Why Governmental 457 Plans Like Stable Value
By Randy Myers
Stable value funds have long been popular with so-called "457" plans--supplemental retirement savings plans that function much like 401(k) plans but are marketed mostly to government employees. Still, there are steps the stable value industry could take to preserve its favored position in that marketplace, says Maryland Assistant Attorney General John Barry, counsel for Maryland's supplemental retirement plans and past president of the National Association of Governmental Deferred Compensation Administrators.
The NAGDCA represents 186 state and local retirement plans with about $82 billion in assets and 1.5 million plan participants. Addressing the 2010 SVIA Fall Forum in Washington, D.C., Barry noted that most of those plans offer stable value funds as an investment option. In fact, he said, three-quarters have at least 30 percent of their participants invested to some degree in stable value funds.
In Maryland, Barry noted, public plan participants have nearly 35 percent of their $2.3 billion of their plan assets in stable value funds. By contrast, participants in the 401(k) plans tracked by the Aon Hewitt 401(k) Index had only about 25 percent of their assets in stable value as of October 2010.
Barry theorized that stable value funds are popular with government workers because they may have less of a "high-roller" mentality than their corporate counterparts. Still, he noted, their current allocations to stable value are down substantially from the early 1990s, when they had about 70 percent of their savings in that asset class.
Barry also observed that government workers tend to leave their money in their retirement savings plans longer than private workers do, in part because they aren't allowed to take it out until they stop working and also because they can typically rely on receiving pension income, too. That can minimize the need to tap into savings.
Government plan administrators, Barry said, tend to favor the use of multiple entities to manage their stable value assets, and they prefer to have control over plan assets. "They view diversity and control as protection against catastrophic failure," he said. Accordingly, he said, state plans tend to favor synthetic GICs in which fund assets are owned by the plan, managed by an investment manager, and backed by a wrap issuer guaranteeing the fund's book value. However, he said, local-government plans with less than $100 million in assets tend to use bundled insurance products.
As enchanted as they are with stable value funds, sponsors of 457 plans are taking a much closer look at their stable value investments today than they were prior to the financial crisis of 2008, Barry said. They are concerned not only about recent fee increases for stable value wrap contracts but also about capacity constraints among wrap providers now that several firms have exited the business. Also, he said, they are concerned about the contract modifications that some wrap providers have been pushing to minimize their own risks.
Finally, Barry said, plan sponsors are concerned that with fees going up and interest rates low, crediting rates offered by stable value funds may be squeezed in the years ahead.
To deal with these concerns, Barry suggested that stable value managers and wrap providers hold fee discussions with plan sponsors. During those discussions, he said, they should review the risk factors they're insuring against and highlight the safeguards built into stable value products. For example, he noted, stable value funds benefit from the risk management capabilities of not only their investment managers but also their wrap providers.
He also suggested that investment managers increase the frequency with which they report to plan sponsors on the assets held in their portfolios, and on the transactions made within those portfolios. "I'm convinced this business can and should survive, notwithstanding the coming squeeze created by increased fees and lower rates," he said. "But that squeeze is going to produce a lot of ferment, and you will want to be able to justify what you are doing. That includes providing contract education for plan trustees and doing increased monitoring to ensure that you are following your own investment policies."
Finally, Barry suggested that the stable value industry create "certified participant-communication materials" that plan sponsors can use to communicate with their participants about their stable value investments. That would be particularly useful, he said, since many wrap providers now include provisions in their contracts that spell out how sponsors may communicate with participants on certain topics.