Understanding Key Drivers of Participant Cash Flows

In a collaborative effort between Valerian Capital Group and the Actuarial Science Department of the University of Lyon, this research offers crucial insights into the driving factors behind participant cash flows for individually managed stable value funds. Analyzing fund-level data from 2000 to 2021, the authors shed light on participant cash flows, drawing from a dataset that encapsulates about 80% of the individually managed stable value plans in the market.

The authors determined that for many of the plans, sticky, non-monotonic cash flows trends dominate. Factors such as participant communications, financial health of the plan sponsor, industry sector, employment policies, employment growth or layoffs, plan demographics, and default options can impact participant cash flow trends, which exhibit regime-changing characteristics.

Among the pivotal observations was the ‘flight-to-safety’ effect exhibited by stable value funds. In turbulent equity market conditions, participants overwhelmingly opt for stable value options, viewing them similarly to traditional safe havens like U.S. government money market funds.

The research delves into the dynamics surrounding the ‘crediting rate deficit’ in comparison to alternative investment rates and reveals that participants often exhibit a delayed or predominantly negligible response to short-term and minor crediting rate deficits. Many 401(k) plans lack direct competitive alternatives, and the presence of the equity wash rule further hampers participants from adjusting their portfolios in reaction to rate deficits. Moreover, participant communications illustrating historical fund performance can lead to delayed participant decision making, with no reaction observed when the crediting rate deficit is within a year or below 1%. It is important to mention that the research data only goes up to 2021, so the potential impact of sustained high inflation rates on stable value cash flows is not addressed.

The study also highlighted cases of mass lapses due to reputational issues. Even though the risk of a reputational mass lapse is plausible, it can be mitigated to some extent with effective communication by the plan sponsors. Additionally, the authors found no significant relationship between market-to-book values and participant cash flows. Nonetheless, a low market-to-book value could be perceived as a vulnerability, potentially elevating reputational risks and the subsequent threat of a mass lapse, even if the actual probability of such herd behavior is minimal.

Beyond these findings, the paper concludes by presenting insightful recommendations for insurers on formulating strategic scenarios to anticipate and understand withdrawal risks within the framework of the wrap contract.

For a comprehensive exploration of the research, including detailed methodologies and further discussions, please refer to the full paper.