Fully Benefit Responsive

[dmb]

An auditor used the term "fully benefit responsive" as opposed to full market value when discussing assets of a 401k plan. Has anyone heard this term, and if so what does it refer to?? Thanks.

[JanetM]

You must have a stable value fund. AICPA article on this topic.

Many defined contribution plans today offer a low-risk investment option — often referred to as a stable value fund — to their participants. According to the Stable Value Investment Association (SVIA), stable value investments are the largest conservative investments in defined contribution retirement plans, with over $355 billion in assets. They are included in almost two-thirds of all defined contribution savings and profit sharing plans and represent over 33 percent of the assets in those plans. Defined benefit pension plans also may invest in such stable value investments.

The AICPA Employee Benefit Plan Audit Quality Center has developed this overview of stable value funds and investment contracts to help Center members better understand stable value investments. This document provides information about the nature and characteristics of stable value investments, the risks associated with such investments, and references to the relevant accounting and auditing standards.

Stable value funds offer safety and stability by preserving principal and accumulated earnings. They are similar to money market funds but offer considerably higher returns. Their returns are comparable to intermediate investment grade corporate bonds, without the associated market risk. Stable value options in participant-directed defined contribution plans allow participants access to their accounts at full “contract

value” for withdrawals and transfers as permitted by the defined contribution plan (“plan”). Stable value funds primarily invest in guaranteed investment contracts (GICs) issued by banks or insurance companies, synthetic GICs, or in a common collective trust or mutual fund which invests in these securities.

A traditional GIC is an agreement between the issuer (generally, an insurance company or bank) and the plan, in which the issuer agrees to pay a predetermined interest rate and principal for a set amount deposited with the issuer. The issuer is obligated to repay the principal and interest in its entirety. The issuer generally will use the money to purchase investments to cover the cost of the interest due.

The investments in this arrangement are owned by the issuer rather than the plan. As such, the issuer is accepting the risk of interest rate fluctuations.

In a synthetic GIC arrangement, the plan itself owns the underlying investments (generally high quality

government securities, private and public mortgage-backed and other asset-backed securities, and investment grade corporate obligations) and purchases a “wrapper” (usually from an insurance company) which guarantees full payment of principal and interest. This guaranteed rate — referred to as the crediting interest rate — will never be negative. In other words, the wrapper guarantees that there will be

no loss of principal or accrued interest.

Many defined-contribution plans obtain beneficial ownership interests in bank or collective trust funds, allowing several smaller unaffiliated plans to gain the economies of scale necessary to participate in the stable value marketplace.

In a stable value fund or common collective trust (fund), the plan invests in a pooled account with other plans by buying shares or units in the fund. The fund then invests in stable value instruments. Each plan is credited with its proportional earnings. In such arrangements, the securities are owned by the fund rather than by the plan.

Investments (Form 5500 Schedule H, line 4i), may list a stable value investment in one of the following ways: • GIC

• Stable Value Fund

• Fixed Income Fund

• Income Fund

• Interest Income Fund

• General Account Investment Contracts

• Security Backed Investments

– group term investment contract

– separate account investment contract

– synthetic investment contract

Fully benefit-responsive investment contracts provide a liquidity guarantee by a financially responsible third party of principal and accrued interest for liquidations, transfers, loans, or hardship withdrawals under the terms of the plan, as long as the plan allows participants reasonable access to their funds.

The “fully benefit-responsive” concept is important, as it determines how a contract will be reported in a plan’s financial statements. FASB Staff Position (FSP) AAG INV-a, Reporting of Fully Benefit-Responsive Investment Contracts Held by Certain Investment Companies Subject to the AICPA’s Audit and Accounting Guide, Audits of Investment Companies, establishes that an investment contract is considered fully benefit-responsive for financial reporting purposes if all of the following criteria are met for that contract, analyzed on an individual basis:

• The investment contract is effected directly between the plan and the issuer and prohibits the plan from assigning or selling the contract or its proceeds to another party without the consent of the issuer.

• Either (1) the repayment of principal and interest credited to participants in the plan is a financial obligation of the issuer of the investment contract or (2) prospective interest crediting rate adjustments are provided to participants in the plan on a designated pool of investments held by the plan or the contract issuer, whereby a financially responsible third party, through a contract generally referred to as a wrapper, must provide assurance that the adjustments to the interest crediting rate do not result in a future interest crediting rate that is less than zero. If an event has occurred that may affect the realization of full contract value for a particular investment contract (for example, a significant decline in creditworthiness of the contract issuer or wrapper provider), the investment contract shall no longer be considered fully benefit-responsive.

• The terms of the investment contract require all permitted participant-initiated transactions with the plan

to occur at contract value with no conditions, limits, or restrictions. Permitted participant-initiated transactions

are those transactions allowed by the plan, such as withdrawals for benefits, loans, or transfers to other

funds within the plan.

• An event that limits the ability of the plan to transact at contract value with the issuer (for example, premature termination of the contracts by the plan, plant closings, layoffs, plan termination, bankruptcy, mergers, and early retirement incentives) that also limits the ability of the plan to transact at contract value with the participants in the plan must not be probable of occurring.

• The plan itself must allow participants reasonable access to their funds.

Contract Value and Fair Value

The trustee or custodian generally provides the contract and fair values on the Schedule of Assets Held for Investments as of the date of the schedule.

Contract value is the total cost of the investment (amount paid at time of purchase plus or minus any

additional deposits or withdrawals) plus accrued interest. This is also referred to as book value.

The fair value of a GIC typically is calculated as the present value of future cash flows. The fair value of a

synthetic GIC is equal to the sum of the fair values of the underlying securities. The market values of those

securities may be determined using the market price on a market exchange if the security is actively traded,

or the present value of future cash flows.

In the case of synthetic GICs, the custodian may separately value and disclose the underlying investments

and the wrapper on the Schedule of Assets Held for Investments. The underlying investments would be

recorded at fair values and the wrapper would be valued at the difference between contract value and fair value, which could result in either a positive or negative valuation for the wrapper.

Average Yield vs. Credited Interest Rate

The custodian should be able to provide both the average yield earned and the credited interest rates

The average yield refers to the actual income earned on the underlying investments in the fund. The average yield would include coupon interest accrued, any premium or discount accrued/amortized for the securities, and any realized gain/loss from sales of the securities. The credited interest rate is the actual guaranteed interest rate paid to the participants’ accounts per the contract. This rate could change on a predetermined frequency (for example, monthly, quarterly, or semi-annually). The issuer will set the interest rate based on various factors, such as projected interest rates, projected administrative

expenses, and realized gains or losses from past periods. For traditional GIC’s, the two rates should be equal as the interest accrued and paid to the plan is merely that of the underlying asset. For synthetic GIC’s, the two rates typically are different as the average yield is based on the performance of the various assets in the fund, and the amount paid to the participant is the contract rate. Over time, however, the cumulative yield and credited rates should be similar.

For traditional GICs, the main risk relates to the issuer’s (the insurance company or bank) financial health. As these contracts are only as good as the issuer’s ability to pay, it is important that an issuer have a high credit rating. In a synthetic GIC arrangement, the plan owns the actual investments and purchases an insurance wrapper to protect the principal from market and cash flow risks. Even so, the plan is not insulated from such risks as default on the underlying bonds, business failures of insurers, plan terminations, or layoffs at the plan sponsor. In other words, the risks are associated with the financial strength of both the insurer and the bond issuer.

Relevant auditing guidance is found in chapter 7 of the AICPA Audit and Accounting Guide, Employee Benefit Plans (the Guide). The Guide describes the objectives of auditing procedures applied to stable value assets as follows:

• Whether those stable value assets exist.

• Whether changes in those plan assets during the period are properly recorded and valued

in conformity with GAAP.

• Whether the plan has any intention of seeking to dispose of or terminate the stable value contract.

• Whether the terms of the stable value contract are being complied with and are appropriately disclosed

in the plan’s financial statements.

References to Auditing Literature

Please refer to the auditing literature for detailed discussions of audit objectives, planning and procedures related to these investments.

SOP 94-4, Reporting of Investment Contracts Held by Health and Welfare Benefit Plans and Defined Contribution Pension Plans, as amended by FSP AAG INV-a “Reporting of Fully Benefit-Responsive Investment Contracts Held by Certain Investment Companies Subject to the AICPA’s Audit and Accounting Guide, Audits of Investment Companies,” provides guidance for reporting stable value investments

in those plans. SOP 94-4, before the effective date of the amendment, requires fully benefit-responsive contracts to be reported at contract value. SOP 94-4, as amended, requires that the statement of net assets available for benefits present amounts for (1) total assets, (2) total liabilities, (3) net assets at fair value, and (4) net assets available for benefits. The amount representing the difference between (3) and (4) shall be presented on the face of that statement as a single amount calculated as the sum of the amounts

necessary to adjust the portion of net assets attributable to each fully benefit-responsive investment contract from fair value to contract value.

FASB Statement No. 110, Reporting by Defined Benefit Pension Plans of Investment Contracts specifies the

accounting for such investments held by defined benefit pension plans. FASB No. 110 requires that stable value investments held by defined benefit pension plans be

reported at fair value.