Recordkeeping has always been a low-margin business, but some providers are finding that tending to administrative chores an pay.
By Jinny St. Goar
October 2002
Institutional Investor Magazine
For the better part of the past decade, 401(k) providers have been abandoning recordkeeping -- a low-margin, technology-intensive business -- as simply more trouble than it's worth. In just the past year, several longtime players have closed up their recordkeeping shops.
But a few hardy survivors soldier on in this tough market, providing administrative services to defined contribution plans and finding ways to make money at it. Among the firms that have managed to either increase the dollar volume of assets under administration or the number of plans they serve (or some combination of the two): Bisys Group, Invesco Retirement, Mellon Financial Corp., SunGard Employee Benefit Systems and GoldK, an online-only 401(k) provider.
Recordkeeping for 401(k) and other defined contribution plans is a nitty-gritty affair -- gathering participants' monthly contributions, distributing them to various investment products (that may or may not be managed under the same corporate umbrella as the recordkeeper), keeping up with regulatory and legal requirements and providing the payouts when participants retire.
Pretax margins average about 12 percent for recordkeepers, down slightly in the past five years, versus average margins of 29 percent for asset managers. Firms such as Fidelity Investments, T. Rowe Price Associates and Vanguard Group, which sell both portfolio management and recordkeeping services to plan sponsors, enjoy synergies and economies of scale in their administrative infrastructure that stand-alone recordkeepers usually cannot match. Other recordkeepers, like Hewitt Associates, reap savings from sharing ad-ministrative costs with their benefits consulting divisions, but they tend to be less substantial than those gained by money managers.
The key to success for the industry's few survivors: increasing distribution channels while keeping a tight rein on costs. In 2001, according to research by Boston-based industry consulting firm Cerulli Associates, recordkeepers sold their services to plan sponsor clients through five channels, with 55 percent of assets garnered from direct sales, 23.5 percent from broker-dealers, 9.5 percent from banks, 8.4 percent from agency sales and 3.5 percent from third-party administrators. The standout recordkeepers have increased their distribution channels with acquisitions, picking up groups of new plan clients without having to pony up the marketing expenses to attract them one by one. In addition, acquisitions often provide the buyer with a new sales force, which can further boost revenues. The ongoing challenge: integrating acquisitions without losing a handle on all-important cost controls.
Once the province of third-party administrators and benefits consultants, the recordkeeping business attracted mutual fund companies in force in the late 1980s. They saw providing recordkeeping services to the defined contribution business as a surefire way to collect assets. As more money flowed in, improved economies of scale were supposed to fatten profit margins. Ten years ago this lured literally thousands of firms, large and small, into the business.
But the market consolidated, as many firms abandoned the market for small defined contribution plans, a move that was often unprofitable.
The five largest recordkeepers now command 40 percent of the market, compared with their 25 percent market share in 1994. They are: Fidelity ($381 billion in assets under administration), Hewitt ($170 billion), CitiStreet ($141 billion), Vanguard ($119 billion) and Merrill Lynch & Co. ($68 billion). Below the $100 billion threshold, competition remains intense, and a number of firms have fallen by the wayside within the past 18 months. The dropouts include FleetBoston Financial Corp., which turned over its business to Invesco as did Wachovia Corp., while Pricewaterhouse-Coopers offloaded its Unifi group to Mellon Financial. In early 2001 John Hancock Funds sold its defined contribution business to Universal Pensions, which was in turn purchased by Bisys Group that June.
"Assets under administration is really the only number that counts," notes Hubert Harris Jr., CEO of Invesco Retirement. Between January 2001 and January 2002, the most recent period for which increased assets under administration are available, the standouts include Mellon ($31.5 billion to $55.1 billion), T. Rowe Price ($51.8 billion to $53.5 billion), SunGard EBS ($36.5 billion to $38.5 billion), Invesco ($27.6 billion to $34.6 billion) and GoldK ($723 million in June 2001 to $1.65 billion in June 2002). Of course, some of these gains have evaporated in this year's tough stock market.
As encouraging as this growth may be, it masks some basic problems. For instance, average account size has not risen, which makes it difficult for the recordkeepers to boost their margins. Profitability typically kicks in when account balances reach about $20,000, according to Joshua Dietch, a consultant with Cerulli Associates. "Ten years ago people expected that profitability would be based on reaching a certain number of accounts, with the expectation that account balances would skyrocket," points out consultant Robert Wuelfing. But that hasn't really happened: The average account balance fell from $45,681 at the end of 1999 to $36,390 at the end of 2001. The decline reflects both rocky markets and the successful expansion of the 401(k) market to new (and smaller) account holders.
Significantly, only 13 percent of 66 million defined contribution accounts provide about 50 percent of the industry's assets. The remaining 87 percent are very small accounts indeed. "The median account balance is the meaningful number," says Wuelfing, "and that is only about $14,000."
Among the firms that increased their assets under administration, Invesco, GoldK and Mellon were active players last year. Invesco gobbled up not just Fleet Bank and Wachovia but the recordkeeping rosters of AmSouth Bank and Frost Bank. The institutions wanted to get out of the recordkeeping business, so they offered their clients the chance to move over to Invesco's recordkeeping system; Invesco did not pay the banks for its new customers. The Invesco-Fleet deal, announced in May 2001, brought $5 billion in assets under administration and 150,000 participants to Invesco, with the conversion of all those accounts completed by the end of the first quarter of 2002. The other deals were consummated during the course of 2001.
Harris, who took the reins at Invesco in January 1998, notes that the company was in a position to consider these deals in part because it was late to the table in technology spending. "We didn't make a serious commitment to technology until 1996," he explains. Although this tardiness had put Invesco at a competitive disadvantage, it spared the firm the burden of legacy computer systems. Instead, Invesco was a beta-tester of SunGard's OmniPlus recordkeeping software, now the state-of-the-art nonproprietary system.
GoldK, by contrast, paid to acquire some small third-party administrators. In the past year GoldK made four significant buys: ACG Associates of Canton, Connecticut; Paradigm Financial Corp. of Kirkland, Washington; Retirement Horizons of Houston; and the retirement services division of Gallagher Benefit Services of Michigan. Combined, these four regional benefits firms added 450 plans, about 60,000 participants and $900 million in assets under administration to GoldK's roster.
The killer for most recordkeepers has been the cost of providing service to small accounts -- those with the median $14,000 or less. The automated part of the business is less onerous than the hand-holding -- the service representatives answering questions on the toll-free phone lines -- which has only become more intense in these jittery markets.
GoldK, the one online 401(k) pro-vider that has been growing its business steadily, touts its ability to cut the costs of plan administration. GoldK provides recordkeeping services directly to its 1,050 plans under contract. It also runs a fast-growing "private label" business in which it sells its recordkeeping platform to institutional clients, particularly banks and third-party administrators, who use it to service their own plan sponsor clients. In the first eight months of this year, GoldK more than doubled its client roster, to 2,250.
Mellon chose yet another route, narrowing its focus to larger plans. Its total number of recordkeeping clients (even with the acquisition of Unifi) plummeted to 295 this year, from 1,237 in 2001. The decision to get out of the small end of the market was not only a function of the difficulties of serving those plans. "We did not have the distribution channels to sell to small companies," explains Anthony Martin, senior vice president of Mellon HR Solutions.
These days, recordkeepers are feeling the pressure to invest in new technologies. Example: self-directed brokerage windows, in which a defined-contribution-plan participant has an unlimited choice of investment options, including indi-vidual stocks, bonds and mutual funds. Only 18 percent of plan sponsors currently offer self-directed accounts, but many recordkeepers feel obliged to have the wherewithal to manage such accounts.
Recordkeeping will always be a technology-intensive, low-margin operation. But for a few participants, it will also be a worthwhile endeavor.
