It’s tempting to focus entirely on portfolio yield, duration, and quality when evaluating and recommending a Stable Value fund to plan sponsor clients. While portfolio yield, duration, and quality are certainly important things to consider, there is one feature of Stable Value funds that is even more important: the fund’s plan-level termination provision.

What is a Stable Value Fund?

A Stable Value fund is essentially a fixed income (bond) investment portfolio managed by one or more investment fund managers with one or more insurance companies that guarantee the book value (cost) of the bond portfolio and accrued interest. This guarantee essentially means that participants will get back all the money they put into the fund (plus earned interest) when they decide to take their money out of the fund to transfer to other investment options or to take a distribution. Individual participant transfers or distributions are considered “participant-initiated” events.

What does a Stable Value guarantee provide?

This guarantee is needed during periods of time when the actual market value of the bond portfolio falls below its book value (cost). This happened during the 2008 financial crisis when market-to-book ratios fell to as low as 88%, and remained below 100% for several months. This was mainly due to lesser-quality assets selling off during a liquidity crisis. A rare event? Maybe, maybe not? Outside of 2008, market-to-book ratios have typically stayed above 100% (as they are today). However, we have been in a falling interest rate environment since the 1980’s which has been a tailwind for bond prices. Market-to-book value ratios will likely come under pressure when interest rates start to rise again. The “above 100% market-to-book norm”, might change to a “slightly below 100% market-to-book norm”.

Participants don’t need to worry about below 100% market-to-book value ratios, because again, the insurance companies within a Stable Value fund are guaranteeing book value plus accrued interest. Up until recently, Plan Sponsors didn’t really need to worry about this either if they decided that they wanted to terminate a Stable Value fund to switch to another fund, switch to another platform (that might not have the fund as an available option), or to close a plan (these plan-level decisions are examples of what is considered “employer-initiated” events). However, due to recent changes in the Stable Value insurance wrap in industry (since 2008), Plan Sponsors now need to worry about below 100% market-to-book value ratios.

Does the fund have a “put option” provision?

Prior to 2008, most Stable Value funds offered a 12 month “put option” provision in the event of a plan-level decision to exit the fund. This meant that in a worst case scenario, plans (hence plan participants) would get all of their Stable Value money back within 12 months, regardless if the fund’s market value was below book value. However, since 2008, many Stable Value funds have been removing their “put option” provision at the mercy of the insurance companies providing the guarantees behind the fund. This means that if there is a plan-level decision to exit a fund, participants might need to take a loss on their money (if the market value of the fund was below book value), otherwise the plan would have to wait indefinitely (potentially up to 10 years depending on the fund) to get 100% of their participant’s money back.

What should Advisors be considering?

When evaluating Stable Value funds, advisors need to consider and educate Plan Sponsors about a fund plan-level termination provisions. There are still funds available today that that offer a put option (12 months or less). The put option will ensure that in the event of a plan-level fund termination, participants will receive book value within a specified period of time, even if the fair market value of the Stable Value fund’s portfolio remains below its book value. If a fund does not have a put option provision, it is important to ask the fund provider, “What would happen in a worst case scenario where a plan-level fund termination occurred during a period of time when the fund’s market value was below book value”?  The Plan Sponsor should be made aware of the fund’s termination provisions and it is always good practice to reflect this in the plan’s IPS.

For more on this, and other features to consider when selecting a Stable Value fund please read the AEPG whitepaper 

Aldo Vultaggio, CFA, CPA is a Portfolio Manager and Steven Kay, CFP, ChFC, CLU, CEBS, RHU, AAMS, CRC, AIF is the President & Founder of AEPG Wealth Strategies (http://www.aepg.com) an advisory firm in Warren, NJ.

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