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Report Says Rocky Road Ahead for Recordkeepers

While it’s not exactly been a smooth road over the past couple of decades, a new report says an even bumpier ride could be ahead for recordkeepers.

The report, “Long-term value creation in U.S. retirement” from McKinsey & Company, notes that while the 10-year bull market has propelled DC asset levels, recordkeepers have had to navigate a series of structural shifts in the market that have pressured their economics.

Margins, already thin in the large and jumbo market space, are likely to come under growing pressure as increasing transparency combined with growing intermediary sophistication in the small and mid-sized plan markets is leading to further downward pressure on pricing, the report observes.

Moreover, the continued bifurcation of plan servicing and investments, rotation to passive investment options and increasing use of institutional share classes and CITs have further pressured revenues, particularly for recordkeepers.

Indeed, the report notes that continued unbundling of asset management and recordkeeping will intensify concerns about the business models of more integrated players. “For the myriad of managers on the outside looking in, developing a viable DC strategy is essential to sustainable growth in the space,” according to authors Alex D’Amico, Jonathan Godsall and Jimmy Zhao.

In addition, fragmentation with the rise of competing benefit offers – including health savings accounts, student loan forgiveness and emergency cash accounts – presents much needed alternative revenue streams for recordkeepers who offer these products, but for those that do not, these products represent long-term revenue leakage, the report advises.

“These shifts raise critical questions for participants in the market that have historically looked at recordkeeping as a high-margin distribution channel, but now find themselves operating standalone, technology- and data-intensive businesses that sit outside their core competencies,” the authors observe. 

Industry Evolution

As to how the recordkeeping industry will evolve over the next 10 years, the authors explain that they see three potential scenarios. The first presumes continuing consolidation but little disruption. They explain that, under this scenario, the industry sees continued consolidation and further pricing pressure as incumbents battle for share and offer pricing concessions to retain business with high proprietary share. Over time, however, marginal players gradually exit as they reach their specific inflection points, with the end state featuring clusters of four to five at-scale providers at a segment level.

Meanwhile, the second and third scenarios see disruption from outside the DC market. The second scenario entails external disruption from digital attackers in retirement, while the third could come from another market, such as the human resources information systems industry, which could be a long-term threat given the access it has to employee payroll and census data fees.

“While many HRIS providers have modules that accommodate defined contribution enrollment today, the modules often lack high-quality decision support tools provided by leading plan providers,” the report states. That said, should they choose to do so, however, HRIS providers could substantially upgrade their offerings and disintermediate recordkeepers, the authors further observe.  

“The common implication across all three is that recordkeepers need to act boldly to secure their futures through a combination of aggressive restructuring to prepare for continued revenue pressures while investing in next-generation client, participant and sponsor experience capabilities to meet rising customer expectations,” the report surmises.   

Nor are challenges isolated to recordkeepers. While noting that retirement “is and will continue to be” one of the largest growth opportunities for wealth managers, insurers and asset managers, the report notes that the largest retirement market is in the U.S., where $26 trillion in assets are held in retirement-related accounts, including public and private DC and DB plans, IRAs and annuities.

What’s more, these accounts collectively support more than $430 billion in revenue for retirement recordkeepers, asset managers, wealth managers, annuity writers and life insurers.

Not surprisingly, leading firms from across the financial services industries are seeking to tap into this long-term growth opportunity. And while the DC market remains large and attractive, it is also experiencing a series of disruptions, the report notes. Asset managers are facing multiple disruptions at once, including:

  • the rotation to passive investments driven by fiduciary considerations;
  • relentless pricing pressure across active and passive investment options, also driven by fiduciary concerns; and
  • the rise of target date funds as the Qualified Default Investment Alternative.