Stable value due diligence

Key stable value due diligence areas

Stable value isn’t built like a mutual fund or a money market fund, and anyone evaluating a stable value fund should understand how it works. The two most widely used types of stable value funds are insurance company accounts and commingled—also called pooled—funds. Whether you’re considering an insurance company account or a commingled fund, there are several characteristics that Employee Retirement Income Security Act of 1974 (ERISA) plan fiduciaries responsible for stable value due diligence should consider.

Structure—An insurance company can create a stable value fund backed by assets in its general account. This type of stable value fund is offered through a group annuity contract—an agreement between the insurance company and a plan sponsor. Under the agreement, the insurance company credits participant account balances with a guaranteed interest rate—the crediting rate. The insurance company also maintains a constant, daily per share price for transactions and provides liquidity for participant trading and withdrawals. A plan’s assets are invested in the insurance company’s general account, and the insurance company earns the difference between investment returns, less the expenses associated with investing and administering the fund and the crediting rate. An ERISA fiduciary should understand the structure of any stable value fund under consideration.

Portfolio—An insurance company account plan invests money alongside the issuing insurance company’s other assets in its general account, which is typically a mix of cash, bonds, stocks, and real estate, although some insurance company account stable value assets may be invested in investment-grade bonds. Plan sponsors ordinarily receive no information about the general account beyond its overall asset mix. Commingled funds, in contrast, consist of one or more bond portfolios run according to guidelines imposed by investment contract (wrap) providers. Details on commingled fund portfolios are accessible and should be reviewed by ERISA fiduciaries as frequently as those of any holdings in other investments.

Plan exit—Both insurance company accounts and commingled funds impose a waiting period, or put, on plan withdrawals if  the fund’s market value is less than its book value. Withdrawals may be necessary when a plan changes recordkeepers, for example. Puts protect remaining investors from the losses that can result when a plan exits a pool that has temporarily experienced a decline in market value, which can happen when interest rates rise. ERISA fiduciaries should be aware of put terms, and, if they’re considering an exit, they should know a fund’s book-to-market value.

Crediting rate—Insurance company account rates are set by the issuer, whereas pooled fund crediting rates are set by an industry-standard formula that includes yield, interest-rate sensitivity (duration), and book-to-market value. An ERISA fiduciary should know why, and how often, crediting rates are reset.

Minimum crediting rates—Insurance company account issuers often guarantee a minimum crediting rate (sometimes fixed, sometimes floating) with broad market interest rates. Commingled funds, which have crediting rates set by formula and depend more directly on market rates, rarely offer a floor above 0%. During a period of low or falling rates, a guarantee, or a floor, above 0% is valuable.

Fees—Insurance company account fees, like those for bank CDs, are withdrawn by the issuer before interest is credited to investors; the amount that the insurance company account issuer earns isn’t disclosed. Commingled fund fees, on the other hand, are stated. Pooled fund fees are stated and explicit, while insurance company account fees may not be. An ERISA fiduciary should understand both explicit and unstated fees.

Guarantees—The financial strength and history of insurance company account issuers are indicative of their ability to pay interest and return principal. Commingled funds typically include several investment contract providers, or wrap providers, which can vary in financial strength and commitment to the stable value marketplace. While having a variety of wrap providers can be valuable, it also makes commingled fund due diligence more challenging. ERISA fiduciaries must consider what level of stable value due diligence they’re equipped to perform. 

Due diligence takeaways for ERISA fiduciaries

Insurance company accounts and commingled funds take different approaches to delivering safety and income. Insurance company accounts are a contract between one issuer and one sponsor, and their ability to perform as expected depends solely on the issuer’s financial strength. Ultimately, insurance company account due diligence should focus on this key factor.

Commingled funds, on the other hand, may have more than one investment manager or wrap provider, potentially leading to more involved due diligence relative to that required of an insurance company account.

There are benefits and drawbacks to both insurance account and commingled fund stable value structures, and there are different due diligence requirements associated with each. For both types of funds, retirement plan fiduciaries should develop a prudent due diligence process, follow it closely, and document how they went about making decisions.