The 401(k) retirement plan market in the United States is mature, and distributors are now more important than manufacturers. This is the main conclusion of a new report on 401(k) pension plan providers by Boston-based mutual fund consultants Cerulli, which predicts the “Ipod-ification” of the 401(k) market.
Cerulli says that providers that lack distribution strength face potential difficulties in retaining assets. Unequivocally, says the firm, 401(k) providers are losing the war in IRA rollover dollars to wirehouse broker/dealers, which have brand, product, marketing cachet, and advice-giving resources to keep gaining share. Building 401(k) rollover capture products or signing on to an outsource platform are good stop-gap strategies, but are proving not enough for providers, says Cerulli.
Cerulli predicts that by 2007, outflows from 401(k) plans will reach nearly $300 billion and widen thereafter by upwards of 15% each year. As such, providers unanimously chose “enhancing distribution efforts with B/D firms” and “focus on retirement plan retention” in Cerulli’s proprietary survey as the most important products and services going forward.
State of the 401(k) Marketplace, a recent release in The Cerulli Report series, aims to identify provider business drivers. These drivers include technology delivery; revenue and profit potential; use of outsourcing; consolidation activity; regulatory and legislative impacts; rollover and retirement income focus; meeting customer needs; service and support platforms; and costs of total benefits integration and healthcare for employers.
Cerulli says these core drivers profoundly affect all providers but play out differently in each major market segment (these include micro, small/mid, and large). Cerulli argues taht “it takes adept and strategic business models to answer the needs of the market.”
The quantitative component of the Cerulli report is based on a survey sent to 401(k) providers across all market segments, while the qualitative analysis is based on interviews. The survey also went to 401(k) providers that aim at different segments, as well as third-party providers whose wide variety of services enable providers to compete.
The second set of interviews was conducted with broker/dealer firms whose advisors function as intermediaries between asset manager and sponsor, allowing Cerulli to identify disconnects in perception and practice that exist among the various market participants.
The key conclusions are:
The industry has gone from simple, one-dimensional retirement savings programmes to multi-faceted and complex arrangements of distribution, service, and product. The 401(k) market is mature, and much of what a manufacturer creates and maintains is highly commoditized. The difference between the basics of ABC and XYZ 401(k) programmes are not discernible. Manufacturers (providers) are under ever-increasing pressure to build new and enhance existing products under shrinking margins in the face of increased costs.
Distribution is now the engine of growth in the industry. Today, the pre-dominant means for employers to review and initiate relationships with 401(k) providers involves the use of some form of intermediary/distributor. Providers and distributors need to work in tandem with one another.
Outsourcers assist manufacturers and distributors on huge undertakings like back-office recordkeeping or phone call centre support. The solutions help providers gain accelerated entry into a segment, usually the small or micro markets, without incurring the heavy burden of technology ownership. Cerulli cautions that manufacturers keep a keen eye that outsourcers do not become the competitors to manufacturers that they purport not to be today.
The retirement industry at year-end 2005 was $13.3 trillion in total assets. The IRA marketplace represents $3.9 trillion of the entire retirement marketplace. The defined contribution (DC) slice of the retirement pie represents $3.8 trillion of the entire retirement marketplace.
Net flows for DC plans have mostly trended downward since reaching a peak of $20 billion in 1995. Cerulli expects net flows to remain in negative territory for many years to come without much relief in sight. The demographics of Baby Boomer retirement are a gathering and inevitable storm of outflows from DC plans.
Cerulli sees a continued and steady rise in active participants over the next five years. Industry movement toward auto-enrollments and slated legislation to support this will positively impact employee participation in 401(k) plans. There were nearly 55 million active participants in DC plans for 2005, an increase of more than 1 million from the previous year.
The top 10 firms control nearly 75% of the marketplace for DC assets while the top 20 control 88% of the market. A view of the top three compound annual growth rate (CAGR) performers tells a tale of firms with successful distribution and service models. Conversely, several firms are struggling with CAGR growth and positive net plan production.
Cerulli has identified a core set of business drivers that profoundly affect all providers in the industry. These core drivers play out differently in the major segments of the marketplace. Drivers include technology delivery, revenue and profit potential, use of outsourcing, consolidation activity, regulatory impact, rollover/retirement income focus, service and support platform, and cost of total benefits integration/healthcare.
Cerulli believes that fee compression is a certain and unstoppable trend in the 401(k) industry.
When Cerulli asked providers about their spending on technology-related initiatives, several firms answered that $20 million is a typical spend in a given year. Providers identified the most important revenue generators as targeted education to participants on asset diversification, plan participation, and deferral savings.
The Cerulli survey asked providers about the main factors that drive consolidation plans at their firms. Topping the list are generating scale, growing market share, and entering new markets. It is becoming increasingly important for 401(k) providers to recognize their place in the benefits pecking order and address benefits solutions in the broader context of healthcare, says Cerulli.
Increasingly, markets demand adviser specialists who can address fiduciary concerns, and consult on plan design. Cerulli says that these days most broker/dealers have a core group of advisers who generate the majority of their income from the sale of retirement plans.
To help providers better understand the dynamics affecting broker-dealers, CA has identified business drivers that they face in the 401(k) marketplace. They include selling to the sponsor, fiduciary role, brand importance of the provider, product choices and plan feature complexity, and revenue and profit potential.
Human relationships and touch points, says Cerulli, have been and remain a very important part of the business. Many providers are dedicating resources solely toward extending their brand with personnel dedicated to servicing broker-dealers and their advisers’ needs. Often, the job of delineating 401(k) product and programmes falls squarely on broker/dealer advisers. They are faced with a complex array of product, features, and separate pricing scenarios from nearly every provider. Also, says Cerulli, some broker-daelers are getting aggressive and creative in finding new sources of revenue from 401(k) assets: one major wirehouse firm Cerulli contacted described a strategy of selling their advisory services as an overlay to the 401(k) programme.
Payroll providers have quickly gained ground on traditional providers in this industry, says Cerulli. A quick glance at firms selling high volumes of 401(k) plans shows that payroll providers such as ADP and Paychex have surprised many traditional 401(k) players in the marketplace. Put simply, the third-party administrator (TPA) model works in the micro segment of the market, says Cerulli. The leading providers have partnerships with thousands of TPAs
The Small/Mid (SMid) market is the most challenging arena for providers, says Cerulli. By some estimates, nearly 10% of the SMid market is shopping for a new provider in a given year. Many firms with which Cerulli spoke are in the beginning stages of formulating plans for retirement income deliveries to the SMid market DC plans.
The industry to a large degree is caught up in “groupthink,” claims Cerulli. Most product innovations that come to market are copied quickly and slapped onto 401(k) offerings without much thought to better marketing, packaging, and delivery.
Investment-only (IO) programme providers are heating up in the 401(k) marketplace, says Cerulli. IO providers are distributing their funds mainly in all market segments, but generally find a sweet spot in the large plan marketplace. Sponsors in the large plan segment are more often grappling with defined benefit issues in tandem with their DC. Total retirement outsourcing (TRO), if done right, is a delivery that can help.
Cerulli notes that an interesting broker consortium trend has started to take shape on the West Coast. A consortium of brokers has formed who specialize in selling 401(k) plans to micro and small businesses. The consortia model provides benefits for both advisors and providers. Advisors in the network are able to leverage strengths across broader retirement specialist platforms and reach into a bigger pool of capital to grow business and make money while providers benefit from consortia members who are predisposed to using certain providers.
The SMid market has become highly penetrated by the retirement specialist, says Cerulli. The firm avows that the “days of one-hit wonders making hay in this market segment are long over.”
Advisers noted growing opportunity from the $6 million to $10 million plan size range, a developing sweet spot whereby plan sponsors of this size seek graduation to better product and needing more fiduciary oversight than previously.
Cerulli asked providers to describe how they define or segment their selling markets. Nearly half of the responders drew “lines in the sand” by employer size and two-thirds by assets in those plans. Cerulli sees a combination of payroll integration with 401(k) and automatic enrollment per the Pension Act as a formidable combination. There is very little that distinguishes one provider’s programme from another, says Cerulli, which believes that the automation trends in 401(k) programmes will drive toward a non-customized, off the rack, best-of-breed program model. Ultimately, each unique and successful model in these segments has a common theme. The models meet the needs of their customers while also building a wall around them to protect from poaching via other providers.
Cerulli asked providers where they saw the greatest opportunities in 401(k). Of the several cited, the leader was building and enhancing strategic distribution alliances. The majority of providers also cited dedicated wholesaling as the best way to provide value to broker-dealer channels. In addition, nearly every survey respondent recognized a moderate to significant increase in the marketing budget for the broker-dealer channel. In sum, the Pension Protection Act of 2006 has given the industry a boost.
The act is far-reaching and touches all segments of the markets. The jury is still out on whether firms have developed successful plans to train new leadership while giving them the opportunities to bring new ideas to fruition in the 401 (k) market. Cerulli believes a model that packages end-to-end solutions in a simple, straightforward but yet resonating way will be the model of the future.
In sum, Cerulli sees the 401(k) industry as ripe for “Ipod-ification” and argues it could be close at hand. The packaging of best-of-breed services that incorporate auto everything, managed accounts and retirement income offers potential for Ipod-ification of the 401(k) industry, says Cerulli.
When providers rate the importance of various product and service initiatives, plan retention rises to the top. In a market that is becoming increasingly a takeover business, protecting a provider’s 401(k) franchise is the most important method for meeting profit objectives, concludes Cerulli.