M&A Activity in Benefits Administration: Round 2

Following the benefits administration merger and acquisition (M&A) frenzy of 2010 that resulted in some major consolidations including Aon Hewitt, Towers Watson, Xerox/ACS and ExcellerateHRO, to name a few, are we poised to see round 2?

The second wave actually began in early 2011 and tends to consist of the more established providers, in their own right, acquiring Tier 2 health and welfare (H&W) administration companies in the U.S.  Examples include:

• Towers Watson acquiring Aliquant in January 2011
• Sedgwick, a leader in the leave of absence administration market with ~20% market share, acquiring the productivity solutions unit of Nationwide Better Health in May 2011
• Morneau Shepell, the leading total benefits outsourcing (TBO) provider in Canada, acquiring SBC Systems Company in January 2012.

As of last week, we can now add ADP to this list since it signed a definitive agreement to acquire SHPS Human Resource Solutions—a subsidiary of SHPS, Inc. ADP has actually been making key acquisitions to strengthen components within its benefits administration offering for the last 18 months. It started with Workscape, which added compensation management services, and was followed by Asparity Decision Solutions for decision support tools and analytic capabilities.

Now, the SHPS acquisition strengthens ADP’s leave administration and reimbursement account administration offerings. The HSA and HRA components will be especially important considering the rising cost of health-care and the transition toward high-deductible health plans paired with these health savings accounts.

The H&W acquisition trend is also expanding beyond the U.S. It started in September 2010, when Capita – a U.K.-based HRO vendor providing total retirement outsourcing (TRO) exclusively in the U.K. – acquired FirstAssist Services Holdings for £12.5m. Then it continued when Mercer acquired REPCA – a brokering and advising firm for health and benefits (H&B) plans – to strengthen its H&B administration offering and advisory services in France.

The remaining question on my mind is whether U.S.-based TRO providers such as ING, Great-West, T. Rowe Price, etc. plan to jump on the H&W acquisition bandwagon to provide a one-stop shop for benefits administration like Fidelity Investments.

I’m eager to see who will make the next M&A move in benefits administration.  In the meantime, it’s always fun to hear about cross-selling opportunities that resulted in contract scope expansions.  Stay tuned.

Amy L. Gurchensky, Research Analyst, HRO, NelsonHall

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The Yellow Brick Road to Financial Growth in Benefits Outsourcing

There are a variety of ways to grow HRO service provider income. Well-traveled roads include winning new clients or expanding services with existing clients. Another avenue is to cross-leverage consulting and outsourcing to build revenues for other service lines. Now, a new path has emerged and it looks like a yellow brick road to generating revenues: provide advisory services directly to defined contribution (DC) plan participants and not just to the plan sponsors.

According to The Financial Engines National 401(k) Evaluation report, approximately three out of four participants are not on track to comfortably retire by age 65 (i.e., they can’t replace 70% of their pre-retirement income with their 401(k) and social security). In addition, 34% do not have diversified portfolios and/or have inappropriate risk levels and 39% of participants do not contribute enough to even receive the full employer match. With DC plans replacing traditional pension plans for many employees, effective participation has taken on increased importance.

Participant DC service options were greatly expanded by the Department of Labor’s regulations, starting with the Pension Plan Act of 2006. Now, DC plans can offer automatic enrollment into qualified default investment alternatives, automatic saving escalations, and investment advisory services. Great, but the regulations are complex and are still being clarified and there are fiduciary responsibilities that must be addressed to provide a safe harbor to the plan sponsors and appropriate protections for the advisors. For BAO providers who have the expertise and fear not to tread on a road still under a bit of construction, this is a growth opportunity.

Amy Gurchensky, one of my NelsonHall HRO colleagues, just added tracking service coverage of Aon Hewitt’s new integrated advisory offering for its DC plan participants through its subsidiary, Aon Hewitt Financial Advisors. Aon Hewitt continues to expand its wealth management and retirement financial services for employers and participants. In 2010, before the merger with Aon Consulting, Hewitt had acquired the investment advisory firm EnnisKnupp.

Aon Hewitt selected Financial Engines to be the sub-advisor and provider of the advisory platform. As Amy notes in her analysis, Financial Engines also provides services for ACS, a Xerox Company, Fidelity, Mercer and others like ING and J.P. Morgan. It is important then that Aon Hewitt is wrapping the standard third party offering in with its own materials so it will be able to extend a new service bundle that creates differentiation.

The bulk of retirement investment consulting revenues will continue to come from services to the plan sponsors, but adding a new road to growth in ancillary services is valuable and this one looks particularly golden. Given the millions of participants with the major BAO players, participant investment services will be a valuable win-win for the employers, participants, and service providers.

Linda Merritt, Research Director, HRO, NelsonHall

HRO Holiday Gifting

What do you get the company that is hard to buy for? How about a new niche acquisition? As we ready for the holiday season and the end of the year, I wonder if there will be any interesting, prettily wrapped presents. If you are shopping to buy or sell all or a portion of an HRO business, here are a few gift buying guide pointers.   

Look at the Bow on the Package

Attractive acquisition factors:

•  State-of-the-art technology infrastructure with low operating costs and great end-user experience

•  Integrated service centers in desirable locations, good regional coverage for languages, deep subject matter expertise and knowledge of local regulations

•  Reputation for service quality and relationships

•  Compatibility in values and culture

•  A well-rounded book of current clients

•  Strong revenue stream with a high percentage of multiyear contracts

•  No/low debt

•  Small enough to be affordable and benefit from the leverage of a larger partner

Shake the Package

While the above characteristics are the ideal, it’s much more likely a potential acquisition candidate will have a mix of elements, some more attractive, some not so much.

Extra due diligence is required if the main asset is a current slate of contracts. If the potential acquisition is friendly, take a look at the customer termination clauses to see if there are easy outs. Larger clients often have Change in Control terms that work both ways, including covering what happens if the provider is acquired. Check the penalties for Termination for Convenience. If the penalties decline over time, how near end of term are the largest clients? Are there signs some of the major clients are already on their way out the door?

Last April, Empyrean Benefits Solutions, Inc. made a bid to acquire ING’s Health and Welfare Unit. By June the deal was dead. According to my information, a key to the deal was keeping the majority of the clients intact as Empyrean already had its own new technology platform. When it became increasingly clear that the full book of clients would likely not be retained, the deal fell apart. As a result, Empyrean decided to stay focused on its own organic growth path. (Which, by the way, Empyrean has successfully done, almost doubling its client base by adding 14 new clients so far this year.)

There are providers looking for the right acquisition, and there are those who would like to sell. A match in the HRO space requires the same level of mutual due diligence required in a major provider and client long term contract. A match in the HRO community is also a matter of attractive elements and compatibility.

Happy holiday due diligence and gifting.

Linda Merritt, Research Director, HRO, NelsonHall

The Demise of the ING/Empyrean Deal: What’s Next for ING and the H&W Marketplace?

A recently posted Note from the CEO on the Empyrean Benefit Solutions website reads, “Empyrean spent three months evaluating and proposing on an acquisition of ING’s health and welfare outsourcing business. At the end of the process, we did not reach a mutually advantageous agreement with ING.”

The fact is that while there may have been other contributing factors, ING’s lack of a solid health and welfare (H&W) technology platform and the jumping ship or tendering for work of at least five of ING’s 11 H&W clients are what ultimately caused the deal to fail.

So what does this mean for ING and the H&W administration marketplace in the U.S.?

It is clearly damaging for ING. Its client base has shrunk and is likely to continue contracting. The resulting instability of its business is undoubtedly unsettling for its employees, and this will likely cause significant morale problems and staff exits, even if layoffs aren’t forced. The company could try and find another buyer, such as defined contribution administrators looking to grow their H&W businesses (for example Fidelity), or other H&W providers, e.g., Workscape, Hewitt and Watson Wyatt, hoping to increase share. Its only other option is to resign itself to losing its whole book of business to other providers.

We believe the latter will happen. It’s far more likely that other providers will look to pick up ING clients without the cash outlay to buy the business, especially in its unstable and dwindling state. But that said…

A cautionary note to H&W providers: be wary of taking on ING clients too quickly with first conducting appropriate due diligence on the contracts. ING has clearly had challenges servicing its clients, and that may not all stem from issues in its own operations. It’s worth paying close attention to the contracts it was bound to honor to ensure there are no hidden pitfalls such as unrealistic cost saving expectations or inappropriate governance structures.

And a word of warning to buyers: if you’re considering outsourcing to the H&W arms of a traditional defined contribution administrator, make certain the provider has made a long-term commitment to the H&W space, perhaps evidenced through investment in real-time decision support tools, self-serve enhancements and analytics technologies. A lack of robust commitment to fully servicing H&W clients may place you in a similar position in which your provider exits the business and you must unexpectedly transition to another supplier.

Until next time,

Helen Neale, Research Director, Human Resources Outsourcing, NelsonHall