In turbulent markets, stable value investments can be an attractive choice for retirement plan participants worried about the fluctuations in the marketplace. And with both the stock and bond markets down for 2022, some participants may be evaluating their options to preserve capital.
Like any investment option, stable value funds have advantages and disadvantages. Consequently, there are circumstances where stable value funds are a great fit and there are situations where they are not the best solution for plan participants.
While most defined contribution plans include a stable value fund option, the best choice depends on the facts and circumstances. Considering a stable value product for a plan’s investment line-up brings on fiduciary liability for plan officials. They are responsible for the prudent selection and monitoring of the option. Understanding the unique aspects of stable value funds is the first step in an effective evaluation and assessment process that, when documented, can help mitigate fiduciary liability under the Employee Retirement Income Security Act (ERISA) of 1974.
The focus here is not whether a stable value fund is appropriate for a certain plan participant. Rather, it is to offer guidance to plan investment committees and other plan officials on how to select and monitor a stable value fund. Not all stable value funds are created equally. Let’s explore the key differences.
Types of Stable Value Funds
Different organizations offer diverse types of stable value-type products. The differences between products are attributable to the different laws that govern the offering organizations. However, at least one commonality among stable value products is the fact that they are only as secure as the organization or organizations backing them up.
Insurance company stable value products, commonly called guaranteed investment contracts or GICs, are backed by the strength of the insurance carrier. If the carrier became insolvent, potentially no assets would be available to pay participants.
Bank or trust company stable value products, commonly structured as collective investment trusts (CITs), are often referred to as synthetic GICs. That is because one or more outside entities are contracted to insure all or a portion of the stable value product for a fee. This is commonly called a “wrap fee.”
What are the Underlying Investments of a Stable Value Product?
It depends. For example, insurance carriers, generally, do not have an earmarked portfolio of assets backing their stable value products. Instead, the stable value product is, in effect, invested in the insurance company itself. Sometimes this is referred to as the general account. Other stable value products, such as those issued by banks or trust companies have a specific underlying bond portfolio associated with the stable value fund.
Are There Restrictions on Distributions from Stable Value Products?
There could be. Again, doing homework is critical when it comes to understanding possible limitations on when distributions can occur. Many stable value products have distribution limitations, commonly known as a “put” option. A put option can limit the amount of a distribution, the timing of a distribution (e.g., requiring a 12 month wait), or even imposing a market value adjustment (explained next).
Market value adjustments are not well understood, yet these adjustments are an important factor to consider when selecting a stable value product as a plan investment option. Essentially, a market value adjustment is a reduction in the amount available to be distributed in certain circumstances. A market value adjustment may occur if the present value of the underlying investment pool is less than the book or face value of the investments. The following simplistic example may help illustrate market value adjustments.
Example: Stable Value product “SV” has a $10,000,000 bond portfolio. From an accounting perspective X is valued at $10,000,000 because this was the original purchase price of the bonds. However, the underlying bonds may not be worth $10,000,000 today. Perhaps their current market value is $12,000,000 or maybe $8,000,000.
Let’s assume the market value of the portfolio is $8,000,000 and the terms of SV impose a market value adjustment is applied if an immediate distribution is requested. Often the market value adjustment will not apply if the distribution is postponed for a specified period, commonly 12 months. The rationale is if the participant wants his or her money immediately, the provider must sell bonds at a loss and this loss is passed on to the participant. Conversely, if the participant waited 12 months, likely, some bonds would mature during that time at face (or book) value, and the cash could then be used to pay participants without incurring a loss.
Put options and their limitations can be complex and require close analysis by plan officials before decisions are made regarding the stable value product selections. Some products allow immediate distributions for participant who have separated from service, others do not. Other products impose a market value adjustment only if the book-to-market value ratio is below a certain percentage.
Do Stable Value Products Offer a Guaranteed Rate of Return?
Some stable value products, specifically those offered by insurance carriers, offer a guaranteed rate of return. Non-insurance carrier products, typically, do not have a guaranteed rate of return.
What are the Fees Associated With Stable Value Products?
As with other features, fees can vary by the product. Some products do not charge a fee, rather, the net amount paid under the contract is reduced by a certain number of basis points, thus reducing the yield.
What Do Plan Sponsors Need to Know?
Stable value products are not created equally. Before committing to an option, plan fiduciaries are encouraged to explore the significant differences in how the funds are structured, backed and credited, and the possible limitations on distributions.
Periodically, conducting due diligence on the capital preservation options offered to participants is wise. All of these factors impact which stable value product would be in the best interest of plan participants.
Plan Sponsor Council of America, 64th Annual Survey, 2021
Source : Retirement Learning Center