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A Year in the Spotlight: Implementing FASB's Accounting Standard One Year Later

Last year will clearly be remembered as an important year for stable value funds. We saw the financial markets and 401(k) investments rocked by increased volatility. Stable value funds were a refuge in this storm. They performed as expected by delivering steady, predictable rates of return with principal stability.

It was also the first year that stable value fund financial statements had to use the Financial Accounting Standards Board's (FASB) stable value accounting standard, FSP AAG INV-1 and SOP 94-4-1. As you may recall, the standard was important to stable value because it reaffirmed the use of contract value, the accounting reference for stable value funds used by corporate defined contribution plans.¹

The FSP required a new presentation standard for stable value funds. Under the FSP's presentation, GICs and wraps must be part of the schedule of investments and reconciled to the corresponding line items in the financial statement. For the schedule of investments, the fair value of each investment contract must be shown along with the underlying investment held by the fund, the wrapped portfolio of assets. An adjustment from fair to contract value is required for each fully benefit-responsive contract. Lastly, the credit rating for the issue or wrap provider must be shown.

Since wrap contracts are non-transferrable, determining the fair market value is not as straightforward as with a bond or stock. SVIA surveyed stable value managers to determine what valuation methodologies were used and accepted in audited stable value fund financial statements. Nineteen stable value managers participated in the December 2007 survey. The survey found that three variations of replacement cost methodology were used. Replacement-cost valuation is the cost of replacing the contract today, then present-valuing this cost over the duration of the contract or the termination notice period of the contract, if longer.

Seventy-nine percent of respondents compared replacement cost to the actual wrap fee at year-end. If they were the same, respondents reported the value of the wrap contract at zero. If there was a difference between the replacement cost and the actual wrap fee at year-end, the value of the wrap is worth the present value of the future cash flows of fee payment difference between the replacement cost and the actual fee.

Sixteen percent of respondents present-valued the future cash flows of fee payments using replacement cost at year-end. The remaining five percent present-valued the future cash flows of fee payments at the beginning of the year using actual wrap fees at the beginning of the year. Then they present-valued future cash flows of fee payments using replacement cost wrap fees at end of year. The difference between the end-of-the-year present value and beginning-of-the-year present value is the value of the wrap contract. If negative, the difference was reported as a liability.

Stable value managers reported that plan sponsors and auditors had turned to them for advice on wrap-valuation methodologies. The majority (75 percent) also found inconsistent use of wrap-valuation methodology among and within the various audit firms. In fact, one manager commented, "We are investment managers, not accountants. It seems odd to provide advice to accountants."

In fact, only 25 percent of stable value managers reported that the wrap-valuation process went smoothly during the first year of the standard. Clearly, stable value managers and the accounting community are looking for improvement in future years. Now that the accounting community has embraced three variations for determining the replacement cost, this process should be smoother in the future. Accounting's goal of consistent and comparable financial information may cause further consolidation of replacement cost methodologies in the years to come.

¹ Please see past issues of Stable Times for more information about the FSP and stable value funds.

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