PANC 2018: Stable Value Fund Mechanics

On the second day of the 2018 PLANADVISER National Conference in Orlando, William McLaren, vice president and stable value business leader for Lincoln Financial Group, offered a crash course on the current opportunities and challenges associated with offering stable value funds on retirement plan menus.

As McLaren pointed out, U.S. retirement investors are now 10 years out of the Great Recession, but there remains a great focus on capital preservation, particularly as interest rates slowly but steadily increase.

“Stable value is an important product set to monitor as rates increase,” McLaren suggested. “Stable value can help protect retirement investors’ dollars as the rate environment heats up.”

Thinking back over several decades, McLaren explained how the overall long-term secular decline in interest rates drove a common perception that bonds are always safe for protecting an investor’s capital. But those with the long-view know this is not true—and those with a short-view are learning as much right now. Rising rates are causing negative book value returns in various types of bond funds.

“It’s a real surprise to some folks to see the value of their bond portfolios respond negatively to interest rate hikes,” McLaren said. “Simply put, many individuals in the markets today do not understand interest rate risk.”

Assessing the stable value marketplace 

McLaren went on to offer a refresher about the basic flavors of stable value that are available, and how these differ from one another. In general, the term stable value can refer to three types of product structures.

First is individually or separately managed accounts. These are customized to meet the objectives of a single plan and do not include assets of other plans.

“This stable value product set is generally limited to plans with $100 million or more in just stable value assets alone, so very large plans,” McLaren explained. “One of the big benefits, besides the economy of scale, is how this type of stable value product provides full transparency of fees and underlying assets, being a custom-made solution.”

The second type of stable value product are constructed as commingled pools, designed to combine the assets of unrelated plans in a complementary way, enabling them to gain economies of scale similar to the separately managed accounts but with some important differences.

“Generally this type of stable value fund employs a multiple wrap structure, which diversifies risk but also makes it more complicated to manage and to do the due diligence,” McLaren noted.

Finally, there are stable value products structured around guaranteed insurance company accounts. These products invest in a single group annuity contract issued directly to the plan.

“This is the oldest and largest segment of the stable value market,” McLaren said. “This is where the insurance company provides a direct guarantee to the plan sponsor. These can be created only once the insurance company gets approval from insurance regulators in their home state. They next have to go state by state to get approval. Because of the challenge of doing this work, you want to make sure of the issuing firm’s long-term commitment to the asset class.”

As McLaren said, depending on the plan sponsor client, one of these options will likely be most appropriate. To help clients define which approach is best, McLaren suggested the following questions be asked: “What is most important to you in protecting your assets? When was the last time you did a fiduciary review of the current stable value investment option? Are you fully aware of the details about fees, liquidity, disclosure support, and portfolio and contract characteristics?”

McLaren concluded by emphasizing how understanding the structure of stable value funds requires looking at contract terms beyond just the crediting rate.

“Plan sponsors must understand what is covered, what is not covered,” he warned. “One thing that surprises people is that merger and acquisition activity can have an impact on the stable value fund that must be considered. Clients should establish a policy that ensures periodic evaluation, selection, oversight and monitoring on a proactive basis. They must get under the hood and study the fixed-income strategy as it exists right now, and where it is going in the next six to 12 months. The Department of Labor’s guidance in Notice 95-1 is a good monitoring framework to follow. It is actually about assessing annuity providers used in a DB termination, but it is a reasonable proxy framework to use for selecting and monitoring a stable value provider.”