Thursday, August 3, 2017

11 Questions Employers Should Ask About Stable Value Funds

Stable value investments have been a core investment option in defined contribution retirement plans since the 1970s and are an attractive alternative to money market investments due to steady returns and principal preservation guarantees. Stable value funds have proven their worth to investors during the protracted period of low interest rates present since the recent financial crisis. Consider the following comparison of 2007-2016 calendar year total return for the Vanguard Federal Money Market Fund (VMFXX)[i] to the SBS MetLife Stable Value Fund.

1. What is a stable value fund?


Stable value funds are low-risk, capital preservation investment options available in employer-sponsored retirement plans and other savings plans. They are invested in high quality, diversified fixed income portfolios and feature protection against interest rate volatility through contracts from insurance companies or banks.

2. How popular are stable value funds when offered as an investment option in a retirement plan?

Within the SBS base of participant-directed plans, 11% of aggregate assets are invested in stable value. Stable value ranks third among major assets classes in popularity, behind equities (40% of assets) and target retirement date funds (35% of assets). Stable value’s low risk and low volatility, compared to fixed income and equity assets classes, appeals to conservative investors. Stable value’s performance has very low correlation to other major assets classes, which may make it a useful addition to a diversified portfolio.

3. Are there different types of stable value funds?

There are three types of stable value funds: traditional guaranteed investment contracts (GICs), separate account GICs, and stable value collective investment trusts (CITs). Traditional GICs are issued by insurance companies. Investors’ assets become part of the insurer’s overall pool of liabilities and are invested with all of the insurance company’s general account assets. Separate account GICs are group annuity contracts where the contract liabilities are supported by separate accounts of the insurance company (versus the general account). Separate account GICs provide the following advantages over traditional GICs: physical and legal separation from the insurer’s general assets/liabilities, investment flexibility, and control. Less commonly used CITs are essentially mutual funds without regulation by the Securities and Exchange Commission.

4. Why include a stable value option in a retirement plan?

The steady, predictable returns of stable value make it an ideal investment for those looking for a conservative investment option. It allows participants approaching retirement to protect potential retirement income while minimizing risk. Stable value’s appeal to very risk-averse individuals can potentially boost plan participation and deferral rates. A stable value offering fulfills plan fiduciaries’ responsibility under Employee Retirement Income Security Act (ERISA) §404(c) to offer an investment option with low volatility and high capital preservation.

5. How does stable value compare to money market funds?

Money market funds typically invest in bonds with shorter maturities than stable value; hence, they have a lower yield. Money market interest rates change daily according to the market, where stable value interest rates are normally reset by the issuer on a quarterly or annual basis. Money market funds do not feature the guaranteed minimum interest rate that is part of many stable value offerings. Some plan sponsors have been the subject of class action lawsuits for offering money market funds instead of a more competitive option.

6. How does stable value protect investors from interest rate volatility?

The primary protection is that all participant-initiated transactions (purchases, sales, and investment transfers within the retirement plan) are transacted at book value (also known as guaranteed value or contract value).

7. What are the differences between offering stable value in 403(b) versus 401(k) plan types?

Stable value investments in 403(b) plans are subject to regulation by the various states’ insurance departments. For example, the New York State Department of Financial Services requires a 1% minimum crediting rate for the term of the contract and the issuer cannot liquidate a retirement plan’s stable value assets at a market loss (less than 100% of book value).

8. Are there any guarantees in stable value?

Yes. The stable value issuer generally guarantees return of the original principal investment. The issuer typically guarantees two crediting rates: the minimum crediting rate (e.g., 1%), and a declared crediting rate that applies for a time period defined in the contract (e.g., 1.75% in effect for 12 months). Note that these are guarantees of the issuer––not the government or other third-party guarantor. If the issuer is an insurance company, the guarantees are backed by the company’s credit worthiness and claims paying ability. Plan sponsors should pay close attention to the independent credit ratings of the issuer (e.g., S&P, Fitch, and Moody’s), or any downgrades in those ratings or the outlook for the firm.

9. Are there waiting periods or restrictions on participant withdrawals?

No. Stable value funds offer daily liquidity for participant-initiated withdrawals. Stable value contracts commonly restrict in-plan exchanges directly from stable value to a “competing” money market or short-term bond fund.

10. Are stable value funds risk-free?

No. All investments carry risks. Stable value funds are considered to be among the lowest risk investments available in retirement plans. The investments in the underlying portfolio are subject to all the risks affecting fixed income investments, primarily interest rate risk and credit risk (default by bond issuer). An unlikely but potentially serious risk for stable value is a bankruptcy of the issuer. Implications in a bankruptcy differ according to the type of stable value fund. In the event of insurance company issuer insolvency, a holder of a traditional GIC would have a claim at the policyholder level, with priority over the insurer’s general creditors. Separate account GICs are considered safer than Traditional GICs because separate account assets are used solely to satisfy the claims of the contract holder. Insolvencies among stable value issuers have been rare. When they did occur in the 1980s, with the failures of Executive Life, Confederated Life, and Mutual Benefit Life, contract holders (retirement plans and their participants) were made whole.

11. What are the fees associated with stable value investments?

The fee is set by the issuer and is stated in the contract with the retirement plan. The fee includes all of the issuer’s services, including the financial guarantees. It also includes all costs associated with management of the underlying investment portfolio. Fees are expressed as a percentage of assets (e.g., 0.7% annually) and are largely determined by asset size. The issuer deducts their fees from the underlying investment portfolio. Therefore, minimum interest rates, declared interest rates, and reported performance are always expressed net of the issuer’s fees. Investors earn the greater of the declared crediting rate or the contract minimum crediting rate, unreduced by the fee stated in the contract. Note: The retirement plan record keeper may also apply an asset-based fee at the plan-level, on all investments including stable value, to cover plan administration expenses.

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If you have any questions, or would like to begin talking to a retirement plan advisor for best fiduciary practices on including a stable value investment option in your retirement plan, please get in touch by calling (855) 882-9177 or e-mail us at sbs@hanys.org.

[i] Source: Morningstar.com
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