business people running along giant pencil line over cliff Challenges ranging from regulatorychanges to potential competition from non-traditional players andmore will force recordkeepers to reshape strategic thinking,McKinsey’s report finds. (Photo: Shutterstock)

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The “razor-thin” margins that recordkeepers of employer-sponsored retirementplans already operate under will narrow in the foreseeablefuture, forcing incumbent providers to rethink their operatingmodels and cultures if they are to compete, according to newanalysis from McKinsey & Company.

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

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

Multiple challenges

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

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

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

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

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

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Recordkeeping fees in the jumbo and large plan market havealready seen considerable compression as plan intermediaries havegrown increasingly sophisticated, and employers have been motivatedto sharpen their pencils by a wave of excessive fee claims againstsponsors of DC plans.

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Those phenomena have also crimped the distribution ofproprietary products through recordkeeping channels, challengingthe historical role of recordkeeper platforms as ways to funnelsales of insurance company or investment management firms’ owninvestments.

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

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

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

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

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What’s a recordkeeper to do?

Shift to technology and custodian services

A fundamental shift in mindset will be required of recordkeepersgoing forward, said D’Amico and Jonathan Godsall, also a partner atMcKinsey.

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Insurance companies and investment firms that have historicallyviewed their recordkeeping arms as distribution channels forin-house investment products won’t have that luxury.

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

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

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

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

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The heightened role of chief technology officers withinrecordkeepers’ chains of command is already being seen inindustry.

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“It’s one of the most important trends we are seeing,” saidD’Amico. “They live and die by the quality of their technology.When you were in a different market structure, and could count onproprietary revenue, you could mask technology sins. Recordkeepersno longer can.”

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Stand-alone recordkeepers have been the beneficiaries of theshift from proprietary revenue dependence, as they have onlyoperated as platform providers.

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Other recordkeepers—stand alone or otherwise—are runningmultiple platforms and systems, either in service to differentmarket segments, or via acquired recordkeepers. “That createstremendous complexity,” said D’Amico.

Evolve to provide additional services

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

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Recordkeepers that offer new products will tap neededalternative revenue streams; those that don’t will experiencelong-term revenue leakage, McKinsey’s paper says.

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

3 potential scenarios

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

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Under the first, further consolidation and pricing pressure willoccur, as incumbents battle for market share by loweringrecordkeeping pricing in order to retain a higher proportion ofproprietary investments.

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

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Under a second scenario, robo-advisors will outmaneuverincumbents in the small plan market, and existing integratedbenefits programs will evolve to include retirement plan services,relegating recordkeeping to a fully commoditized transactionprocessing service.

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

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Competing, and winning, will require bold action and meaningfulinvestments.

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

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READ MORE:

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Latest recordkeeper mergers show small providersare still in the fight

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Big 401(k)s shedding pro rata recordkeepingstructure

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Financial wellness programs give recordkeepersholistic opportunity

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Nick Thornton

Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.