401(k) record-keeper consolidation is about to heat up

Though there have been a few recent high-profile 401(k) record-keeper acquisitions — think Transamerica’s purchase of Mercer’s defined-contribution business and Blackstone’s acquisition of Aon Hewitt’s — there has been a lull in the consolidation. That’s likely to change soon as a result of escalating costs, low interest rates and the natural maturation of the 401(k) record-keeping business.

It is widely reported that Newport Group, which is owned by private-equity firm Stone Point, is on the market, and there are also rumors about another, unnamed record keeper that oversees 2 million to 3 million participants being shopped. How do plan advisers stay ahead of the curve and avoid placing new business with exiting providers?

There are currently almost 40 national 401(k) record keepers, most of which service plans with less than $250 million in assets — the sweet spot for advisers. This number is unsustainable. Record keepers are about to exit the second stage of a typical four-cycle consolidation curve: Stage 2 of the consolidation curve is highlighted by “…rapid consolidation, with survivors honing acquisition skills, protecting core culture as they absorb others, retaining the best employees from acquired companies and building scalable IT platforms.”

Randy Long, managing principal at SageView Advisory Group, commented that “1 million participants used to be fine; the new measurement [to be viable] is 3 million.”

“If JPMorgan — which was a good record keeper, with great service and scale as well as good funds — couldn’t make it work, it raises a lot of questions for others, especially banks,” Mr. Long added.

While the top 10 401(k) record keepers already enjoy a 75% market share, with the top six at 60%, the concentration should continue, according to many industry analysts.

Ed Murphy, president of Empower Retirement, believes that 401(k) record-keeper consolidation is about to heat up, in part because of “increased costs caused by cybersecurity risk and new regulations, fee compression and well-heeled providers raising the bar.”

These sentiments are echoed by Charlie Nelson, CEO of retirement and employee benefits at Voya Financial, who suggested: “Key to successful acquirers is the organizational skills and knowledge to consolidate record-keeping platforms. Those that lack this skill are vulnerable to execution risk.”

So what should plan advisers do? How can they identify which companies are likely to consolidate rather than be consolidated? Some providers, such as Voya, Empower, Principal, Lincoln and Prudential, are publicly traded or make their financials available with their retirement-division metrics listed. Look to see if they are profitable and are growing faster than the market. Does retirement appear to be core to the overall entity?

Asset-management skills can be a blessing and a curse. Some providers that loaded up early on proprietary products, especially target-date funds as the default investment option, are losing market share, which erodes their margins; others have taken a different approach by adding custom target-date strategies and managed accounts, which could increase profitability.

One method to identify winners and losers is to watch the wholesalers. At watering holes in the jungle, other animals stay close to giraffes because they have the best view and are easily spooked. The wholesalers are advisers’ giraffes. Look for patterns of good wholesalers exiting a provider and where they land, as they will sense danger before advisers can.

But advisers are inherently conservative and may not have the ability to consolidate their roster of record keepers, in part because it may not be their choice and also because it takes time and money.

Dick Darian, CEO at The Wise Rhino Group, a consulting firm, asks, “Can advisers really afford to do nothing? Putting their entire book of business out to bid may seem logical, but the risks may seem to outweigh the benefit, especially if they choose poorly.”

“Nothing is linear,” Mr. Darian added. “Everything catches up at once, leaving advisers scrambling.”

Here’s a recent example: Does anyone remember when The Hartford hastily announced the divestiture of its DC business in 2009?

Though most advisers will probably do nothing, Mr. Long of SageView offers a warning for those that dawdle.

“As a consultant, the last thing you want to do is place business with a provider that then exits the market,” he said. “It can have a huge impact on your reputation.”

(More: Insurers’ 401(k) record keepers gain big share in small, midsize markets)

Fred Barstein is the founder and CEO of The Retirement Advisor University and The Plan Sponsor University. He is also a contributing editor for InvestmentNews‘ Retirement Plan Adviser newsletter.