Stable Value Fund - What questions do you ask?

[Guest Fred Benefits]

We're considering offering a stable value fund as an investment option to participants in our 401(k) plan.

What sorts of issues should we address before deciding whether to offer a stable value fund? For example, how do you deal with market adjustment charges that the insurance company can impose if the plan decides to terminate the stable value contract with the insurance company? Market adjustment charges permit the insurance company to pay over the lesser of market value or contract value (the value as determined under the contract) on termination.

[Jon Chambers]

If I were selecting a stable value fund, I'd want to know:

Current yield

Number of issuers

Distribution of assets across issuers

Distribution of ratings across issuers

Use of synthetics/policy on synthetics

Manager tenure

Management fee

Liquidity policies

Termination notification requirements

These are just a few of the issues off the top of my head. I'm sure there are many more.

Market value adjustments typically don't apply to stable value funds, although they are common in single issuer contracts. I'd strongly recommend staying away from a single issuer contract.

[Guest Fred Benefits]

Thanks for your response. But now I have more questions. I don't understand some of the points you raised. (Shows how little I know about stable value funds.)

But first let me say that the presentation by the insurance company has me wondering whether what's been offered is a stable value fund or something else. The insurance company's brochure call this its "managed GIC" and the trust company's brochure calls it a "guaranteed account." According to the insurance company's brochure, the contract accepts participant contributions to the plan's "stable value option." The trust company's brochure say that principal and interest are backed by the full faith and credit of the insurance company. The insurance company's brochure says that specific separate accounts are used to fund the contract based on the objectives of the plan's stable value option.

Does the above describe a stable value fund or a GIC? Is there a difference?

Now, regarding your response:

"Number of issuers": does this mean the number of issuers of the debt instruments in which the insurance company invests the assets of the stable value fund? If so, is the relevance diversification (don't have all your eggs in one basket)? Is there a minimum diversification one should look for?

"Distribution of assets across issuers": Assuming I'm right about "issuers" above, I take it this is to better understand how diversified the investment is (6 issuers, but one having 90% of the assets, wouldn't be too diversified).

Distribution of ratings across issuers: I assume this means the Moody's, S&P or similar ratings of the issuers of the debt instruments in which the stable value funds assets are invested. Is that right? Is there a minimum rating we should look for?

As to the first three points above, I take it that this will only be an accurate picture as of the date the information is collected. The next day the stable value fund could change the issuers it invests with, right?

Use of synthetics/policy on synthetics: I don't understand this at all. What's a synthetic, and how might a synthetic be used? Is this good or bad?

Manager tenure: Tenure of the stable value fund manager.

Management fee: Fee the stable value fund manager is receiving. What's reasonable? We understand that the consultant/brokerage house that's proposing the stable value fund will be receiving fees, too. What's reasonable for them.

Liquidity policies: this is of course our great concern. What should we expect? Are these matters subject to negotiation?

Termination notification requirements: what should we expect? Are these matters subject to negotiation?

You say "Market value adjustments typically don't apply to stable value funds, although they are common in single issuer contracts. I'd strongly recommend staying away from a single issuer contract."

First, what's a single issuer contract, and how do I know whether that's what's being offered? Does that mean the insurance company invests the assets of the stable value fund in the debt instruments of a single issuer? (The proposal here is for a contract with an insurance company.)

Maybe that's what we have. The the insurance company's brochure clearly says that if the contract is terminated, we receive the lesser of contract value or market value, with contract value essentially being the contributions made plus a rate of credited interest, less withdrawals.

What's the alternative to a "single issuer contract?" There seems to be a strong sentiment to provide a an option to participants that preserves principal and provides a steady return, so if there's a better way to do this, we'd like to know.

Finally, is there any good source on the Web to learn more about the issues you raise? (All the web sites we've seen so far have a sales pitch aspect, and don't raise the issues you have.)

[Guest halka]

Sounds like a GIC fund. If so, all the points raised by Jon are important considerations. Liquidity is particularly critical for a 401k plan. Most GICs are benefit-responsive (allow liquidation to fund distributions to participants) but may have significant delays and/or costs associated w/ a participant simply wanting to reallocate his balance from GIC/stable option to, say, the equity option. May be similar delays/expenses associated w/ dropping the GIC fund and replacing w/ alternative stable asset option.

"Full faith & credit of the insurance company" hardly means you have a risk-free investment. You might go back and read some of the stories on the Executive Life collapase.

The Plan should independently identify which characteristics of a stable fund are most important. Then, search for a product that fits the model. You are correct that you are hearing the sales pitch. Buying what the vendor/insurance company wants to sell is often less than ideal.

[Jon Chambers]

Don't have time to answer all your questions, but if you have a broker/consultant involved, they should be able to help you. A stable value fund is a managed combination of GICs and similar investments from numerous insurance companies (issuers). As such they are significantly less risky than a GIC from a single insurance company. In my opinion, a stable value fund is a far superior option to a single issuer GIC, but maintains most of the desirable characteristics of a GIC. You pay the manager to run the fund, like a mutual fund. Typical fees range from 0.20% to 0.50%. Manager tenure is how long the manager has been running the fund.

Since stable value funds purchase relatively long term contracts, the review that you do will be valid for a reasonable period of time. Number of issuers and issuer concentration is unlikely to change overnight, similarly, average ratings may go up or down, but don't tend to change too rapidly. It's unlikely that a fund that has historically focussed on highly rated issuers will shift rapidly to lower rated issuers. In fact, most stable value fund managers will stop using a given issuer if its ratings drop significantly. Of course, the choice of any given contract is based on many factors, including the guaranteed crediting rate, credit quality, liquidity, etc.

For a stable value fund, it's typical to require 12 months notice of termination, although many funds waive the notice requirement. You can typically get a sense of whether notice would be waived by looking at the fund's cash flows and cash position. Funds with little cash and low cash flows are unlikely to be able to waive the notice, particularly if your plan has a large position in the fund.

I suggest you check out www.morley.com for more information. Although it is a sales site, there is a very good glossary of terms, and some reasonably objective information regarding these products. Morley is one of the leading stable value fund managers, but there are also plenty of other good managers out there. I'd definitely recommend considering stable value funds as an alternative to a traditional GIC or insurance separate account product.

Hope this helps,