Change is in the wind. Just when 401(k) service providers think they've figured out how to structure an effective program, they find the competitive world entering an entirely new phase that will change the business forever. Just as the push into daily valuation left many players gasping for breath, so too will the coming move into comprehensive employee benefit services.
In the years ahead, we are likely to see a significant move toward providing the administrative tasks of all employee benefits through a single service entity. This not only moves the 401(k) business far from its roots as a stand-alone product, but also makes it truly significant in that it will virtually end service delivery as we know it.
What makes this move inevitable is the sheer logic of it. Today, companies might hire as many as 10 different service providers to help advise and administer their employee benefit plans. These involve:
A benefits consulting firm to advise them on the structure and design of plans as well as to provide assistance on compliance issues.
An asset consulting firm to help them select money managers or mutual funds for their various programs, as well as to monitor investment performance.
An actuarial firm for their defined benefit plans.
A trustee/custodian for the assets held in their plans. There could easily be more than one entity providing these services, depending upon the needs of the company and the capabilities of the firms selected.
One or more investment firms or mutual fund companies to manage money.
A communications firm to provide plan information to participants.
A record keeper to maintain participant records.
An accounting or financial planning firm to help participants devise appropriate investment strategies.
A claims-processing agent for the handling of welfare claims and possibly the payment of benefits.
Legal counsel to oversee the entire operation.
Not only is it cumbersome having so many service providers, but in many cases, they must share information with each other to perform their particular function. Even when some of these activities are handled in-house, the company is still required to support a variety of administrative tasks associated with its benefits program.
Most companies also maintain an in-house staff to coordinate the activities of the people or firms providing these services. This, of course, involves the hiring and training of more employees or firms, negotiating contracts, moving information from one party to another as needed, and managing the staff. By consolidating these functions, companies can operate their benefit plans more efficiently and professionally while saving money.
Vertical integration through acquisitions and strategic alliances is the future for 401(k) service providers. This will alter the service business forever, as stand-alone organizations will play much less of a role in the continuing competitive battles. Eventually, independent and specialty firms and organizations that provide limited services will recognize that they are faced with two choices: limiting their work to plans of smaller companies or affiliating with a larger, full-service firm. Clearly, the last option is the only one for serious players.
The case for consolidating all employee benefit administration is overwhelming. What makes it difficult to implement is there are now few organizations that can execute more than two or three of these functions with any degree of expertise. This, however, is beginning to change.
In one case, State Street Bank & Trust Co. entered into a joint venture with Watson Wyatt Worldwide to provide full benefits outsourcing to plan participants. This is one of the first efforts to combine the expertise of a consulting actuarial firm that has record-keeping skills with those of a large, custodial trust bank that provides basic investment and trust services. Together they can offer far more comprehensive services with a greater degree of skill than either of them could separately.
In another case, Mellon Bank announced its intention to purchase Buck Consultants. This is not being done on a whim. Nor is it just a way of adding fee-based services to an industry that craves this type of business. It is part of a strategic approach to handling employee benefit plans that provides Mellon with the consulting, actuarial and investment consulting components that fit so nicely with its basic trust and investment services (including its Dreyfus mutual funds). With these capabilities, Mellon will be able to present itself as the first truly full-service benefits provider in the business. And, given the benefits noted above, they will be positioned to help corporations meet their business and benefits objective efficiently and in a cost-effective manner.
These examples represent only the tip of the iceberg. Many independent firms want to affiliate with larger service providers as they find it increasingly difficult to compete with those who have more significant corporate relationships in their target market. At the same time, larger service providers are searching for ways to differentiate their services from those of their competitors. The ones that are most forward-looking recognize that by broadening the scope of their services they can add volume and new sources of revenue to their business - two things that will substantially improve their profitability.
Ever since 401(k) plans were first recognized as a serious retirement alternative to defined benefit plans and other defined contribution plans, administration has been the focal point of all kinds of service specialists. These included consultants, investment managers, insurance companies, banks and other firms, focusing on one aspect or another of administrative functions that the business required. Because the administrative activities of these plans generally were straightforward, traditional service providers had little problem meeting the needs and expectations of sponsors.
Today, the situation is different. Plans are more complex.
On the investment side, there has been a strong move toward the use of mutual funds as the primary investment vehicle. This has been accompanied by a move toward daily valuation. And, lately we have seen a major move toward adding additional investment options that plan participants and human resources people both are ill-equipped to handle.
Administratively, the government upped the stakes in three ways: first, it inserted itself into the process of seeing that participants were well informed as to their investment options; second, it placed limits on the amount of money that could be contributed and diligently monitored discrimination rules; third, it began taking an active role in making certain that contributions to 401(k) plans are made in a timely fashion.
The result is that plan sponsors are more dependent upon prompt, accurate information than ever before. The tasks associated with these activities are time-consuming and expensive for human resource departments, even when much of the administrative functions are outsourced to specialists. The challenge to all plan sponsors, especially large ones, is to simplify the administrative tasks associated with their 401(k) plans and to reduce the costs of administration.
The first outward attempt to change the way plans traditionally have been handled showed up within the past three years as companies began to look seriously at totally outsourcing their benefits administration. This was the first time they even considered the possibility that at least some of the 401(k) administrative tasks could be combined with those of other employee benefit plans. While few people today recognize this as the defining event it really is, it clearly sets the stage for a whole new way of providing 401(k) services. nPaul I. Kampner is president of TMark Associates, Chicago, a consultant to banks addressing strategic issues on employee benefit services.