The Markets March 26, 2014

Risk of Rising Interest Rates on Stable Value

While retirement plan sponsors will find the market for getting into stable value funds has improved, the threat of rising interest rates poses a risk they need to keep in mind.
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An article from Portfolio Evaluations, Inc. (PEI) explains while most of the concern pertaining to the potential rise in interest rates has been focused on fixed income funds, stable value funds have been significantly impacted as well. Pooled stable value funds are essentially fixed income portfolios supported by insurance wraps or guarantees, so they carry a significant level of interest rate risk. The market value of the underlying fixed income portfolio will decline as interest rates rise. Participants do not experience these market value fluctuations due to the products’ insurance component; however, last year’s rise in interest rates had a potential negative impact on the liquidity for stable value funds at the plan sponsor level.

Marc Lescarret, senior investment analyst at PEI in Warren, New Jersey, and author of the article, tells PLANADVISER if plan sponsors use a fixed income instrument and interest rates go up, that will generate a negative return, but stable value funds are a way to protect against negative return. Stable value funds are capital preservation vehicles.

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He explains that stable value funds usually impose liquidity restrictions—if a plan sponsor wishes to terminate a pooled stable value product, they may be required to wait in a put queue which is typically 12 or 24 months depending on the ratio of the fund’s market-to-book value of assets. According to Lescarret, currently many investment managers still have a market value of 100% or just slightly above book value, so they are keeping a loose policy on sponsor liquidity. Many are letting investors out within months now, he says.

However, as interest rates get higher, market value can drop below book value, and managers may have to pay if funds leave, so they are beginning to enforce the puts.

One thing this means for plan sponsors is it is a good time to review their stable value products because if they are unhappy and want to make a switch, now is their opportunity, according to Lescarret. If a plan sponsor adopts a stable value product and becomes dissatisfied, the window for getting out is narrowing.

In addition, he notes in the article, in order to protect against potential rising interest rates, most stable value managers have shortened the duration of their portfolios. These actions lowered the yield on their portfolios, which reduced the crediting rate offered to participants. When deciding whether to get into a stable value product, or when monitoring their current offering, it is important for plan sponsors to understand how stable value funds have been affected by the recent rise in rates in addition to what steps managers have taken to adjust portfolios.

Greg McCarthy, principal and director of the Investment Consulting Group at PEI, tells PLANADVISER, just because market-to-book values have improved and products are opening up doesn’t mean plan sponsors can lower their due diligence efforts. “It is important for plan sponsors to remember they have to carry out the same prudent process and due diligence for stable value investments as with any other asset class,” he concludes.

Lescarret’s article is here.

Compliance March 26, 2014

An Inside Perspective on Rollover Rulemaking

Ever wonder why so many different regulators are voicing concern over employer-sponsored retirement plan account rollover practices—especially rollovers into individual retirement accounts (IRAs)?
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Besides the Department of Labor (DOL), which has been considering a new fiduciary definition that could add certain IRA rollovers to the list of prohibited transactions barred by the Employee Retirement Income Security Act (ERISA), both the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) are weighing rollover rule changes of their own (see “Some Advisers May Want to Pause on Rollovers”). Why so much simultaneous attention from the distinct regulatory groups?  

Follow the money, says Tamara Cross, assistant director of education, workforce and income security issues at the Government Accountability Office (GAO). She points to a wide range of research showing rollovers into IRAs could top $2.1 trillion over the next five years (see “For IRAs, It’s All About the Rollover”). With so much money flowing out of the employer-sponsored plan environment, it’s no surprise multiple regulators want to head off potential conflicts of interest and make sure participant dollars are treated fairly, Cross says.

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Cross discussed the various regulatory efforts related to IRA rollovers and plan distributions during the final day of the 2014 NAPA 401(k) Summit, hosted by the National Association of Plan Advisers (NAPA) in New Orleans. She describes the role of her agency as the “watchdog of Congress” that conducts nonpartisan investigations into social and economic issues. The results of GAO investigations are shared with lawmakers and a long list of regulatory agencies that have a standing in the various subjects on which the office reports.

A little more than a year ago the GAO published a report on IRA rollovers and plan distribution practices, Cross explains, which was shared with Congress, the DOL, the SEC and others. The report levels fairly harsh criticism at the DOL and the other regulatory groups tasked with policing the different facets of plan rollovers and distributions. Cross says the GAO observed a systematic bias towards IRA rollovers compared with other options participants have for pulling assets out of an existing 401(k) account and strongly encouraged the various regulatory groups to reconsider how they oversee rollovers.

“During our research we saw the most significant barriers exist when it comes to participants rolling their assets into a new plan,” Cross explains. “Compared with IRA rollovers, service providers make plan-to-plan rollovers exceedingly difficult. We’re urging the regulators to change that.”

One problem is the complete lack of standardization among service providers (and thus within employers’ plan designs) on the steps required to move money from plan to plan, Cross says. Some plans and providers require a lengthy waiting period, while others allow immediate plan-to-plan rollovers. Some plans require the assets being rolled in to be independently verified as coming from a qualified plan, because if problems arise with those assets it can lead to the disqualification of the entire new plan, she says.

Cross explains that IRA rollovers are not necessarily simpler for the individual participant, but IRA rollover service providers tend to aggressively court participants with offers of help in navigating the rollover process. When it comes to plan-to-plan rollovers, far less assistance is typically available, she says, so participants must rely on fiduciary advisers who may be reluctant to give specific advice because of conflict of interest rules already on the books.

Cross explains that regulators are also concerned about marketing practices for IRA rollovers. The GAO’s report and investigation found that plan participants often receive guidance and marketing that favor IRAs when they look for guidance on their 401(k) plan savings. This is especially true when participants turn to providers’ call center representatives for advice, Cross says, as often advice is given to roll into an IRA when call center reps don’t know anything about a participant’s individual circumstances—which could call for another option.

The GAO believes participants may also interpret plan information about retail investment products from the plan’s service providers as suggestions to choose those products, Cross says. “We absolutely don’t want to give the impression that it’s bad to offer assistance on rolling into an IRA, or that IRAs are an inferior option,” she adds. “What we have a problem with is whether they’re taking a suggestion as coming from a fiduciary when it is not. We’ve seen participants tend to think any advice they receive in a plan context is given in their best interest, when currently that is not the case. If you’re pervasively persuading participants to go into an IRA and they’re thinking you’re giving unbiased information about the options, that’s the conflict.”

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