A new wave of consolidation has struck the defined contribution industry, as bundled providers gracefully attempt to get their record-keeping businesses off their books while continuing to manage the assets of their bundled clients.
Joint ventures and alliances, created to allow the bundled provider to retain control over plan assets, are no longer necessary, consultants say. Instead, bundled providers are selling their record-keeping businesses in exchange for a piece of the action. Here is a sample of recent deals:
c After months of rumors, Deutsche Asset Management, New York, in April sold the $11 billion record-keeping business of Scudder Retirement Services to Automatic Data Processing Inc., Roseland, N.J., in exchange for an undisclosed interest in future bundled defined contribution and total outsourcing business. That model may be duplicated by other bundled providers.
c Northern Trust Retirement Consulting LLC, Chicago, sold its defined contribution business, with gross annual revenue of about $74 million, to Hewitt Associates LLC, Lincolnshire, Ill. Hewitt agreed to take over Northern's defined benefit and defined contribution plan record-keeping, administration, consulting, actuarial and communication business and will be hiring the 500 associates in the Atlanta office, said Jennifer Frighetto, Hewitt spokeswoman. The companies also formed a non-exclusive preferred provider relationship, in which Northern Trust will recommend Hewitt for record keeping and other outsourcing services and Hewitt will recommend Northern for custody and trust.
c The Charles Schwab Corp., San Francisco, reorganized its business into three units: retail, including the newly formed Schwab Bank; affluent investors; and institutional asset management. Some observers say the reorganization is a prelude to the sale of its bundled defined contribution business, but Schwab executives deny it.
All about scale
"The defined contribution business has always been about scale," said Dave Eager, partner in the Louisville, Ky., consulting firm of Eager & Davis LLC. "To the extent some organizations generate size and prominence on the record-keeping side, they may find (that) fees they are able to charge for record keeping are higher than they would charge when it is embedded in asset management fees."
At the same time, plan sponsor demand for more investment options outside their bundled providers' menu is making joint ventures and alliances obsolete as a model, Mr. Eager said.
Meanwhile, other providers like Great-West Life & Annuity Insurance Co., Greenwood Village, Colo.; BISYS Retirement Services LP, Dresher, Pa.; and now ADP are preparing to provide record-keeping and administration services at a higher fee than they could have charged as part of a bundled arrangement.
And while Schwab does not provide record-keeping services for competitors, it does lease record-keeping software to 110 bundled providers and third-party administrators with 2,000 to 400,000 participants, said Mike Peterson, senior manager.
Executives at companies making a business of providing record-keeping services say they are getting more inquiries this year than ever before. After all, defined contribution plan record-keeping costs are significant.
For example, Great-West spends $30 million a year to maintain its record-keeping system, said Charlie Nelson, senior vice president. Not only does Great-West provide record keeping for its own list of defined contribution plans, but a subsidiary provides record-keeping services for All First Financial Inc., American Funds Distributors Inc., SunTrust Banks Inc. and Metropolitan Life Insurance Co.
`Serious cost saving'
According to market estimates, about 60% of a bundled sponsor's cost of operating a defined contribution plan is record keeping, vs. 20% for investment management. Companies that outsource could save $20 to $30 per participant, said Mr. Nelson. "It's a serious cost saving to a bottom line."
According to data provided by Corporate Executive Board, a Washington research group, the average defined contribution plan provider's total costs, including record keeping, is $100 million to $120 million.
"There's a lot of scale in this business, and the firms that do the best job have the best cost structures," said Wallace Blankenbaker, project manager with the Corporate Executive Board. And competition is driving up the costs of winning new business, he added.
So, for example, Scudder did not have the size to get the per-participant cost low enough to compete, he said.
"Consolidation will continue until it reaches equilibrium, where providers have enough of a participant base to get scale to offset lower revenues and rising costs, Mr. Blankenbaker said. "A large percent of providers, at least half, are losing money in this business."
Even so, the tough balancing act for bundled record keepers looking for a change is to get the expensive record-keeping and defined contribution plan servicing costs off the books while retaining the assets under management.
"It's critically important that we retain our client base," said Scott David, managing director and president of Scudder Retirement Services.
Together, Scudder and ADP will have $16 billion under record keeping. Scudder accounts for about half of those assets. The other half is ADP's record keeping for small to midsized defined contribution plans. ADP's large plan business is not part of the deal, said Mark Phillips, senior vice president and general manager of ADP retirement services division.
In addition, Scudder Retirement Services is retaining a financial interest in the future performance of the ADP's business. This means that Scudder's parent, Deutsche Asset Management, will have a financial stake in any new business. Neither Mr. Phillips nor Mr. David would give any details.
ADP will be hiring some 350 Scudder employee benefit services professionals in Salem, N.H., and Kansas City, Mo. It is unclear how many Scudder executives will also be hired, said Mr. Phillips.
"We expect to see more and more of these relationships in the marketplace," said Mr. David, who is joining ADP. "We're a model for the marketplace. It's a practical, sensible solution."
Joshua Dietch, associate director at Cerulli Associates Inc., Boston, said the transaction matches complementary strengths. ADP is getting access to a new distribution arm - Scudder's underused relationships with third-party administrators, Mr. Dietch said.
"It makes ADP more attractive," he said. "ADP has a nice defined contribution business, but this creates a nice benefit services business." Mr. Dietch added that more deals could follow, because they tend to go in "mini-waves."
Ward Henry, president and chief executive officer of McHenry Consulting, Berkeley, Calif., said deals "are going to accelerate." It no longer makes sense to own the record-keeping system if you can outsource it, but have access and control over the funds' brand names, Mr. Ward said. n