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Home > Library > Stable Times > Volume 5, Issue 2

The quarterly publication of the Stable Value Investment Association
Second Quarter 2001 • Volume 5 Issue 2

Mergers and Acquisitions: A Stable Value Guide

By Randy Myers

In the hurly-burly of merger negotiations, planning for the deal's impact on the company 401(k) plan-and vice versa-seldom makes it onto management's top 10 list of things to do. While that's understandable, it can also be unfortunate, since poor planning can leave companies saddled with unexpected costs and a retirement plan that doesn't perform as well as it could.

Coordinating the merger of two defined contribution plans isn't rocket science, but it isn't child's play, either. In most cases, it will require the input of legal, treasury and human resources executives from both companies, as well each plan's consultants, custodians, trustees and investment managers.

Let's use stable value funds as an example. "Merging stable value options can be a little more complicated than merging other investment options," says Greg Wilensky, a vice president and portfolio manager for Alliance Capital in New York. "But if what you're getting is the participants' right to an extra 150 basis points of return year in and year out, on average, versus a money market fund, then it's worth the effort."

One New Company … But Two 401(k) Plans

After the merger or acquisition, the surviving entity has to decide if the 401(k) plans will be kept separate (a costly option in the long term) or merged. If they will be merged, a number of critical decisions must made and some complex operational issues address:

Select trustees, custodians, and record keepers.
Select the surviving investment options.
Select investment providers/managers .
Transferring securities or liquidate positions as appropriate.
Develop a plan for mapping investments from terminated options.
Communicate new investment line up.
Conversion of recordkeeping information.

With respect to many of these issues, a stable value fund is just like the other investment options. However, stable value funds differ from other 401(k) investment options principally by virtue of their book-value guarantees. These guarantees, issued by banks and insurance companies, provide that even if the market value of the stable value fund's assets have fallen below book value, plan participants can still make withdrawals from it at book value. This insurance promise is written into the guaranteed investment contracts (GICs) held by many stable value funds and into the "wrap contracts" that insure their bond portfolios.

Because a merger or comparably significant corporate restructuring can dramatically alter the risk profile for a stable value fund, issuers of book-value guarantees usually specify that such events require their prior approval if the guarantees are going to remain in effect. The issuers want to gauge how the fund's structure, liquidity and future liabilities will be impacted.

Planning Ahead

To make the merger of one or more stable value funds as smooth as possible, industry experts say sponsors should first take stock of their plans and their stable value funds. That process begins by inventorying all assets and reviewing all plan documents to be certain that they are up to date, in order and understood. Among the important questions to be answered: who are the parties to any contracts covering investment held by the stable value fund? They could include the wrap/GIC issuer, the plan sponsor, the plan trustee and/or the "qualified professional asset manager, or "QPAM," managing the fund's assets.

Having verified all of the contractual terms, sponsors have 3 basic choices:

Keep the plans separate permanently.
Merge the plans including the stable value funds.
Allow for transition period when two plans are maintained separately but brought into alignment so they can be merged in the future.

In making and implementing these decisions, says Al Turco, a partner in the Hartford, Connecticut, law firm of Pepe & Hazard, plan sponsors will typically need to do three things:

Communicate with their stable value managers, wrap/GIC issuers and plan participants about the upcoming changes.
Anticipate and minimize the impact of any negative cash flow in the stable value fund that might be created by participant withdrawals (an unlikely but not impossible outcome).
Restructure the investment portfolios underlying the stable value funds, and/or their wrap contracts, as needed, to fund participant withdrawals and satisfy the issuers of the book-value guarantees.

Communication

As soon as plan sponsors know that a merger or similarly significant event is planned, they should alert the vendors servicing their stable value fund. If an external stable value manager is used, they typically handle all the communications and renegotiations (if necessary) with the money manager and GIC/wrapper issuers. For internally managed plans, the plan sponsor should contact all the parties involved with the fund. Because the vendors are likely to have worked through similar events with other clients, they can be immensely helpful in determining the most effective ways to handle the merger/acquisition.

But they can only do it if they are given adequate notice. As noted earlier, an M&A transaction typically requires the consent of the issuer if the plan does not want to risk their stable value fund's book-value guarantee. Yet Marla Kreindler, a partner in the Chicago law firm of Katten Muchin Zavis and chair of its employee benefits department, says she has represented issuers who didn't receive notification letters from plan sponsors until months after they went through a merger. "Unfortunately," Kreindler says, "we have to reply with a letter that says, 'Thanks for letting us know, but we can't promise you that we're going to consent to it.'" If the issuer won't consent, of course, it could put the book value protection and book-value accounting treatment of the stable value fund in jeopardy.

Once a plan sponsor does know what will happen to its 401(k) plan and stable value fund, it should share that information with plan participants. They must be told how their investment options might change, how and when they can revise their investment elections and attend to other administrative details, and what rights and responsibilities they have if their employment, or their plan itself, is terminated.

If only one company has a stable value investment option in its 401(k) plan-and the decision is to maintain a stable value investment option-the communication effort may have to include explaining why stable value funds are better fixed-income investment options than money market funds or bond funds. If a money market and/or bond fund are being kept, an equity wash will probably have to be put in place and communicated to employees. If such option (s) are being eliminated with the investment balances being transferred to the stable value option, this also needs to be communicated.

Managing Cash Flow

In some circumstances, the combination of two plans could cause significant cash flow activity for the stable value fund. Large inflows might occur if a stable value option is being added for a group of participants. These inflows would need to be invested by the fund manager.

Outflows could occur if the lineup of investment options was significantly expanded or if significant layoffs accompany the merger or acquisitions and the departing participants chose to withdrawal their money from the plan. If interest rates have been rising causing the market value of assets to be below the book value of the fund, the remaining investors in the stable value fund may earn diminished returns going forward.

Even when the combination does not result in significant cash flow activity, merging two stable value funds can affect the future returns earned by participants. Suppose, for example, that two funds of equal size are being merged, one with a crediting rate of 6% and the other 7%. Simply merging the two would create a blended rate of 6.5%. That would be good for the participants in the fund being terminated but bad for those in the surviving fund.

In mergers, acquisitions or divestitures where the stable value fund is not being terminated but only shrunk, generating cash to meet withdrawals may compromise the fund's future performance. "You can't just rush to liquidate certain assets because they are liquid and be done with it," says Turco. "You need to examine the landscape and determine whether asset liquidation might be less desirable than some of the other techniques that are available."

Investment managers can employ several strategies to help plan sponsors deal with these challenges:

Bolster the fund's cash buffer. Given adequate notice, the manager of a stable value fund can begin to build up its cash buffer in an orderly fashion by not investing any deposits or transfers into the stable value fund, shortening the duration of the underlying bond portfolio, or, in the case of a GIC portfolio, by putting the proceeds of any maturing contracts into cash equivalents rather than rolling them over into new contracts. This will make more cash available to handle anticipated withdrawals.
Access the corridor. Most stable value investments contain a so-called corridor provision specifying that they will permit some percentage of withdrawals from corporate events at book value-perhaps as much as 20%. Plan sponsors should take advantage of this feature if the contract provides it, recognizing, though, that the corridor clause may have a cumulative payout limit.
Tap into the advance benefit payment features of wrap contracts. Wrap contracts often allow the sponsor to take a certain amount of the contract's value as an advance that typically must be paid back (plus interest) when cash flow into the stable value fund next turns positive again. This may provide beneficial liquidity and reduce transaction costs.
Negotiate/renegotiate. Most money managers, wrap providers and GIC issuers will do their best to help plan sponsors through a merger or acquisition. "They want to work with you," says Kreindler. So it can pay to negotiate and renegotiate the terms of your relationship. For example, a GIC issuer whose contract calls for certain participant contributions to be deposited within, say, a month, may agree to extend that deposit window. This will allow the sponsor to use incoming cash to cover withdrawals, then make up the deposit at a later date. If a stable value fund is being merged into a pooled stable value fund, the latter's manager may be willing to take the assets of the other fund as an in-kind contribution. This will allow the plan sponsor to avoid the cost of liquidating assets. Stable value experts say they've also seen banks managing synthetic GIC portfolios agree to buy traditional GICs from plan sponsor clients involved in mergers, and have also seen plan sponsors sell GICs in the secondary market rather than liquidate them and incur penalties. "There are a lot of alternatives, but you won't know if you can do them unless you ask," Kreindler says.

Of course, some or all of these strategies are likely to have an effect on current and expected stable value fund crediting rates. The manager will have to take this effect into account in deciding which strategies are in the best interests of the participants of the stable value fund.

Conclusions

By far the worst option for plan sponsors, says Kreindler, is to do no planning at all. "To me, the greatest cost associated with failing to think about these issues during a merger or acquisition is getting stuck with programs that don't make a lot of sense," she says. "Instead of getting a nicely run, logical stable value fund, you end up with some kind of mutant."

Paul Reisz, a vice president and stable value product specialist with money manager Pacific Investment Management Company in Newport Beach, California, says many plan sponsors implement a global wrap structure to streamline management of their stable value funds, a benefit that also pays dividends during merger, acquisition and divestiture activities. Under such a structure, the fund works with multiple wrap issuers and multiple money managers, but each issuer's wrap contract covers a percentage of the total assets in the fund rather than one manager's specific securities.

"A global wrap structure enables plan sponsors to plan ahead for merger activity by making it easier to strategically restructure their stable value fund," Reisz says. "It gives sponsors greater flexibility to modify the characteristics of the underlying portfolio to meet the performance needs of current participants and to minimize the impact of potential outflows."

"Plan sponsors should really look at these corporate events as an opportunity rather than an obligation," agrees Reisz. "It's an opportunity to reevaluate their 401(k) plan and make sure they're offering the best possible investment options, including a stable value fund with the best benefit-responsive coverage, equitable fees, competitive performance and a flexible structure."

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