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A bleary-eyed controller for a small tool and die manufacturer located in the midwest logs onto the Internet at 10:00 p.m. to educate himself about starting a 401k plan for the company's employees. He enters his firm's criteria and then runs a search against a database of products offered by financial service providers, and out pops a list of contenders.
If he chooses, the sponsor can potentially design a plan online, pick investment choices and hire a recordkeeper to do the fund accounting. Or, he can hire a financial advisor, even find one through the site, that works in his region. Once on the Internet, he is going to be confronted with many choices. No sleepy backwater, the 401k market for small and medium sized companies is being rocked by the entrance of 401k marketplaces that potentially bring a greater degree of price transparency and standardization to what is a complex and confusing decision process.
Companies like Search401k.com, 401kexchange.com and 401Konnect.com - matching corporate plans sponsors with plan providers and recordkeepers- are shaking up the status quo by launching Internet-based platforms that can potentially cut administrative costs and simplify a complex selection process.
E-marketplaces are vying for a piece of the $1.7 trillion in U.S. 401k assets, of which 45% were invested in mutual funds at the end of 1999, according to the Investment Company Institute, and Cerulli Associates projects the number will reach $2 trillion by 2002.
Fidelity Investments started the trend about 18 months ago with the launch of Fidelity e401k-an Internet-delivered 401k plan. As of July, Fidelity e401k had $12 million in assets with 229 plans in service.
The trend underscores the importance of 401k plans as the most dominant retirement savings vehicle offered by U.S. employers. Calling Fidelity the "8,000 pound gorilla," Chris Lynch, president of 401kexchange.com says the "one-size-fits-all" approach may not be good for all small companies.
Rather than going direct to mutual fund company's web sites, these exchanges are designed to represent a broader universe of choices for small and medium size companies that can't afford to hire consultants.
Each of these so-called 401k marketplaces allows a corporate plan sponsor to run a search against a database of providers and send out requests for proposals (RFPs) through the Internet to a short list of financial services companies and vendors that have agreed to participate. All three marketplaces connect buyers and sellers of 401k plans with intermediaries-financial advisors and third party administrators, known as TPAs, that provide the accounting and record keeping.
Streamlining RFPs
"We have e-engineered an existing business process by which RFPs are generated and analyzed by financial advisors and other intermediaries that facilitate 401k sales," says Lynch of West Palm Beach, Fla.-based 401kexchange.com. But because 85 to 90% of 401k plans are sold through intermediaries-usually financial advisors, financial planners, accountants and brokers-most of the 401k marketplaces are targeting the financial adviser as the main user. Who pays?
Though each of the 401k marketplaces are still tinkering with their business models, in most cases, the corporate sponsors can do the research for free, but it's only when a plan is set up, after investment choices are selected and a record keeper and plan administrator are appointed, that the B2B exchange makes any money. Lynch says that 401kexchange.com is migrating to a "winner pays all model," meaning the services provider who wins the business pays. By contrast, Search401k.com charges the vendors for each RFP they respond to.
Usually the plan provider-either a bank, insurance company, mutual fund company or brokerage wire house- pays the 401k exchange a fee based on the amount of assets in the plan.
The benefits to corporate plan sponsors of smaller plans-$10 million and under-are powerful. For starters they can avoid paying a consultant $5,000 to $30,000 to conduct a search for 401k providers. Mid-size companies with fewer than 1,000 employees and $100 to $200 million in assets can also benefit. Financial advisors can save time comparing the different 401k products, fees and performance histories and even print out a report they can present to the sponsor. Meanwhile, financial service companies-banks, insurance companies, brokerage wire houses and mutual fund companies-are being lured to list in the databases as another means of receiving qualified leads. Critics say these sites are no more than search engines and lead generators that still require the expertise of seasoned intermediaries.
The rise of 401k marketplaces appears to be "a natural evolution in the industry toward more of a self-service model," says Winn Hackett, partner in Price Waterhouse Coopers' Boston office, specializing in investment management/retirement services.
"The investment management industry is at the forefront of this kind of phenomenon," she says, noting, "first you have the Morningstar and Lipper ratings of the funds, then Schwab came along with mutual fund supermarkets and everyone said no way. Look where it is now," she says. "I'm a little surprised that the 401k marketplace concept didn't come up sooner." Comparing it to Quote-smith.com, a site where individuals can get quotes from insurance companies, Hackett says, "first of all it's a research engine, and secondly, take it to the next level, you could make it an auction type concept." Whether the plan sponsors would look at it that way, she said she doesn't know. "When you blow away all the smoke, it is an auction vehicle-you put out some criteria and the best way is defined as the best match, not necessarily the best, and a provider pops up." Lynch, however, disagrees. "It will be quite some time before the 401k product will be commoditized. "Every 401k plans is priced uniquely. A $1 million plan with 20 employees and cash flow of $200,000 a year and one fund location will be priced differently than the same company in 10 locations," he says.
Keeping Intermediaries in the Middle
Because the products are complex and need to be customized and comply with IRS regulations about discrimination testing and other issues, the vast majority of 401k plans are sold through intermediaries-mainly financial advisors, brokers or financial planners.
That means most corporations hire either third party administrators (TPAs) which could be a local CPA firm, a lawyer or an employee benefit consultant to design the plan and make sure it meets the IRS requirements for discrimination testing.
Some of the sites act as prospecting tools for financial advisors, who can send RFPs to a short list of providers. "It's a lead generation mechanism for us to market the adviser market, our indirect channel," says John Stilley, vice president and general manager of defined contribution services for Teamvest, a defined contribution services company based in Charlotte, NC.
