Focusing on Stable Value Pooled Funds: Wither the 12-Month Put?

By Randy Myers

Would changing one of the most common features of pooled stable value funds help bring more wrap capacity to the stable value marketplace?

The feature in question is the 12-month notice that retirement plan sponsors must typically give to a pooled fund if they want to exit the fund and no longer offer it to their plan participants. The significance of the feature is rooted in the basic promise that stable value funds offer to participants, which is that, except under clearly defined and exceptional circumstances, they will always be able to execute transactions in their stable value fund, including withdrawals, at contract value. Contract value represents their accumulated interest plus principal.

Different types of stable value funds have different exit requirements. In the case of a segregated account stable value fund built for a specific sponsor, the fund is wound down over a period of time that matches the duration of its underlying investment portfolio. That can take two or three years.

Most pooled funds, by contrast, simply require that plan sponsors give 12 months notice before exiting a fund. This “12-month put” is designed to provide for an orderly withdrawal from the fund and to protect the fund’s remaining plans, plan participants, and wrap issuers. All of them could be negatively impacted by an abrupt and unplanned liquidation of fund assets, especially when the fund’s market-value-to-contract-value ratio is below 100 percent. That MV-to-CV ratio is always fluid, but when it is less than 100 percent, wrap issuers can be required to make up the difference between market and contract value for exiting plan participants. Fund managers, plan sponsors, and wrap issuers all seek to avoid invoking a wrap contract, though, since doing so can raise future costs for all parties.

In the wake of the recent credit crisis, some wrap issuers are no longer convinced that a 12-month put is adequate in an extreme, “run-on-the-market” scenario. Lengthening the term to as much as 18, 24, or even 36 months would minimize their risk, they argue, and perhaps bring more, much-needed capacity to their industry.

The follow-up question, of course, is this: Would plan sponsors be willing to accept such an extension?

Participants in a panel discussion at the 2011 SVIA Fall Forum couldn’t reach a clear consensus on either question. Anthony Luna, a vice president and stable value portfolio manager for T. Rowe Price Associates, suggested that a 12-month put is probably adequate for prudently managed, well-diversified funds. He also argued that prudent fund management should be a bigger concern than plan exit terms. By contrast, William McCloskey, a vice president in the Stable Value Markets Group at Prudential Retirement and head of its wrap and traditional GIC businesses, said that since longer put periods could mitigate some of the risk issuers face in pooled funds, it might allow them to underwrite more business.

Such diverging opinions were reflected in a recent poll, the panelists observed, in which 10 of 12 wrap issuers said a 12-month put does not provide adequate protection against “run-on-the-bank” scenarios, while five of 17 stable value managers said it does. Similarly, 11 of the 12 issuers said longer put terms would bring more wrap capacity to the market, but only five of the 17 managers agreed.

Luna warned that if longer put terms weren’t accompanied by fee reductions, better contract terms, or more wrap capacity, plan sponsors would almost certainly oppose them. “If this is just a pure give, it’s just not going to work for plan fiduciaries,” he said.

A plan sponsor in the audience commented that sponsors would likely view longer put terms as a negative. “Why would we want to go with something that has a higher put level?” the sponsor asked. “People already don’t like the 12-month put. Try to explain to plan trustees that we can’t get out of a fund because we have a 36-month put.”

Bradie Barr, senior vice president, client management, for wrap issuer AEGON, pointed out that plan sponsors who use segregated rather than pooled stable value funds already have longer exit requirements.

Both wrap issuers and stable value managers surveyed on the issue agreed that two other risk-mitigation strategies would likely be more palatable to plan sponsors as a means to increase capacity. They are: shortening the duration of stable value asset portfolios and requiring higher cash buffers in stable value funds.