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Taking Stable Value Global

Japan would seem like an ideal candidate for stable value products. Its $2 trillion pension market is the largest outside the U.S., and its rapidly aging population has a conservative investment culture, said Sandy Chotai, global asset consultant with Towers Perrin, at the SVIA 1999 National Forum in Washington, D.C. Next year, new provisions in Japan's tax code will allow employers to introduce defined contribution plans patterned on the 401(k) model in the U.S. And finally, sponsors of new DC plans will be required to offer at least one low-risk investment option featuring a principal guarantee.

Other international opportunities would seem to abound as well. In continental Europe, defined contribution plans are becoming increasingly popular, especially in Switzerland, Denmark, Spain, Italy and France, where, again, investors tend to be conservative, with a risk profile far more suited to investing in stable value than the risk profile of the typical U.S. investor. DC plans are also growing in popularity in Australia. And in Hong Kong, a new DC system is being introduced in 2000 that will require plan sponsors to offer at least one "capital preservation product."

"I think we will see increasing demand for stable value investment options as the DC model takes root around the world," observed Larry Zimpleman, senior vice president, global expansion, for the Principal Financial Group.

Yet the U.S. stable value industry faces considerable hurdles in transferring their products and know-how to the international marketplace. For starters, the very existence of stable value products depends on having the flexibility to account for participant balances at book value-and in Japan, as in most of continental Europe, that flexibility doesn't currently exist, said Paul J. Donahue, director of product development for PRIMCO Capital Management. Getting approval to do it would likely require government sanctions, he said, which in turn would require the patient work of experts, especially in Japan.

Why? Unlike their counterparts in the U.S., Japanese accountants play little role in setting accounting standards. Instead, that responsibility is held by the Business Accounting Deliberation Council, a division of the Ministry of Finance. And when pensions are at issue, the Ministries of Health and Welfare, Industry and Trade, and Labor can also be involved. Combine Japan's cultural preference for consensus and its general conservatism with the possibility of involving multiple government entities to approve accounting changes, and the stable value industry faces significant barriers to innovation in Japan, Donahue said.

Donahue also noted that the yield curve in Japan is highly compressed right now, which suggests that stable value products invested in intermediate-term fixed-income securities-the usual approach in the U.S.-likely would not offer returns sufficient to attract Japanese investors. In addition, he said, the cost of the wrap contracts needed to guarantee principal in Japanese stable value funds is likely to be significantly higher, at least initially, than it is in the U.S., since issuers will need to recover their development costs and because they have no experience base from which to develop a pricing model. Again, this would lessen the appeal of stable value products.

In the U.K., the stable value industry also finds itself confronted with a compressed yield curve, but a less restrictive regulatory environment. British accountants have considerable flexibility, and often look to American best practice where no precedents exist, Donahue said. On the other hand, U.K. investors tend to be much more aggressive than their counterparts in continental Europe, a negative for anybody hoping to market a stable value product there.

Despite these challenges, Donahue - whose own firm has been exploring opportunities in the U.K., Japan and Hong Kong - stressed that stable value products should appeal to many investors outside the U.S., particularly since their risk-reward tradeoff is superior to money market funds and many intermediate-term bond funds as well.

"Pension assets outside the U.S. are growing rapidly, and there is a major shift from defined benefit to defined contribution plans," agreed Chotai. "As participants become more sophisticated, we should see increased investment options in those defined contribution plans, and that should present an opportunity for the stable value industry."

To best take advantage of those opportunities, Donahue suggested that U.S. financial institutions partner with local companies in those international markets. Chotai noted that a number of alliances have already been formed in anticipation of tackling the DC market in Japan, including Travelers/Nikko, Prudential/Mitsui, Nippon Life/Putnam, and Sumitomo Life/Templeton.

"Going it alone in establishing stable value options abroad is unlikely to be profitable," Donahue said. "Resident affiliates know the rules of the game, not only economic, which Americans are quick to pick up, but also social. When the required expertise must be purchased for stable value alone, it is likely to come at too high a price. With affiliates, access to expertise at working the regulatory levers is available at little or no direct cost."

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