More workers move 401(k) savings to stable-fund investments

Stable-value funds are the safest investment option available to 401(k) plan participants, but recent problems at two funds illustrate why sponsors should exercise caution in selecting them, according to observers.

Stable-value funds invest money in a fixed-income portfolio that is protected against volatile interest rates by contracts with banks and insurance companies.

One or more financial institutions provide so-called wraps which guarantee that participants will receive the fund's book value even if its market value falls.

Although very large companies will have their own separately managed investment portfolios, other sponsors' accounts generally are invested in such funds alongside other companies'.

According to the Washington-based Stable Value Investment Association, individuals had about $520 billion invested in stable-value funds through 138,000 defined contribution plans as of the end of last year.

RISING POPULARITY

In recent months, they have become particularly popular because of the stock market turmoil. As of March 31, for instance, stable-value funds accounted for 35.6% of 401(k) plan assets, versus 21% at yearend 2007, said Pam Hess, director of retirement research at Hewitt Associates Inc. in Lincolnshire, Ill.

Concern has been raised, however, because of payments that were less than expected by participants in a Lehman Brothers Holdings Inc. fund and a Chrysler LLC fund, both of which had separately managed accounts.

Other concerns include the quality of investments, the spread be-tween the book and market values and the available capacity for wrappers. But observers maintain that while not risk-free, stable-value funds are the safest investment option in the 401(k) plans that offer them.

A stable-value plan offered by Auburn Hills, Mich.-based Chrysler as part of a supplemental-savings plan paid out 89 cents on the dollar when workers withdrew their investments early this year. In December, a fund managed by Atlanta-based Invesco Ltd. for the bankrupt Lehman paid 1.7% below book value.

Observers said that both situations were unusual.

The Chrysler payout was affected by market volatility and a high number of participants who took a January distribution, the company said in a statement. A spokesman said that the automaker hasn't disclosed how many employees were involved.

The situation with New York-based Lehman's account involved “a very unique set of circumstances” that were specific to that company, an Invesco spokesman said.

Under normal circumstances, matters can be worked out during a bankruptcy reorganization. But in this case, “it was such a quick dissolution of the company” that four of the seven wrap providers that underwrote the credit value of the assets canceled their policies, and “we couldn't get new coverage for that,” the Invesco spokesman said.

That led to the 1.7% write-down for participants who withdrew their assets from the plan. The spokesman noted that for 2008, the plan generated a 2% return.

SOUND OPTIONS

Observers said, however, that stable-value funds remain among the safest investment options.

“I would say they're as safe as your employer is,” said Sheldon Gamzon, a principal with PricewaterhouseCoopers LLP's human resources division in New York. If the business is one that is “getting through this economic crisis … then I don't think you have an issue.”

The security of these funds is “largely a function of how they're built,” said Randy Cusick, the Philadelphia-based leader of the U.S. investment consulting practice for Towers Perrin of Stamford, Conn.

“You have some providers out there who have done a very good job” of managing the plans, he said. Others that were more aggressive “got caught in this particular environment, and those are the ones that are having liquidity issues,” Mr. Cusick said.

One area of concern has been investments made by the stable-value funds.

Many investments have come under pressure, some have performed poorly, and many include mortgages and asset-backed securities, said Ruth Falck, a senior investment consultant with Watson Wyatt Worldwide in New York.

However, “the underlying portfolios run by these managers are very well-diversified, and therefore, the vast majority of portfolios have not been enormously impaired,” she said.

Another issue is capacity to provide wrap coverage.

“There are fewer and fewer organizations that want to be wrap providers,” said Angie Parrish, Tampa, Fla.-based senior vice president and global practice leader for Aon Investment Consulting, a unit of Aon Corp. in Chicago.

Phil Suess, a Chicago-based worldwide partner who heads New York-based Mercer LLC's DC consulting group, said that market-to-book ratios during the past 18 months haven't been “as favorable as they've been in the past.” That has forced wrap providers “to put up capital to support this difference” and “essentially limited their interest in writing new business or taking on new business within their existing relationships,” he said.

WRAP COVERAGE?

American International Group Inc. of New York, which has been a major provider of wrap coverage, no longer is taking new business, according to reports.

Mr. Suess said that he is particularly concerned that many of the banks, for which stable-value funds represent only a small portion of their business, “are going to elect not to continue” providing wrap coverage, given their concerns.

Cynthia Mallett, vice president of products and market strategies for New York-based MetLife Inc.'s institutional business, said, however: “What we're really seeing is the quick rise and relatively quick decline in non-traditional wrap capacity” provided by non-insurance companies. “I don't think anything fundamental has happened to core wrap capacity here, and the insurance industry doesn't have a problem with capacity,” she said.

Employers need to make careful choices, observers said.

“You do need to understand what's in the portfolio. You need to ask questions about who are the wrap providers and what is their financial condition and what have they put in place in the event of default by one of the wrappers. What agreements do they have in place by the other providers?” Ms. Falck said.

Observers said that even if the stock market rebounds, there will be no rush to return to equities.

“The average plan participant may be a little bit shy of going back into the equity market with the full force they were in before,” said Betsy Vary, director of investment consulting for Buck Consultants LLC in New York.

“There will be a modest flow back to equities, but it will be lagging. The 401(k) participants tend to be slow [to make changes in their investments], and inertia often governs,” Ms. Mallett said. “So it took an enormous market downturn to actually move people out of equities in a significant way, and I think this will have an … effect for a long time.”

Judy Greenwald is a reporter for sister publication Business Insurance.