What Is a Stable Value Fund? 

Stable value funds are a common capital-preservation option in retirement plans. They’re offered by 82% of plan sponsors¹ and have more than $900 billion in assets.² Stable value funds seek to preserve capital while providing income and liquidity. They have tended to offer higher yields than money market funds since they invest in fixed-income securities with longer duration. Stable value funds use insurance contracts to wrap the underlying portfolio, guaranteeing participants will not lose principal while facilitating benefit responsive withdrawals at book value.³ These insurance contracts enable stable value funds to preserve principal and minimize volatility. 

 

What Happens When Interest Rates Rise? 

After an extended period of historically low interest rates, we’ve transitioned to an environment of rising rates and higher inflation that we haven’t seen for more than 40 years. When interest rates rise, the market value³ of the underlying securities in stable value funds declines, but since participant accounts are based on book value,⁴ their account values aren’t as directly impacted as they would be if they were instead invested in a bond mutual fund. Higher rates also enable the maturing underlying fixed-income investments to be reinvested in higher-yielding securities, resulting in a higher crediting rate that is applied to participant accounts.

 

What Happens if the Plan Sponsor Exits From the Stable Value Fund?

There are several reasons why a plan sponsor would choose to exit from the stable value fund, the most common being a change in the plan’s recordkeeper. If the plan sponsor decides to move the plan from its current recordkeeper to a new one, they generally have three options to consider that may impact the stable value fund: 

Portability – Some stable value funds can be transferred over to the new recordkeeper without penalty. It’s a good idea to first check with the new recordkeeper to see if this option is available.

Liquidate at Book Value – Liquidation usually transacts at the fund’s book value or market value. If the book value is higher than the market value, the plan sponsor could elect to liquidate at book value. In this scenario, the fund may require a waiting period before the plan can receive the book value of the fund, commonly referred to as a put option. This could be for a period of 12 months or longer.⁵ The challenge with this option is the plan sponsor would effectively maintain two active recordkeepers: one for the legacy stable value fund and another for the plan’s other investments. This presents several administrative challenges, one of which being that the former recordkeeper may not agree to administer a single asset.

Liquidate at Market Value – If the plan sponsor chooses to move to a new recordkeeper without exercising a put option, then the fund will be liquidated at market value. It’s common during periods of rising rates for the market value to be below the book value. When this occurs, the difference between the book value and the market value is referred to as the market value adjustment (MVA). Participants invested in the fund would see a decline in their account value to reflect the MVA. 

 

What Are the Plan’s Options To Avoid the MVA?

In order for the participant’s accounts to not incur the MVA, the plan sponsor has other alternatives to consider.  

Portability – Move the existing stable value fund to the new recordkeeper. 

Recordkeeper Pays the MVA – In the event the stable value fund isn’t portable, the new recordkeeper might reimburse the plan for the MVA so the participants accounts aren’t impacted. They may choose to recoup this expense through higher recordkeeping fees. 

New Stable Value Fund Pays the MVA – The new stable value fund may pay the MVA in exchange for offering a lower crediting rate until the cost of the MVA is recouped.

 

What Are the Fiduciary Considerations?
– by Fred Reish, JD Partner, Faegre Drinker 

The issues discussed above raise another important question: Have the fiduciaries of the departing plan violated their fiduciary duties by investing in a manner that causes a MVA “haircut?”

The answer is “no” as long as the fiduciaries engaged in a prudent process to select and monitor the stable value fund. 

 

A Prudent Process for Selecting a Stable Value Fund 

ERISA’s prudent man rule requires that fiduciaries engage in a prudent process to reach an informed and reasoned decision. An “informed” decision is one for which the fiduciaries examine the “relevant” information, i.e., information a knowledgeable person would consider material to making the decision. Once that information is considered, the decision should bear a reasonable relationship to that information and the analysis.  

As a starting point in applying that standard, it’s clear that plan fiduciaries could consider the increased interest earnings for participants if a stable value fund were offered instead of a money market fund. Then there are the usual considerations for any investment: the quality of the manager, the expenses, the track record of the investment, etc. Finally, the financial stability (or claims-paying ability) of the insurance company should be considered. After all, if the bond market falls in value, it’s the insurance company that insures against any loss of value for participant withdrawals. 

Assuming that all of those factors are favorable to the selection of the stable value fund, the next step is to consider the possible impact of the removal of the fund at some point in the future and the possible imposition of an MVA. 

The key is for fiduciaries to consider the material factors and make a conscious decision that they reasonably believe to be in the best interests of participants. In the absence of extraordinary circumstances, if a dispute later arose, that process and decision-making process would be evidence of a prudent and compliant process. 

Whether the plan decides to incur a lower crediting rate with a new stable value fund or have the participants pay a higher recordkeeping fee to avoid the MVA, plan fiduciaries should consider the impact of both options and make a determination about which option is in the best interest of their participants. 

 

Concluding Thoughts 

Stable value funds have successfully provided participants with bond-like interest rates and principal protection for decades. They are a common holding of 401(k) plans, including many larger plans. 

Plan fiduciaries may worry that the imposition of an MVA when the investment is surrendered by the plan could result in liability. As is often the case for fiduciary responsibility, the requirement is that the fiduciaries engage in a prudent process to make a decision that is in the best interest of their participants. Losses can occur due to market fluctuations of investments, interest rate changes, and so on. That can happen with virtually all investments. However, that does not, in and of itself, constitute a fiduciary breach. Instead, fiduciaries are expected to engage in prudent processes to make informed and reasoned decisions.