By: Randy Myers
In the wake of the financial crisis, some stable value products popular decades ago are coming back into vogue. Insurance company–issued guaranteed investment contracts, or GICs, as well as a variety of similar guaranteed products, were at the height of their popularity through the 1980s. The guaran- tees provided by GICs were backed by the full faith and credit of the insurance company. And, in turn, the insurer invested contract proceeds in its own General Account. The insurance company owned the underlying General Account investments, and any returns from those investments accrued to the benefit of the insurance company while it typically paid fixed interest rates to contract holders.
Following the 1991 collapse of Executive Life Insurance Company, which had been a big issuer of GICs, the insurance industry began to offer “Separate Account GIC” (SAGIC) products as an alternative to traditional GICs. In SAGICs, the contract deposits were invested in investment pools separate and distinct from the insurer’s General Account. Typically, the SAGIC investor received, over time, the returns generated in the insurer’s separate account, subject to performance and liquidity guaran- tees from the insurer. This product essentially unbundled the investment management and insurance guarantee functions of the traditional GIC, and made them available as a package – but viewed separately – to investors.
In the SAGIC products, the insurance company separate account still held title to the underlying product investments, while returns from those investments eventually accrued to investors rather than to the insurance company.
Also in the 1990s, the unbundling concept of SAGICs got extended even further. This time, the evolving product design pro- vided that the underlying assets are owned by the plan/trust rather than by the insurance company (in the General Account for GICs, or in the separate account for SAGICs). This new product had an insurance guarantee function provided by a contract issuer similar to that provided by the GIC or SAGIC issuer. The original issuers of these new products were banks, although eventually insurance companies began issuing similar contracts as well. Originally, this product involved placing a single bond –owned by the plan/trust – and attaching the new contract to that bond. Typically, that bond was held to maturity and was replaced by a new bond at that point. This new product has been called a variety of trade names, but a common one is “Synthetic GIC,” reflecting that it functionally works much like the traditional GIC. The contract itself is often referred to as a “wrap contract,” as it “wraps” around underlying investments.
The essential advantages of SAGICs and Synthetic GICs were two-fold: If the guarantor failed,the plan would still own the underlying investments (separate account units for SAGICs, or bonds for Synthetic GICs); they also give more control over the management of the underlying assets. Plan sponsors and stable value managers began to migrate to synthetic GICs, which were viewed as less risky.
In the 2000s, industry product design began shifting again, this time to include not just individual bonds inside Synthetic GICs but also use of fixed income collective trust funds as the underlying con- tract investments. The use of fixed income collective trust funds instead of individual bonds pro- vided greater degrees of asset diversification for plans of all sizes. This practice also provided vehicles for use of outside sub- advisors for style diversification. As Synthetic GICs took hold as a dominant product design, SAGIC growth slowed significantly.
Throughout stable value’s his- tory, there have been both single- plan stable value accounts and pooled stable value accounts. In pooled stable value accounts, many smaller plans can participant to get the benefits of diversification. All of the investment products noted above (GICs, SAG- ICS, Synthetic GICs) have been used in single-plan and pooled stable value account management
The recent financial crisis never touched the stable value industry the way the Executive Life debacle did. Indeed, stable value funds continued to generate steady, positive returns throughout the latest period of market turmoil. Still, the crisis prompted many in the stable value industry to reassess the risks associated with their products. In this environment, GICs, and especially separate account GICs, have begun to find new favor.
“We’ve had a sea change,” Stephen LeLaurin, senior client portfolio manager for INVESCO Advisors, told participants at the 2011 SVIA Spring Seminar. “We’re coming back to where things were many years ago.”
MetLife is one insurance company that never left the separate account GIC business, and it has been a beneficiary of the product’s revival. Warren Howe, managing sales director for the company, presented data at the Spring Seminar indicating that in 2006, their SAGIC product (called MetManagedGIC) accounted for a little less than half its $20 billion- plus in stable value business. By 2010, the separate account GIC business had more than doubled to over $20 billion and now accounted for about two-thirds of MetLife’s total stable value business.
Other facets of the stable value business also show signs of returning to the industry’s roots, LeLaurin and other industry executives told Seminar participants. Wrap fees, for example, which had fallen precipitously over the past couple of decades, are climbing higher again, noted Karl Tourville, managing partner at Galliard Capital Management. Also, he said, commingled or pooled funds have been shortening the duration of their underlying fixed income portfolios.
“Historically, durations were about 2.8 years,” he said. “They’re now averaging about
2.5. We think they could go down to 2.2 years. That, incidentally, was the duration of collective funds in the mid-to-late 1980s, when we used to run five-year laddered GIC funds.”
Tourville noted that pooled funds remain popular among smaller retirement plans. “Pooled funds started in the early 1980s and two decades ago might have had $20 billion in assets,” he said. “Today there is probably at least
$125 billion and perhaps more than $150 billion in collective pooled funds. We’re seeing, in some ways, more demand for them than ever.”
Meeting that demand has become a challenge, however, as some wrap issuers have exited the wrap business or cut back their appetite for it in the wake of the financial crisis. While a few new players have entered the market recently, industry insiders say still more capacity is needed.
Robert Whiteford, managing director in the Pension/Insurance Derivatives Products Group at Bank of America, noted that wrap issuers historically have liked the pooled fund business, primarily for the diversification benefits it provided. He also cited the presence of “tens or hundreds of thou- sands of plan participants in a single fund making individual decisions,” often diversified by company sector and geography.
“These were all good things,” Whiteford said. “In fact, we traditionally viewed pools as less risky than separate accounts.”
But that view, too, has evolved. During the financial crisis, Whiteford said, wrap issuers dis- covered that there was greater “concentration risk” in pooled funds than they had previously recognized. Many pooled funds, he said, had a few large retirement plans in them that could decide on short notice to exit the funds, typically over 12 months. Mass withdrawals can be difficult for funds to manage efficiently, especially if they occur when the market value of a fund’s assets is below contract value. In that situation, the remaining pooled fund must bear the financial consequences of paying contract value to departing plans when market value is lower. In the extreme scenario of an entire pooled fund winding down through plan withdrawals when market is less than book, wrap issuers could be on the hook to make up the difference.
Whiteford noted that investment performance among pooled funds varied significantly during the crisis as well, which prompted some retirement plans to shift money from one fund to another more than had been common in the past. In some cases, they acted on the advice of consultants. “We saw transfers of assets from one manager to another in a way we never saw before,” Whiteford said. While insisting that wrap
providers recognize the social benefits of pooled funds, Whiteford also exhorted those funds to take measures to encourage new wrap capacity. They can do that, he said, by ensuring greater plan sponsor diversification in their funds and by continuing to pro- duce safe, steady returns. “I think in the past the mantra, too much, was yield,” he said. “Now it should be safety. This is a safety product, and that is what people should focus on first.”
LeLaurin added that a vibrant pooled fund business is critical to the stable value industry itself.
Despite the fact that most of the managed stable value assets in the industry is held in single-plan
accounts, he noted that the over- whelming preponderance of retirement plans in the United States—perhaps as many as two- thirds—use pooled funds to offer stable value to their participants. Smaller plans are most heavily represented in that group.
“If we don’t have a vibrant pooled fund environment and community, then we’re not serving the vast bulk of the plans in the United States,” LeLaurin said. “In fact, some people would argue that without pooled funds, the stable value industry can’t exist. It’s not likely that regulators would be happy about allowing stable value to hang around just for large plans.”