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Stable Value Managers Embrace New Guidelines Affirming Book Value Accounting

The stable value industry had something to celebrate other than the New Year this past December. The Financial Accounting Standards Board issued formal guidance on accounting for stable value funds: FSP AAG INV-a, Reporting of Fully Benefit-Responsive Investment Contracts Held by Certain Investment Companies Subject to the AICPA Investment Company Guide on December 29,2009.

The FSP clarified that contract value-stable value accounting-is appropriate as long as, among other things, all the investment contracts in a stable value fund meet certain conditions qualifying them as "fully benefit responsive." The FSP also requires that the investment contracts be reported at market value. Lastly, managers of stable value commingled funds, which are essentially pools of assets from two or more defined contribution plans, must conduct and report two sensitivity analyses showing how the pools react to changes in interest rates and changes in withdrawals. The new guidelines take effect for annual financial statements covering periods ending after December 15, 2006.

Benefit Responsiveness
The FSP specifies that an investment contract is considered fully benefit responsive if it meets several specific criteria. Some of these criteria are straightforward. For example, permitted participant-initiated transactions, such as withdrawals, must be allowed at contract value. Other criteria introduce new complexity to the accounting and reporting process. For example, the new guidelines say that if an event occurs which makes it no longer probable that participants can access their stable value fund at contract value-maybe the contract issuer or wrap provider experiences a significant decline in creditworthiness-then the contract is no longer deemed fully benefit-responsive. The FSP reinforces this point by adding that a contract is only benefit- responsive if it is not probable that any event will happen that would limit the ability of the fund to transact at contract value with the issuer. It cites, by way of example, a bankruptcy filing, merger, or offering of early retirement incentives by the plan sponsor, as well as several other possible scenarios. The directive isn't as clear as it might sound. Speaking in April at the SVIA's 2006 Spring Seminar in Henderson, Nevada, Steve Kolocotronis, Vice President and Associate General Counsel for Fidelity Investments, cautioned that determining whether a particular adverse event makes contract value no longer probable will have to be decided on a case-by-case, facts and circumstances basis. For example, he said, even a decline in an issuer's creditworthiness may not make it probable that a fund would not be able to realize full contract value for an investment contract it had issued.

To provide his audience with some idea of the sorts of contracts that might not meet the new definition for being fully benefit- responsive, Kolocotronis listed four examples. They included contracts that provide no benefit payments prior to the maturity date of the contract, that limit the percentage of benefit payments allowed during a calendar year, that preclude the payment of benefits within a specified period following termination of the contract, or that limit the percentage of a participant's account that can be transferred to another investment option during a calendar year.

Kolocotronis said he can't predict how auditors will deal with such contracts once the new rules take effect or say whether they will require the contracts to be amended or reported at fair value rather than contract value.

Brian Gallagher, National Audit Partner for Big Four accounting firm Deloitte & Touche, advised the SVIA audience that if stable value managers think they might have a problem qualifying any of their contracts as fully benefit-responsive, they should bring it to the attention of their auditor as early as possible. A solution should be worked out, he said, before reporting deadlines pressure the auditor into a decision.

Wrap Valuation
Assigning values to wrap contracts is a thorny issue the SVIA task force is trying to make less so by coming up with a standard valuation method that could be adopted throughout the industry. Although that work is ongoing, James McKay, Director of Stable Capital Management for Ameriprise Financial, said the task force is evaluating three methodologies. One methodology is based on an income approach, a second is based on a market approach, and a third is based on a replacement-cost approach. The income approach would involve using either option-pricing models or Monte Carlo simulations to value wrap contracts, and the task force has found that while more testing needs to be done, the Monte Carlo approach can produce disparate results while using the same assumptions. A market approach would rely on knowing the actual fees paid for wrap contracts, while the replacement-cost approach would look to the current cost to replace a wrap contract. Apart from settling on a methodology, stable value managers may need to convince their wrap providers to help them in assigning values to their wrap contracts. It is a sensitive issue. Some wrap issuers have expressed a reluctance to assign and disclose values for individual wrap contracts, saying they would prefer to value only their entire book of business with an individual manager.

Sensitivity Analyses for Pooled Funds
One of the more intriguing elements of the new accounting guidance is the requirement that stable value managers conduct two separate "sensitivity" analyses for pooled stable value funds. The analyses will have to be done using varying assumptions for market interest rate changes and fund cash flows. Kim McCarrel, a Senior Account Manager with INVESCO's fixed income division, explained that a pooled stable value fund will have to project its crediting rate for four quarters under two different cash flow scenarios and four dramatically different interest rate scenarios. The cash flow analyses assume no cash flows with an immediate withdrawal by participants of 10 percent of the fund's assets. The different interest rate scenarios include a 25 percent increase in current market yields, a 25 percent decrease, a 50 percent increase, and a 50 percent decrease. To help the industry comply with this requirement, the SVIA task force has created a sample disclosure form, including suggested footnotes for explaining the methodology used in creating the sensitivity analyses. It is now soliciting feedback from the accounting community, after which it plans to finalize its recommendations and present them to the SVIA members.

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