“The financial crisis provoked a much more comprehensive analysis of risk in the marketplace; what risks [stable value] providers take on, and what the appropriate pricing level is for taking on those risks,” Michael L. Davis, senior vice president and head of Stable Value at Prudential Retirement, told PLANSPONSOR.
The white paper, “Assessing Stable Value After 2008 Performing as Designed,” explains that during the 2008 credit crisis, many financial institutions were forced to increase their capital reserves to reflect deteriorating balance sheets; some financial institutions that issued wrap contracts (principal and accumulated interest guarantees)—a large number of them banks—exited the business. This made it difficult for stable value managers to secure the wrap capacity they needed. In turn, a number of stable value managers exited the business too, forcing some plan sponsors to either remove stable value from their plans or find new providers.Since then, after evaluating the risks, wrap prices have increased to be more consistent with stable value providers’ risk levels, and now more providers are back in the stable value business, Davis said. One may think higher expenses would be a bad thing, but the white paper notes higher wrap fees are helping to attract new providers, extend wrap capacity, and ensure stable value’s book-value redemption guarantees remain available for current and future generations of retirement plan participants. The paper also says relative performance is very strong despite higher wrap fees.
In addition to raising wrap fees, some wrap issuers established more rigorous underwriting standards, Davis said. According to the white paper, some required that managers adhere to more conservative investment guidelines, limiting or precluding investments in securities deemed to have excessive credit or duration risk. Others required managers to boost the cash buffer in their funds, providing an extra cushion to meet participant withdrawals in the event the market value of their underlying bond portfolios fell below book value. Finally, some issuers expanded their equity-wash rules, adding additional types of investments to the list of “competing funds” that cannot accept direct transfers from stable value investments.
“While the changes to the stable value marketplace may have been disruptive in the short term, many in the industry consider them to be additive, heralding a return to the conservative investment strategies, risk parameters and performance goals that characterized the asset class when it debuted four decades ago,” the white paper states.
When looking for a stable value provider, Davis recommended plan sponsors consider the financial health of the company. “Do they have the credit quality and capital strength to offer plan sponsors’ comfort they can provide guarantees?” Davis said. For providers offering synthetic guaranteed investment contracts (GICs), plan sponsors want to look at the strength of investments in the underlying fixed income portfolios, and evaluate whether the company has a good track record of earning successful returns, Davis suggested. Finally, plan sponsors want a stable value provider that is committed to stable value, can endure market conditions and follow through on promises.
As of December 31, 2012, Prudential Retirement had $106.9 billion in stable value retirement account values. Davis said some plan sponsors have raised questions about flexibility in stable value contracts because some providers have very onerous restrictions, but Prudential said it is aware and respectful of the fiduciary obligations plan sponsors have, and will take that into consideration when negotiating with plan sponsors.The Prudential white paper is at http://news.prudential.com/images/20026/STABLEBR.pdf.