up to 50 percent.
That is good news for plan participants, who are usually the ones paying service fees. The Labor Department points out that an employee with 35 years until retirement with $25,000 in a 401(k) account could grow that balance to $227,000 at retirement using a 7 percent return on investment and a 0.5 percent fee reduction. Using a 1.5 percent fee on the same account would bring the balance down over time to $163,000.
Plan sponsors and their advisers are looking for providers with staying power and the ability to provide the best service to suit their needs. Kathleen Kelly, managing partner with Compass Financial Partners in Greensboro, North Carolina, said her firm works with 20 different record-keepers and benchmarks provider services annually for plan sponsor clients to make sure the record-keepers they use are competitive.
“If you see a gap which shows the record-keeper isn’t keeping pace, they are likely not to continue being in the business,” she said.
About 67,000 401(k) plans could very likely switch record-keeping providers within the next 12 months, a Cogent Reports study showed from Market Strategies International. While this number is statistically the same as last year’s report, more plan sponsors (57 percent) are in that middle ground of “maybe land” compared with last year. Fees continue to be the main reason plans consider switching providers.
Cogent’s May “Retirement Planscape” study noted the top five plan providers most likely to be considered by all plan sponsors: Ascensus, Fidelity Investments, Vanguard Group, Empower Retirement and Wells Fargo & Co. Linda York, vice president at Market Strategies noted that some providers, like Aon Hewitt, only cater to larger companies, and would not be considered by smaller clients.
“Consolidation is definitely on the mind of plan sponsors,” York said. “It’s not the be-all-to-end-all that is causing the [consolidation] action, but it is certainly something worth noting.”
Meanwhile, some plan advisers are beginning to narrow the number of record-keepers they will recommend to clients. Cogent Reports data show plan advisers work with about three providers on average. Plan advisers managing $50 million or more in defined contribution assets work with about four providers.
Sheridan Road’s O’Shaughnessy said his company is trying to get bigger, and needs to whittle the number of record-keeper relationships in half from the 25 they currently recommend. The company currently manages $10 billion in assets for 200 defined contribution clients and is shooting for $50 billion in assets with 500 clients.
“For us to build that kind of scale in our business, I have to create efficiencies,” O’Shaughnessy said. “From the [plan] advisory end, we see a massive amount of consolidation going to happen, too.”
As a way to make money, several providers sell proprietary investments alongside their record-keeping services. But many plan sponsors are taking a second look at that relationship because they want to make sure that when selecting investments and service providers, they are fulfilling their fiduciary responsibility in acting in the best interest of their plan participants.
Only 14 percent of defined contribution plans used the record-keeper’s investment funds last in 2015, according to consulting firm Callan Associates’ 2016 Defined Contribution Trends survey, which tracks larger plans. In 2014, nearly 20 percent of plans fit that strategy.
“There is a higher bar out there,” said Callan’s McAllister. In terms of separating investments from the record-keeper, “it keeps things cleaner.”
Some advisers, like Compass’ Kelly, prioritize the investment menu before helping a plan sponsor choose a record-keeper. There can be cost savings if a plan sponsor uses the record-keeper’s brand-name investments, but often the fee for the investments gets tangled with the record-keeping cost.
“Considering the investment menu before the record-keeper helps to take those unknowns out and makes it a more transparent process,” Kelly said.
Even though providers are exiting the market, robo record-keepers are coming on the scene. Last year, robo-adviser Betterment entered the record-keeping space with its Betterment for Business line. The company launched in January with 50 plans.
Betterment’s main selling point speaks to plan sponsors’ major concern: cost. Management fees range from 0.1 percent to 0.6 percent, depending upon the size of the plan. Betterment is a full-service provider, offering web-based fiduciary advisory services for participants, plan sponsor support, and professionally managed accounts that use passive or indexed investments.
The company certainly has skeptics. Several experts said the business model only works for smaller plans or for those plans that don’t have sophisticated users who want to invest in specific stocks.
“For those companies just starting plans, this may be a decent solution,” said retirement adviser Lawton. “The problem with robos is the executive of a $1 million plan probably isn’t interested in getting investment advice from an automated answer or a 23-year-old kid on the line.”
Others, like Barstein, are interested in seeing what Betterment can do with its low fees in this cutthroat record-keeping space.
“The world is changing and robos are creating a new paradigm,” Barstein said.
Patty Kujawa is a writer based in Milwaukee. To comment, email firstname.lastname@example.org.