Katie Sue Stewart hoped to lighten her load. During the past two years, Nashville, Tennessee based Ardent Health Services, where Stewart is vice president for human resources, has been on an acquisition spree. The company’s annual revenues, about $200 million in 2002, are forecast to grow to $1.3 billion by year-end, and its payroll is expected to swell from 2,500 to 9,500. By the end of last year, Stewart had already successfully melded three small defined contribution plans into Ardent’s existing 401(k).
But in January, when her employer sealed its largest acquisition ever, buying Lovelace Health Systems, an Albuquerque, New Mexicobased health care company that included a hospital and an HMO, the Ardent 401(k) ballooned from $21 million to $200 million in assets.
Stewart knew she would have her hands full shepherding the integration of the two workforces. So she decided to farm out some of the work of combining the multiple 401(k) plans.
It made sense to consolidate plan assets from Ardent’s provider, Fidelity Investments, and Lovelace’s four different providers. In the past Stewart would have used a consultant for such an assignment, but this time she made an increasingly popular choice. She hired an employee benefits broker -- Willis Securities, a Bethesda, Marylandbased division of U.K. insurer Willis Group. In mid-June, Ardent settled on Putnam Investments as its sole 401(k) provider.
Brokers, registered investment advisers and financial planners are selling more and more defined contribution plans. The biggest brokers in the marketplace: Merrill Lynch & Co. and Salomon Smith Barney, who are selling both their own and outside investment platforms to 401(k) clients.
“In the mid- to late ‘90s, there was a trend away from using brokers,” explains Donald Stone, a financial services consultant. “But now the trend is back toward the brokers.”
Broker-dealers accounted for more than 25 percent of all defined-contribution-plan sales in 2002, up from 16 percent in 1997, according to Boston-based research firm Cerulli Associates. They’re taking market share from insurance companies, whose cut declined from 44 percent to 38 percent over the same period. To a lesser extent, brokers are also taking business from consultants, who charge a one-time fee to plan sponsors.
A similar shift is under way in mutual funds, where brokerages accounted for 45 percent of sales last year, up from 32 percent in 1998.
While small and midsize plans have come to rely heavily on brokers, the largest plans, those with more than $100 million in assets, still tend to be sold directly--that is, in an arrangement between the plan sponsor and the 401(k) provider.
As 401(k) assets have dwindled during the bear market, plan providers have been turning to brokers to generate new sales. In the late 1990s the 401(k) industry grew accustomed to $40 billion in net new assets a year and about $255 billion in market appreciation on total defined contribution assets that reached $2.5 trillion at the end of 1999. But from January 2000 through year-end 2002, net new assets flowed in at a more moderate $35 billion annual pace, while the market’s downturn vaporized about $120 billion in assets each year, according to researcher Cerulli.
“People are looking for any way possible to get distribution,” says Stephen Malbasa, who heads retirement plan services at Los Angelesbased American Funds, which administers about $65 billion in defined-contribution-plan assets.
In a sense, the roles of broker-dealers and consultants in selling defined contribution plans are converging, notes Joshua Dietch, who follows the industry for Cerulli. Brokers are offering more ongoing services -- such as monitoring a plan’s investments and educating participants -- that used to be the purview of consultants. At the same time, consultants increasingly are asking to be paid like brokers, with their fees coming out of assets rather than a company’s pocket.
Brokers and financial planners have the freedom to strike their own deals. The county of Dauphin, Pennsylvania (which includes the state capital, Harrisburg), for example, recently used a broker to move its $8 million defined contribution plan from Nationwide Mutual Corp. to Principal Financial Group. As part of the arrangement, the county commissioner is permitting the broker, Harrisburg-based Hetrick Investment Group, to sell college savings programs, known as 529 plans, as well as other services to the county’s employees.
Some plan sponsors are using brokers to shift costs from corporate coffers to employees’ retirement plans. Here’s how that works: Consultants typically charge $20,000 to $45,000 for a provider search, which the plan sponsor pays out of company revenues. A broker selling a 401(k) plan charges a one-time finder’s fee of about 75 basis points of the plan’s assets. (A 75-basis-point fee for a $2.6 million plan would generate a $19,500 broker fee.) For ongoing services, consultants charge by the hour, whereas brokers collect annual 12b-1 distribution fees, which may legally run up to 100 basis points of the plan’s assets.
“In tough times plan sponsors would rather not have to write checks,” explains Michael Falcone, a senior defined contribution consultant at Aon Consulting. “Sponsors are realizing they can charge the plan assets.”
Some traditional direct sellers are getting into the act and using brokers to market defined contribution plans. In February, TIAA-CREF introduced a new fee structure that takes advantage of a provision of the Economic Growth and Tax Relief Reconciliation Act of 2001 that applies specifically to not-for-profits’ 403(b) retirement plans. The law allows providers to use up to 150 basis points of plan assets to compensate brokers. Unlike the 12b-1 fees that mutual funds pay brokers, these fees do not require Securities and Exchange Commission approval.
“Within the first six weeks, we brought in $30 million in new 401(k) money with very little publicity,” says Michael Lane, director of advisory services at TIAA-CREF. He anticipates that the new fee structure will attract close to $500 million in new defined contribution assets this year.
Where do brokers turn for leads? They may try to claim some of the $150 billion, or roughly 7 percent of total 401(k) assets, that annually moves from one provider to another. Brokers can also market to the 30,000 or so new plans created each year.
Traditionally, brokers have done well selling new plans to small business owners. Although they still sell mostly at the low end of the market (plans with $10 million or less in assets), brokers are making headway with large companies, too.
“In the past 18 months or so, it has become more common to see a broker sell a large company plan,” says American Funds’ Malbasa.
Joseph Masterson, director of retirement services at Diversified Investment Advisors, agrees. “Now 60 percent of our plan clients with more than $100 million in assets are coming to us through a broker,” he reports. Three years ago, he says, none of those clients came in via brokers. And Robert Francis, who runs the employee benefits and retirement division of ING U.S. Financial Services, which has close to $50 billion in defined contribution assets, estimates that brokers currently have a hand in selling about 35 percent of all plans with between $20 million and $250 million in assets. “That represents an increase of 75 percent over their market share three years ago,” says ING’s Francis.
Merrill Lynch is a case in point. Until mid-2000, says Cynthia Hayes, head of retirement plan sales, “any plan with more than $50 million in assets had to be direct-sold,” meaning that a Merrill executive approached the plan sponsor. But in an effort to boost sales, Merrill in mid-2000 started using brokers -- its own as well as those of rival broker-dealers -- to help find new clients with more than $50 million in assets. Among the roughly $22 billion in assets that Merrill currently administers from plans with more than $50 million, about one quarter -- or $5.5 billion -- were generated through the efforts of brokers.
Until 2001, New York Life Investment Management worked exclusively through the direct channel for retirement plan sales. “In the summer of 2001, the company did a 180-degree turn,” says Gary Jackson, who joined New York Life a year later to manage the sales effort. The company has hired four new wholesalers in the past six months, and about 40 percent of New York Life’s business now arrives through brokers. New York Life Insurance Co. agents, consultants to Taft-Hartley funds and the firm’s institutional alliances deliver the rest.
But Jackson, like many of his industry peers, believes that brokers can do even better. He expects about 50 percent of New York Life’s 401(k) business to come in through brokers by the end of this year.
“We’re on a roll,” he says.
