What 401(k) plan sponsors need to know about stable value funds

Stable value generally refers to a relatively low-risk asset class that focuses on capital preservation and liquidity while providing steady, positive returns to participants. These funds use insurance and/or banking guarantees and a special type of accounting—book value accounting—to provide 401(k) participants with liquidity, preservation of principal, and income. 

There are two broad categories of stable value funds: insurance accounts and commingled funds. 

Insurance company accounts are agreements between an insurance company and a plan in which the insurance company credits participant account balances with a guaranteed rate (the crediting rate); maintains a constant, daily per share price for transactions; and provides liquidity. A plan’s assets are invested in the insurance company’s general account, and the insurance company earns the spread between investment returns and the crediting rate.

Commingled stable value funds, typically offered by banks or trust companies, are made up of a portfolio of bonds that's guaranteed by third-party insurance company or bank wrap contracts. Similar to an insurance company account, a commingled fund preserves capital, credits interest, provides liquidity, and allows for daily purchases and sales at a fixed price, a process accomplished through book value accounting.

Understanding the following concepts and terms will help you feel more comfortable discussing and evaluating stable value.

Benefit responsiveness allows purchases or sales at a known contract or book value to satisfy participant-level transactions or benefit distributions. 

Book value (contract value) is defined as principal, plus additional deposits, plus accrued interest, less withdrawals or expenses. Stable value transactions are fulfilled at book value.

Competing funds are investments that have an objective similar to stable value, such as money market funds or short-term bond funds. If competing funds are offered in a 401(k) menu, transfers between the stable value fund and competing fund are usually subject to restrictions.

Contract holder is the owner of a stable value contract, usually a plan sponsor. 

Credit quality is a measure of the financial strength of an entity.

Crediting rate is the interest rate that a stable value investment contract earns on its book value. It's quoted as an effective annual yield and may be expressed as a gross or net crediting rate. 

Employer-initiated events refer to plan-wide transactions, such as a plan termination or a removal of the stable value fund as a designated investment option, that results in the withdrawal of plan assets from the stable value fund.

Equity wash refers to the requirement that, before participant balances may be transferred from a competing fund to stable value, they must first be transferred to a noncompeting fund, typically for 90 days. 

Expense ratio is defined as the fund’s operating expenses as a percentage of average net assets. It's usually referred to as the fund’s fee. 

Fiduciary is a party defined by law or designated in a plan document who owes duties of prudence and loyalty to plan beneficiaries. 

General account is a life insurance company investment account, usually invested in stocks, bonds, cash, and real estate, that contains the insurance company’s own assets, capital, surplus, and reserves held against liabilities.

Guaranteed investment contract (GIC), usually a group annuity contract, is a contract issued by an insurance company that pays a specified rate of return for a specified period of time, uses book value accounting, pays benefits to plan participants, and provides annuities, if requested. 

Lesser of book or market value withdrawal refers to the value at which a plan exiting a stable value fund is permitted to do so. Exit usually occurs at the lesser of the book value of the stable value investment contract or the market value of assets backing the book value of the stable value investment contract.  

Liquidity is a measure of the extent to which an investment can be sold or converted into cash at its current price. 

Market value adjustments are the adjustments to an investment contract’s market value due to employer-initiated events. For some GICs, it’s the adjustment market value due to termination before the stated maturity date.

Money market funds are mutual funds that attempt to preserve principal and maintain a constant net asset value of $1 per share while paying interest. Money market funds consist of securities that mature in less than one year, such as high-quality commercial paper, certificates of deposit, U.S. Treasury bills, and repurchase agreements. 

Put option refers to a provision that allows a plan to leave a stable value commingled fund at contract or book value, subject to a notice period. This term is used differently in securities markets where puts are a type of option. 

Rate resets refer to periodic changes in the crediting rate on the stable value investment contract.

Synthetic GICs are made up of a portfolio of assets held by one or more entities that are not insurance companies but wrapped by an insurance contract, an arrangement that ensures book value transactions. 

Wrap contracts are insurance contracts used in the creation of synthetic GIC. These provide assurance 1) of the book value for that portfolio, 2) of the crediting rate payment, and 3) that participant transactions are executed at book value.

Source: https://www.jhgroupannuities.com/content/INSTANN/en/helpful-terms.html.