Already operating on razor-thin margins, recordkeepers face increasingly competitive future

The “razor-thin” margins that recordkeepers of employer-sponsored retirement plans already operate under will narrow in the foreseeable future, forcing incumbent providers to rethink their operating models and cultures if they are to compete, according to new analysis from McKinsey & Company.

The good news for recordkeepers looking to grow is that the $26 trillion retirement market–the defined contribution market accounts for $8 trillion–will continue to grow, even as baby boomers retire.

McKinsey projects that total assets in DC accounts will grow 7 to 8 percent annually over the next seven years, or from $8.1 trillion in 2017 to $13.9 trillion by 2025.

Multiple challenges

But retaining and winning business will not come easily. A host of challenges ranging from the regulatory and litigation landscape, potential competitive threats from non-traditional players, and the continued move away from proprietary product offerings will force recordkeepers to fundamentally reshape strategic thinking, McKinsey’s report finds.

“In some cases, firms are already losing money on their recordkeeping services,” said Alex D’Amico, a partner in McKinsey’s global banking practice.

In 2017, about 20 percent—or $6 billion–of the $30 billion in revenue generated by service providers and money managers from DC plans was accounted for by recordkeeping fees.

About $3.9 billion in revenue was generated from recordkeepers’ proprietary investment products, while non-recordkeeper products generated $20.1 billion, or 67 percent of all annual revenue.

Earnings from recordkeeping and proprietary products are expected to shrink as a share of all revenue going forward, according to McKinsey.

Recordkeeping fees in the jumbo and large plan market have already seen considerable compression as plan intermediaries have grown increasingly sophisticated, and employers have been motivated to sharpen their pencils by a wave of excessive fee claims against sponsors of DC plans.

Those phenomena have also crimped the distribution of proprietary products through recordkeeping channels, challenging the historical role of recordkeeper platforms as ways to funnel sales of insurance company or investment management firms’ own investments.

“For certain providers, having the proprietary share of investment sale revenues north of 50 percent would have been the norm 10 years ago,” said D’Amico. “Now, you are lucky if you are getting 30 percent.”

Proprietary share of revenue is harder to claim in the jumbo and large plan market, he said.

“In the larger markets, where sponsors have become more sophisticated, it’s very hard to draw meaningful propriety share. Consultants are certainly driving this—they know what they are doing, and they too are have become increasingly sophisticated from both an investment and legal standpoint,” added D’Amico.

Sponsor and intermediary sophistication is happening downstream, in the mid and small plan market, said D’Amico.

What’s a recordkeeper to do?

Shift to technology and custodian services

A fundamental shift in mindset will be required of recordkeepers going forward, said D’Amico and Jonathan Godsall, also a partner at McKinsey.

Insurance companies and investment firms that have historically viewed their recordkeeping arms as distribution channels for in-house investment products won’t have that luxury.

Instead of product distribution platforms, recordkeeping will become more of a technology and custodian service.

“Much like great tech companies, the client’s digital experience will take on greater imperative,” said Godsall. “Providing a superior digital experience for plan participants is something that will differentiate recordkeepers.”

Ten years ago, the differentiation in participant experience was minimal from recordkeeper to recordkeeper, said Godsall.

Today, there is wider dispersion. “The differentiation is growing and is an important battleground for recordkeepers. That is a good thing—anything that helps individuals make better decisions is a good thing,” added Godsall.

The heightened role of chief technology officers within recordkeepers’ chains of command is already being seen in industry.

“It’s one of the most important trends we are seeing,” said D’Amico. “They live and die by the quality of their technology. When you were in a different market structure, and could count on proprietary revenue, you could mask technology sins. Recordkeepers no longer can.”

Stand-alone recordkeepers have been the beneficiaries of the shift from proprietary revenue dependence, as they have only operated as platform providers.

Other recordkeepers—stand alone or otherwise—are running multiple platforms and systems, either in service to different market segments, or via acquired recordkeepers. “That creates tremendous complexity,” said D’Amico.

Evolve to provide additional services

Firms will also evolve their platforms to provide additional services, from tailored advice in plan, to health savings accounts, emergency savings funds, and student loan forgiveness programs.

Recordkeepers that offer new products will tap needed alternative revenue streams; those that don’t will experience long-term revenue leakage, McKinsey’s paper says.

“There will be real value in diversifying revenue pools,” said D’Amico. “By broadening services, you should be stickier as an incumbent, and have higher client retention. It will be a hedge against money not going into 401(k)s at the same velocity it has in the past.”

3 potential scenarios

So what is the upshot for the recordkeeping industry? McKinsey projects three potential outcomes.

Under the first, further consolidation and pricing pressure will occur, as incumbents battle for market share by lowering recordkeeping pricing in order to retain a higher proportion of proprietary investments.

Marginal players will weigh the value of selling versus the value of continuing to compete. Four to five at-scale competitors will congeal around different market segments—jumbo and large plans, smaller plans, and 403(b) plans.

Under a second scenario, robo-advisors will outmaneuver incumbents in the small plan market, and existing integrated benefits programs will evolve to include retirement plan services, relegating recordkeeping to a fully commoditized transaction processing service.

And in a third, existing information technology companies—think enterprise-level software provider Workday—throw their hat in the ring, potentially disrupting incumbent recordkeepers’ revenue.

Competing, and winning, will require bold action and meaningful investments.

“For incumbents, they are on a journey to reposition themselves culturally to better compete,” said D’Amico.

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