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 HBS MetLife Stable Value Fund.
1. What is a stable value fund?
2. How popular are stable value funds when offered as an investment option in a retirement plan?
Within the HBS 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.
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 (800) 388-1963 or email us at hbs@hanys.org.