Wednesday, August 22, 2012

How Stable is your Stable Value Fund?

Several weeks ago, it was in the news that a major financial institution was allegedly the subject of a Department of Labor (DOL) Investigation surrounding its' Stable Value offering and the potential inappropriate nature of the holdings of that fund.  Linked below.

While the news article alleged the investigation, it specified that the fund in question had between 4% and 13% of its underlying holdings in private-mortgage debt that was rated and also underwritten by that same firm.  To those operating in a fiduciary environment, this shouts conflict of interest (i.e. prohibited transaction) and is a potential violation of ERISA.  If the DOL were to find that the firm violated ERISA with respect to the investments within the fund it could have a domino effect.  The plan sponsors who welcomed this fund into their 401(k) plans, and the advisers who recommended it, could be liable for improper due diligence and a breach of their fiduciary duty.

How does a plan sponsor protect itself when considering (or being sold) an opaque investment structure such as a Fixed Account or GIC?   
A stable value fund's stability cannot simply be assumed.  Plan trustees, and their financial advisers, have a fiduciary responsibility to conduct thorough due diligence when evaluating a plan's stable value option. This is easier said than done.  Proper due diligence isn't simply a matter of reviewing underlying holdings, manager pedigree, or declared interest rates. It is far more complex. Is the provider who is guaranteeing the stable value option financially strong? Are rates consistent? Are costs/fees reasonable? Are contract limitations onerous?

As a discretionary trustee for our clients, my firm's Trust Investment Committee (TIC) has implemented several decisions and due diligence process' to help ensure that the Stable Value investments offered to our clients are transparent regarding its holdings and its fees.  Some of the items we look at are:

  • Insurer Quality - Annually, TIC conducts a review of the fund.  Part of the review is a detailed investigation of the Insurer.  Of particular focus, is the claim's paying ability, which backs the guaranteed rate that makes up the difference between Market and Guaranteed Values.  We also monitor the "spread" between the Market Value and Book Value on a weekly basis, and customarily review their capacity to take on added risk, defined as more assets in our fund or funds they are insuring.
  • Holdings - Annually, the Investment Committee interviews each Portfolio Manager about their holdings.  During this interview process they are reviewing factors such as what the holdings are, the credit quality and duration against their benchmarks.
  • Structure - Structure of this asset class is very important.  We prefer the structure of a Common Collective Trust.  They are required to be audited annually at the request of the Office of the Controller of Currency of the U.S. Treasury.  The holdings are examined separately by an outside independent auditor.  As a prudent measure, the committee opted for a Separate Account structure that allows us to isolate the assets from the creditors of the Insurer.  Thus, our clients are protected against instability and the fund is potentially portable between insurers, under a "worst case" scenario.
  • Fees - Most fixed accounts/GIC's are opaque when it comes to fees.  Typically, they are embedded in the difference between the fund's gross yield (what the provider earns), and the fund's net yield (what the client receives).  These funds often quote an expense ratio of 0%, and the yield is expressed as a percentage as well.  Given the Collective Trust structure, we can identify precisely how much cost is associated with each manager and the fund as a whole.  This amount is then expressed the same way as a mutual fund cost would be shown.  

To answer the original question, one way that a Plan Sponsor can protect itself is to hire a professional fiduciary that has built a solid and prudent due diligence process that includes a thorough investigation of the Stable Value/Fixed Account offering.

Monday, August 20, 2012

The Secret to Retirement - Working Longer, or maybe not?

In the Retirement Plan industry there is a lot of discussion surrounding retirement income adequacy.  Everyone's trying to work out at what age we can all retire at and what if there's a savings shortfall (there is one in the aggregate!!!) for an individual person.  How do we adjust for it, etc.  The answer that lies in most of these retirement readiness planning services is to reduce that person's liability.  Plainly, this means to shorten the amount of time that a person needs to finance. 

So how do we shorten that time at the end of our lives that we need to finance? 

One very morbid way would be to die younger....but let's say that this won't be a voluntary option for most of us.  Living longer seems to be the goal for most of us and the actuarial life expectancy tables all confirm that we, in the U.S., are in fact living longer.  At present, the average American (male or female) will live well into their 80's or 90's.  Most retirement calculators are static in the retirement age at around 65 or 66. 

The other way would be to retire later.  Aha!  This is the answer to the question.  I didn't save enough when I was young so I can't afford to retire at 65, let's find a point in time where I can afford it if I save like crazy from now on.  This delaying of retirement can be powerful in helping the math work out.  However, there are assumptions being made here, namely that an employer will actually KEEP you in your mid-late 60's, when they can hire someone younger, cheaper and with perhaps more and better skills. 

Recently, I read this article in Kiplinger's, Rethinking Retirement by Eleanor Laise where she addresses this problem specifically.

What if 'Working Longer' isn't an option?  She references a recent Employee Benefit Research Institute (EBRI) study where more than 1 out of 4 workers now plan to retire when they reach 70, up from 16% from five years ago.  Unfortunately, this plan to work longer may not work out.  In the same survey, of the retirees surveyed, 50% of them stated that they retired younger than they expected and 92% of those cited a negative circumstance for the reason why.  I.E. it may not be a choice for us to work longer.  Some examples of negative circumstances are company downsizing or poor health/disability. 

So, here's the's the same one that we always say and this just illustrates it yet again.  The only sure thing to fight against our own elderly poverty is to save.  Very simple, just save and make the lifestyle adjustment necessary to accommodate a policy of savings.  Thank you Eleanor for a good article highlighting a true societal problem.