No slowdown expected in record-keeper M&A

High-profile acquisitions and mergers among record keepers will continue as the firms cope with pressure for lower fees and more services in a low-margin business.

The early April announcement that Great-West Financial would acquire the large-plan institutional record-keeping business of J.P. Morgan Asset Management might have been the biggest deal in the past 18 months, but it only illustrates that the industry shakeout isn't abating, according to defined contribution plan consultants and other industry participants.

Although executives involved in five major acquisitions and mergers since early 2013 cited specific strategic reasons for their deal-making, DC plan experts say several common themes have emerged that will affect record-keeping consolidation trends in the future.

Reasons include the pressure to reduce fees, the cost of improving record-keeping technology and the skill in deriving sufficient income from selling other products and services to participants. Consultants and others interviewed for this article wouldn't speculate on the next deal or dealmakers.

“We will see more consolidation as record-keeping fees continue to be driven down year after year,” said Ross Bremen, a partner at Boston-based investment consulting firm NEPC LLC.

Research by NEPC shows median record-keeping fees dropped to $80 per participant at year-end 2012, the latest available data. In 2006, when NEPC first conducted its annual survey of DC plans, most of which are clients and 401(k) plans, the cost was $118 per participant.

As fees fall, service providers “have to determine if low margins make sense” to continue their record-keeping business, said Lew Minsky, the Jupiter, Fla.-based executive director of the Defined Contribution Institutional Investment Association. He expects more consolidations in the next six to 12 months.

When Callan Associates Inc. began keeping track of record keepers that offered services to its clients, there were 40 in 2006. Now, there are 27.

“There's less of a choice out there,” said Lori Lucas, Callan's Chicago-based executive vice president and defined contribution practice leader. “If the pool shrinks, the fees could go up and service could go down.”

Ms. Lucas predicts consolidation will continue primarily because of pressure on fees and record keepers' need to add clients. “You need (economies of) scale,” she said. “It's a low-margin business.”

There are several sources of fee pressure — competition among record keepers, a heightened awareness of costs by plan executives, Department of Labor fee-disclosure regulations that took effect in mid-2012, and fiduciary breach lawsuits against sponsors claiming excessive fees.

“If fees don't stabilize, innovation could be stifled and services levels could drop,” Mr. Bremen said. “That would not be in the best interests of participants.”

Aside from fees, technology plays a key role in whether a record keeper decides to stay or go.

The cost of improving and updating record keeping technology was one reason cited by J.P. Morgan Asset Management for selling its J.P. Morgan Retirement Plan Services unit to Great-West Financial.

“Like other record keepers in the marketplace, we recognized that over the next three to five years, there's going to be a major transformation in the underlying technology that supports this industry,” David Musto, chief executive of J.P. Morgan Retirement Plan Services, Kansas City, Mo., said in an April 23 conference call with DC plan consultants.

“We thought long and hard in terms of the path for this organization,” Mr. Musto told the consultants. By itself, it would take five or six years for J.P. Morgan “to dramatically enhance and even in some ways rebuild the underlying technology” of its record-keeping platform, he added.

Because the time and money needed for enhancing technology would affect efforts to improve products and services, Mr. Musto said J.P. Morgan executives decided that “the best path forward” for clients was the acquisition by Great-West and the use of Great-West's record keeping technology.

Another factor in consolidation is whether a corporate parent believes record keeping is a strategic component for the future. “Even if organizations find ways to execute profitably, they still have to contend with shifting priorities of top-level management,” said Mr. Bremen, declining to discuss specific cases.

In 2012, for example, Hartford Financial Services Group hung a “for sale” sign on its record-keeping and several other businesses because they no longer figured in the company's long-term strategy. The Hartford DC business was acquired by Massachusetts Mutual Life Insurance Co., Springfield, Mass., in January 2013.

A general formula for survival includes the ability to use record keeping as a way of generating more revenue through the sale of other products and services, said Martin Schmidt, principal and client services director at HS2 Solutions Inc., Chicago, a retirement plan and technology consulting firm.

He cited as examples Fidelity Investments for proprietary asset management; Prudential Financial Inc. for retirement income; and Aon Hewitt for offering online advice and managed accounts from Financial Engines Inc.

Record keepers also benefit from having a strong individual retirement account rollover business. “Fidelity is widely known to have the top rollover capture ratio in the industry,” said Mike Alfred, CEO and co-founder of BrightScope Inc., San Diego, which provides retirement plan ratings to participants, DC plans, asset managers and advisers.

Mr. Alfred said record keepers most likely to be acquired or merged are those that haven't been able to sufficiently exploit their bundled services and products or those that “don't have a strong asset management franchise.” Companies that can't differentiate their record keeping technology from those of competitors also could be vulnerable, he said.

A prime market for consolidation is among record keepers serving DC plans with $25 million to $100 million in assets, said Drew Carrington, senior vice president and head of defined contribution — institutional for Franklin Templeton Investments, San Mateo, Calif. His firm isn't a record keeper.

“In this market, companies are transitioning from small to larger,” requiring more sophisticated administration of investments and benefits, Mr. Carrington said of potential DC clients for record keepers.

The ability to sell ancillary products suggests to some DC consultants that insurance companies might have an advantage — especially in the small and midsize DC plan markets — thanks to the multiple products they can sell to DC plan participants and sponsors.

“For the next consolidation, a record keeper will more likely be bought by an insurance company than a traditional asset manager,” said Christopher Lyon, a partner at Rocaton Investment Advisors LLC, Norwalk, Conn. “Some insurers could be natural acquirers.”

Mr. Lyon didn't cite any candidates, but he noted that insurers could have an advantage thanks to their focus on annuities as well as their efforts to develop retirement income products.

“Insurance companies look at record keeping as an entry to getting a captive audience,” said Jacob O'Shaughnessy, adviser at Arnerich Massena Inc., Portland, Ore. “Maybe they can offer wraps and stable value. Maybe they can offer annuities.”

He added that insurance companies “have done a decent job of leveraging their record-keeping relationships into achieving other revenue streams.” As examples, Mr. O'Shaughnessy mentioned Prudential Financial, Nationwide Mutual Insurance Co., Voya Financial Inc. and Great-West. He declined to speculate on possible buyers or sellers among record keepers.

Insurance company executives aren't shy about promoting what they say are their advantages.

“We are uniquely positioned to provide other protection products” such as annuities, disability insurance and life insurance, said Elaine Sarsynski, executive vice president of MassMutual's retirement services and worksite insurance division, and chairwoman of MassMutual International. “MassMutual and others are positioned to have asset management arms. We have multiple ways to impact employers and participants.”