A battle is heating up between a few traditional purveyors of 401(k) services and a host of small start-ups, all of which are selling an entirely Web-based approach to the defined contribution marketplace.
By Jinny St. Goar
July 2001
Institutional Investor Magazine
A battle is heating up between a few traditional purveyors of 401(k) services and a host of small start-ups, all of which are selling an entirely Web-based approach to the defined contribution marketplace.
Fidelity Investments fired the first salvo in this fight in October 1999, when the Boston-based mutual fund power launched its online 401(k) product. Over the next 18 months, a few other defined contribution plan providers, including Principal Financial Group and CitiStreet, the joint venture between Citigroup and State Street Corp., began to develop and market their own e401(k)s. Today some 14 firms - three traditionals and 11 start-ups - have a presence in the market for all-electronic defined contribution services. Generally, these online plans offer participants most of the functions and features of a full-service 401(k).
The industry is now reassessing the profit potential of what seemed an exciting new way to reach untapped markets, such as small businesses. Although many providers are considering buying, building or creating a new Internet presence, for the moment most of the top firms are hanging back. Is there money to be made from an electronic delivery system? When? And how?
At the end of May, e401(k)s claimed roughly $2 billion in assets under management, a tiny portion of the total $1.7 trillion in defined contribution plans.
“We have a team of five who have been working for more than nine months on the small-plan market,” reports Paul Heller, who heads up defined contribution services at Vanguard Group. “But the Web will have to take out an awful lot of costs [from the traditional industry’s small-plan average of 146 basis points] to maintain our level of service.” Vanguard currently charges its large-plan clients that are served offline an average fee of 28 basis points, but that fee climbs as the number of participants declines, hitting about 50 basis points for plans with 500 employees or less. For now, the industry’s second-largest player isn’t much interested in plans with fewer than 500 employees.
Although pricing structures vary, e401(k) providers charge an average 120 basis points for a plan with 50 employees or less and $2 million in assets. That compares favorably to the average of about 146 basis points for a similar-size plan using traditional 401(k) services, according to HR Investment Consultants, a data-gathering firm based in Baltimore. Proponents of e401(k)s argue that they should especially appeal to small employers.
At the moment, though, e401(k)s face two major drawbacks. Investment options can be quite limited - Fidelity offers only 26 funds, all their own, for example. And at the end of the day, operating entirely online means, by definition, that “you just can’t get a human being to help,” says Dan Esch. Esch is the managing director of Defined Contribution Advisors, a fee-only boutique based in Minneapolis that advises Fortune 500 companies on their defined contribution plans. Referring to all the e401(k) products in the marketplace now, Esch says, “There’s much more sizzle than steak.”
The newcomers that sell e401(k)s can be loosely categorized as Internet-based service providers or third-party administrators. The former include Emplanet, GoldK, Fast401k, theonline401k, 401keasy, ExpertPlan and Persumma Financial. All have created an entirely Web-based system of recordkeeping and will hook up investment management services as well. None have proprietary investment products; instead, they use broker-dealers or registered investment advisers for investment products.
The key for any start-up in the 401(k) business is gathering assets as quickly as possible to provide a steady stream of fee income to turn a profit. Plenty of small businesses have yet to set up 401(k) plans - some 85 percent of companies with fewer than 100 employees do not have a retirement plan, according to the Employee Benefits Research Institute. But the challenge is to find companies whose plans will accumulate assets fast enough to become profitable.
To get through the months of negative cash flow, Boston-based Emplanet can draw upon the deep pockets of Oak Hill Capital Partners, Robert Bass’s venture capital group. Oak Hill was Emplanet’s lead investor for the first round of $4 million in venture capital funding in early 2000. As of mid-June Oak Hill was stepping up for a second round of funding that will total more than $10 million.
GoldK, which is also headquartered in Boston, received initial funding of roughly $10 million from about 50 high-net-worth individuals, rounded up by Bryan Boyle, the firm’s CEO and a high-tech entrepreneur with five successful start-ups under his belt. Both Emplanet and GoldK are staffed by former employees of Fidelity, Morgan Stanley, State Street Research & Management Co. and Putnam Investments. GoldK now has 94 employees, while Emplanet has 55.
Fast401k, theonline401k, 401keasy and ExpertPlan are less well capitalized. They also make do with very small staffs - the firms have 17, nine, 12 and 20 employees, respectively. These start-ups are looking to partner with brokerages, bankers and insurers that are already selling 401(k) services and serve as the distributors of these Web-based approaches. Persumma Financial, created by MassMutual Financial Group, is marketing its services on the Web and through MassMutual’s sales force.
The online third-party administrators - firms that handle back-office recordkeeping and other administrative tasks but provide no investment management - include DailyAccess.Com, BenefitStreet, Invesmart and 401kservices.com.
Both classes of start-ups assumed that the Internet would rewrite the economics of the small-plan market - the companies with fewer than 100 employees that currently do not offer a retirement plan. But in these first few months of operations, they have had a tough time realizing their goals.
Persumma Financial, for example, claims 14 plans as clients, while others’ numbers range somewhere between 1,300 (Fidelity), 131 (GoldK), 115 (theonline401k) and 54 (Emplanet). Even the higher numbers are quite low, considering the capital that has been devoted to this corner of the industry over the past two years - roughly $150 million, according to Venture Economics, which tracks private equity investments.
Small-business owners, the natural audience for e401(k)s, are difficult to reach. Next to the difficulties of the start-up market, however, converting established plans to e401(k)s looks equally daunting. “The efficiencies fly out the window with conversions,” says Joshua Dietch of Cerulli Associates, a financial services consulting firm. He’s referring to the process of shifting an existing 401(k) plan from one provider’s system to another. That’s because the conversion process is so labor-intensive. At GoldK, vice chairman Troy Shaver reports that start-ups take about 20 hours to get into the system, while conversions require about 50 hours.
Even Fidelity started taking conversion clients for its e401(k) product late last year in the critical search for assets. “Now conversions constitute about 15 percent of our sales,” reports Bill Carey, the Fidelity vice president who oversees the e401(k) program.
It’s a tough business. Emplanet gave pink slips to ten out of 64 employees in March, saying that the company had completed its development phase and was shifting to marketing its products. At the same time, Emplanet hired a new president, Mike Perez, who was lured out of early retirement after years as a top marketer for Fidelity.
Some e401(k) providers are switching gears. Instead of waiting for the day when they can distribute and operate plans through the Internet, they are doing the hard work of establishing relationships with banks, brokerages and CPAs - networks of selling agents that can reach small-business owners efficiently and, it is hoped, help them sign up small-business e401(k)s.
Emplanet sells its services through such intermediaries as LPL Financial Services (a network with about 3,800 independent brokers managing about $40 billion in assets) and North Track Funds (a fund family with $2 billion in assets that markets its funds to more than 500 registered investment advisers). Theonline401k is being sold through TriNet, an automated payroll company with 20 sales representatives nationwide. DailyAccess.com has relationships with Legg Mason, Dain Rauscher, Eaton Vance Corp. and the funds of AIM Management Group.
One critical question for the average e401(k) start-up: Can it hang in long enough to partner with a large provider like Vanguard? Heller reports that when Vanguard set out to sign up a firm that would help advise plan participants, the process took “at least 18 months” (in the end, Vanguard chose Financial Engines). Were the firm to partner up with an online start-up for 401(k) services, it would probably take just as long to evaluate the candidates. Unless market conditions change, some possible partners may not be around for the review.
