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How Adding Advice to a 401(k) Plan Can Impact Stable Value Contracts

Amid the ongoing debate over whether it is appropriate and effective to offer online investment advice to participants in defined contribution plans, a subtle technical factor sometimes gets overlooked: the impact that offering advice has on the benefit responsive contracts in stable value funds.

These contracts are, in effect, insurance policies that ensure that shareholders of a stable value fund can withdraw their money at book value, regardless of the market value of the underlying assets in the fund. In most defined contribution plans, the addition of an advice service qualifies as a plan change requiring notification to the issuer of the stable value wrap contract. If the wrap provider concludes that the change could increase the risk of providing the contract—perhaps by encouraging plan participants to withdraw substantial amounts of money from the stable value fund—it could take any number of steps potentially detrimental to the stable value fund and its shareholders. Speaking at the Stable Value Investment Association 2000 National Forum, Steve LeLaurin, senior account manager with stable value manager PRIMCO Capital Management, said those steps could include canceling the contract or assessing higher fees.

Wrap providers are leery of advice services because they are new, and, as a consequence, there is little historical record of their impact on cash flows within defined contribution plans. Also, said Henry Kao, a director with wrap provider UBS AG, "some advice models provide misleading recommendations to stable value funds because they do not capture the basic characteristics of stable value (in their asset allocation models)."

Thus far, says Kao, his firm has signed off on only one advice model (he didn't specify which one). In some cases, he says, UBS has terminated some of its wrap contracts when it didn't agree with, or understand, the advice model being introduced, or when it didn't feel that the existing contract terms sufficiently insulated it from the potential changes that could be triggered in the plan.

Aruna Hobbs, director of institutional products for Aegon Institutional Markets, says her firm has been asked to review the introduction of advice services at a handful of the plans for which it provides stable value wrap contracts, and in each case has okayed the move. Speaking after the National Forum, Hobbs said that Aegon hasn't given blanket approval to any advice service. Instead, her firm is reviewing each plan proposing the change on a case-by-case basis to determine whether any action on its part is necessary.

"We look at this along with the rest of our standard underwriting parameters and take into consideration a broad range of factors, such as the historical volatility of the plan's cash flows, the manager's record managing liquidity, and presence or absence of a buffer position ahead of us that would protect us if a lot of participants suddenly wanted to pull their money out of the stable value fund," Hobbs said.

Thus far, observed Hobbs, Aegon has not had any cases in which it concluded that the addition of an investment advice program would materially escalate its risk. Among the advice providers that Aegon has approved on a case-by-case basis, she said, are Financial Engines and mPower, as well as a number of in-house advice services.

Now that advice services are becoming more commonplace, Hobbs added, Aegon is building provisions for them into its underwriting discipline. In the meantime, Kao recommends that the stable value community continue to maintain a dialogue with advice providers on this issue. He also suggests that plan sponsors make the treatment of stable value funds a search criteria when selecting advice providers for their defined contribution plans.

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