Consolidation of record keepers for 401(k) plans ‘worrisome’

Consolidation among record keepers in the retirement-plan business has created concern among some financial advisers.

While deal activity has waned since a feverish pace of blockbuster acquisitions leading up to 2016, experts believe the frenetic activity will resume within two years’ time — especially if there’s a downturn in the stock market. And the next round of deal-making is likely to yield some whoppers, they say.

While advisers don’t view mergers among big-name providers as inherently bad news, they see a reduced pool of record keepers as a potential problem — fewer firms able to service quirks and complexities among clients’ 401(k) plans, and a greater ability to impose restrictions and push proprietary products to boost margins.

“It’s getting worrisome,” said Ellen Lander, principal and founder of Renaissance Benefit Advisors Group.

Provider consolidation has been a steady force in the retirement industry since its early days.

Going back just a decade, there were as many as 400 to 450 U.S. record keepers (which track employee assets in retirement plans), according to Peter Demmer, CEO of consulting firm Sterling Resources Inc. That universe, which includes national as well as smaller regional and local firms, has shrunken to around 160 today, he said.

And the deals are becoming more significant in scale as the market continues to mature and more assets and clients are concentrated among fewer players — meaning greater numbers of DC-plan advisers and their clients are likely to be directly affected.​

Great-West Financial’s acquisition of J.P. Morgan Retirement Plan Services in 2014 was gargantuan — among the industry’s largest ever — bringing $167 billion in assets and 1.9 million participants to its platform. That deal ultimately led to Great-West’s creation of Empower Retirement, the second-largest record keeper today by number of participants.

Notable deals

There were other notable deals around the same time, including: Massachusetts Mutual Life Insurance Co. buying The Hartford’s record-keeping unit (2012), John Hancock buying New York Life’s (2014), OneAmerica Financial Partners buying Bank of Montreal’s (2015) and Aegon (the parent company of Transamerica Retirement Solutions) buying Mercer’s (2015).

“There haven’t been that many large deals occurring in that short a time frame in the history of the DC business,” Mr. Demmer said. “There could clearly be more.”

All of the big transactions have a common characteristic: They were attempts to boost scale.

Scale has grown increasingly important for 401(k) providers amid an environment of fee compression. Scale helps record keepers reduce cost — the larger a firm’s base of participants, the more firms are able to reduce their unit costs per participant for things like investment in technology, new products and services, and regulatory shocks, experts said.

“Anyone with 1 million participants or more either has the scale to go it alone, to acquire or survive easily,” Mr. Demmer said. “We used to think 500,000 was enough.”

Median record-keeping fees dropped by around half over the decade between 2006 and 2016, from $118 annually per participant to $57, according to NEPC, a consulting firm.

Investment fees have fallen in lockstep. 401(k) investors paid an average 0.48% asset-weighted expense ratio for equity mutual funds in 2016, compared with 0.74% a decade earlier — a drop of 35% — according to a joint study conducted by BrightScope Inc. and the Investment Company Institute.

The latter trend hurts firms that derive revenue not just from record-keeping but from participants investing in their in-house funds. This is the case for most major record keepers, which are primarily insurers and fund managers. To add insult to injury, 401(k) plans are using proprietary funds less frequently than in the past. The portion of DC plans using their record keeper’s target-date fund fell by more than half, to 23%, between 2012 and 2017, according to Callan.

Record keepers’ coffers aren’t as fat as they used to be. And, to a certain extent, advisers have contributed to record-keeper consolidation because of their continued push for lower fees, Ms. Lander said.

“If you can make money in this business you’ll want to stay in this business,” she said. “If you can’t, why the hell do you want to be in the business?”

Advisers should be concerned because the remaining providers will likely look to get rid of plans they can’t make money on, or impose restrictions, asset minimums or bifurcated business models based on plan size, Ms. Lander said. For example, a firm that accommodates and services a small but complex plan today may not do so in the future — potentially leaving the adviser and client with fewer and unappealing options.

“For an adviser like me who has plans that may not be $50 million, but by definition are complex, where do I go?” she said. “You can’t get a Maserati on a Kia budget.”

Some advisers don’t see record-keeper consolidation as a gloomy proposition, though — they even see it as a benefit if firms continue improving their offering.

“I don’t really care [about consolidation] as long as the major people I work with and their service don’t go bad because of it,” said Shawna Christiansen, a consultant at Retirement Benefits Group. “If you’re committed to that book of business, good. But don’t buy a book and then leave it.”

A strong market is partly responsible for the subdued level of merger activity since the end of 2015, experts said — it helps dull the sting of fee compression.

Private equity

The prevalence of private equity in the market and its desire to invest also have given pause to would-be buyers. Valuation expectations as a multiple of earnings are elevated relative to past years, said Edmund F. Murphy III, president of Empower Retirement.

Blackstone Group, for example, purchased Aon Hewitt’s record-keeping business last year, and a duo of private-equity firms (Genstar Capital and Aquiline Capital Partners) bought Ascensus Inc. in 2015.

Mr. Murphy expects deal activity to pick up in the next 18-24 months. While experts said trying to identify would-be sellers is a fruitless exercise, one potential signal is a lack of growth and investment in new products and services.

“If a provider is not aggressive in the market, chances are you’ve got a player considering a sale,” Mr. Demmer said.

He sees around a dozen large firms — primarily insurers — who seem to be making the requisite investments to grow and effectively combat fee pressure.​

“The $64,000 question is, will we see that group of 10 or 12, even 15, doing another round of transactions?” Mr. Demmer said.