- 1 Introduction to Stable Value Funds ›
- 2 Key Terms for Stable Value ›
- 3 The Stable Value Industry ›
- 4 Operational Nuances with Stable Value ›
- 5 Final Exam
Section 2 of 5 · ~25 min
Key Terms for Stable Value
Learning Outcomes
Executive Summary: This section is designed to provide learners with a comprehensive understanding of the key terminologies and concepts associated with stable value funds, including the intricacies of investment contracts, accounting methods, and risk management strategies. This section will explain the definitions and applications of terms such as blended rate, book value, cash flow risk, and synthetic GICs, among others, essential for navigating the landscape of stable value investments.
Learners will:
- Understand key stable value fund terms including blended rate, book value, and cash flow risk.
- Learn accounting methodologies specific to stable value funds such as book value accounting and its significance in financial reporting.
- Recognize and assess the risks associated with stable value funds, including contract issuer risk and the impact of competing investment options.
- Explore the different types of investment contracts, such as guaranteed investment contracts (GICs) and synthetic GICs (book value wraps), and articulate their respective features and roles within stable value funds.
- Understand the purpose and implications of key contractual features like put options, corridors, and exit provisions on the overall management and stability of the investment.
Key Terms for Stable Value
| Term | Definition |
|---|---|
| Amortization | With respect to separate account GICs or synthetic GICs, the process of recognizing realized and unrealized market value gains and losses into the book value over a specified period of time via periodic adjustments to the crediting rate. |
| Arbitrage | In general usage, a relatively low-risk purchase and simultaneous sale of an asset to profit from a difference in the price. With respect to stable value investment options, exploiting short-term differences between a competing option, a plan investment option with similar objectives or characteristics as the stable value investment, whereby assets flow to the competing option to take advantage of higher interest rates. |
| Associated Assets | A portfolio of bonds that are owned by the plan or trust and that are supported by synthetic GICs or book value wraps. |
| Bank Investment Contract | An investment contract issued by a bank. Unlike GICs, BICs generally do not include annuity provisions. Synonyms: BIC |
| Benefit Payment | Any payments resulting from a participant's retirement, death, disability or termination of employment, and any payments resulting from a participant's election to withdraw, borrow, or transfer an amount from such participant's account in accordance with the terms of a plan under which a participant is an eligible member. |
| Benefit-Responsive | The ability to transact at book value for benefit payments. |
| Blended Rate | The aggregate yield on the investments in a stable value investment option. |
| Book Value | For a stable value investment contract, the value of initial deposited principal, plus accumulated interest, plus additional deposits, minus withdrawals and expenses. The book value of an investment contract is the amount owed by the issuer to the contract-holder on behalf of the plan participants, subject to certain terms and conditions. Synonyms: Contract Value |
| Book Value Accounting | The accounting methodology allowed under AICPA Statement of Position (SOP) 94-4-1 and FASB Statement of Position (FSP) AAG INV-1 by which the valuation of a fully benefit-responsive stable value investment contract is allowed to be reported at book value with market value or fair market value provided as additional disclosures. (If the plan sponsor is a governmental entity the accounting methodology is described under GASB Statement No. 53.) Certain pre-defined criteria by FASB or GASB must be met in order for an investment contract to qualify for book value accounting and be reported at book value on financial statements. |
| Book Value Withdrawals | Benefit payments made at book value. Most stable value investment contracts allow book value withdrawals only for participant-initiated withdrawals. Synonyms: Qualified Withdrawals, Ordinary Withdrawals |
| Buy and Hold | A stable value investment strategy that refers to a portfolio of assets that are typically purchased and then held to maturity. In this buy and hold strategy, the investment contract associated with such assets typically terminates at the maturity of the assets. |
| Cash Flow Risk | The risk that participant-directed contributions, withdrawals, and net transfers have an adverse financial impact on the issuer of a stable value investment contract or such contract's crediting rate. Alternatively, the risk that cash flows are different than expected. |
| Claims Paying Ability Rating | An evaluation by an NRSRO (Nationally Recognized Statistical Rating Organization, for example Moody's or S&P) of the financial strength and relative ability of an insurance company to pay claims on its insurance policies or contractual liabilities as distinct from its debt obligations. |
| Competing Option | An investment option offered by a defined contribution plan in addition to the stable value investment option that has principal preservation as a primary objective (such as a money market option or short-term bond option) or other characteristics similar to stable value. Additionally, self-directed brokerage or mutual fund windows may be deemed competing if a competing option is made available through the window. The presence of competing options subjects stable value investment options, invested participants, and investment contract issuers to the risk of arbitrage, so the addition of such an option by the plan sponsor usually requires issuer consent and the use of an equity wash so as to restrict direct transfers from the stable value investment option to the competing option. |
| Comptroller of the Currency | A federal agency that charters and regulates national banks, including a bank's collective trusts. State-chartered banks are not subject to OCC jurisdiction, but many state banking regulations are similar to the OCC's. Synonyms: OCC |
| Contract Issuer Risk | The risk an investment contract issuer could default, become insolvent, file for bankruptcy protection, or otherwise be deemed by the plan's, or trust's, auditor to no longer be financially responsible. |
| Contract-Holder | The owner of a stable value investment contract, typically the plan sponsor or trustee. The contract-holder is usually the party responsible for taking any actions allowed or required under the terms of such contract. Synonyms: Trustee |
| Corridor | A provision included in an investment contract that provides a limited amount of book value coverage for certain specified employer-initiated and/or market value events. |
| Credit Risk | The risk that an investment will default, i.e., the borrower or guarantor (the bond or investment contract issuer) will not pay principal and interest as scheduled. Synonyms: Default Risk |
| Crediting Rate | The interest rate applied to the book value of a stable value investment contract, typically expressed as an effective annual yield. As provided in the investment contract, the crediting rate may remain fixed for the term of the contract or may be "reset" at predetermined intervals. The crediting rate may be expressed as a gross or net crediting rate. For separate account GICs or synthetic GICs and book value wraps, the crediting rate is the mechanism that allows the contract to amortize differences between the book value and market value over time. |
| Defined Benefit Plan | A tax-qualified pension plan that provides for the payment of a retirement benefit, according to a specified formula, usually reflecting years of employment service and salary. Required contributions by the plan sponsor are usually actuarially determined. The plan sponsor makes all investment decisions and is responsible for the funding adequacy of the plan. Defined benefit plans do not invest in benefit-responsive stable value contracts because they do not qualify for book value accounting. |
| Defined Contribution Plan | A tax-qualified retirement plan under which the amount of the participant's benefit will vary depending upon the amount of employer (or plan sponsor) and/or employee contributions made to the participant's account and the investment earnings or losses thereon. Most defined contribution plans that include employee contributions (e.g., 401(k) plans) permit participants to direct the investment of their accounts. |
| Department of Labor | A federal agency created in 1913 to advance workers' welfare, working conditions, and, in general, employment opportunities. A division of the DOL, the Employee Benefits Security Administration (EBSA) is responsible for the interpretation and enforcement of ERISA, e.g., regulating fiduciary standards for pension plans and plan reporting on Form 5500. Synonyms: DOL |
| Employee Benefits Security Administration | A division of the DOL, EBSA is responsible for the development of regulations for the security of retirement, health, and certain other workplace related benefits, for assisting and educating workers, plan sponsors, fiduciaries and service providers on these rules, and for enforcing the law. Synonyms: EBSA |
| Employer Initiated Event | Plan changes or certain other related events that are in the control of the employer (including, but not limited to, a plan's termination, layoffs, or changes in a plan's design), that may trigger participant withdrawals or transfers. These withdrawals or transfers are either not covered at book value or receive limited book value coverage by stable value investment contracts. |
| Equity Wash | A provision in a stable value investment option that requires any transfer a participant makes from the stable value investment option to a competing option to first be directed to any other investment option not designated as a competing option for a period of time (usually 90 days) before the transfer to the competing option may be completed. |
| Evergreen | A stable value investment strategy that employs a portfolio of actively managed fixed-income assets that are constantly rebalanced to maintain a targeted duration. In a constant duration (also known as an "evergreen") structure, the stable value investment contract does not have a defined maturity date. Synonym: Constant Duration |
| Exit Provisions | Exit provisions are stipulated in the contract between the stable value contract issuer and plan. Exit provisions generally require the plan sponsor to wait a stated period before receiving the full book value (principal plus accumulated interest). If a plan sponsor does not wish to wait, the sponsor may be able to redeem stable value assets immediately at current market value, which may be less than the book value of the stable value product and may result in plan participants not having their principal preserved, which is a core investment objective of stable value. |
| Expense Ratio | A fund's operating expenses expressed as a percentage of average net assets. The expense ratio for a stable value option may include investment manager fees, wrap contract and other investment contract fees, and administrative, trustee, and custody fees. Synonyms: Fees |
| FASB Statement of Position (FSP) AAG INV-1 | FSP AAG INV-1 defines the rules under which book value accounting may be used for the investment contracts issued to stable value funds for defined contribution plans offered by public companies. Synonyms: FSP AAG INV-1 |
| Funding Agreement | An insurance contract under which the issuer guarantees principal, accumulated interest, and a future interest rate for a specified period of time. Unlike guaranteed investment contracts, funding agreements are not group annuity contracts and can be issued to entities other than tax-qualified plans. |
| GIC or Guaranteed Investment Contract | A traditional GIC is typically a non-participating, fully guaranteed investment contract backed by the assets in an insurance company's general account. Synonyms: Traditional GIC |
| Group Annuity Contract | A contract issued by an insurance company that allows a tax-qualified plan to purchase retirement annuities for plan participants. Most guaranteed investment contracts are group annuity contracts. |
| Immunization | Managing a portfolio to a set maturity date such that the investment manager seeks to manage the value of the portfolio assets to equal the value of the corresponding liabilities at maturity. The duration of the bond portfolio determines the initial targeted maturity date, but that date may be extended if the market value is not yet equal to the book value by the initial maturity date. |
| Individually Managed Funds | An investment account, typically preferred by plan sponsors with larger plan assets, in which the stable value assets are owned by and managed for the specific plan's participants and are generally not commingled with the assets of other investors. With respect to a stable value investment option, when compared to commingled funds, individually managed funds may allow for a degree of customization. |
| Interest | The payment or cost for using money, usually expressed as a percentage rate per period of time. With respect to stable value investment contracts, interest refers to the amount paid or credited by the issuer to the contract-holder expressed as an effective annual yield. (See also crediting rate.) |
| Interest Rate Responsiveness | The degree to which a stable value investment option's yield (or an investment contract's crediting rate) moves in conjunction with the changes in the overall market level of interest rates. A stable value investment option's returns typically tend to follow changes in current market interest rates, but with a time lag. |
| Investment Contract | Any of a variety of stable value contracts including bank investment contracts, traditional GICs, separate account GICs, and synthetic GICs or book value wraps. Within a stable value investment option, such contracts are benefit-responsive, meaning they permit, subject to their terms and the plan's rules, participant-initiated transactions at book value. Investment contracts may have a fixed or floating interest rate, which may not be less than 0%. Investment contracts may have a stated final maturity (such as a traditional GIC) or may have no stated final maturity (such as a separate account GIC or synthetic GIC). |
| Lesser of Book and Market Withdrawal | A type of plan-initiated withdrawal for plans departing certain commingled funds or insurance company stable value investment options that allow the departing plan to withdraw its investment at either the book value of the investment contract (or stable value investment option) or the market value of the associated assets supporting the book value of the investment contract (or stable value investment option), whichever is lower. |
| Life Insurance Directly Sold | Also known as guaranteed insurance accounts, a stable value investment option entirely offered and guaranteed by a single insurance company, with the underlying assets managed by the insurance company or an affiliated investment manager. Guaranteed insurance accounts may be provided via a group annuity contract or a funding agreement that can be issued either from the insurer's general account or from an insurance company separate account, in which case the investment is first supported by the assets in the segregated separate account and then, to the extent necessary, by the insurer's general account assets and surplus. Synonyms: GIA, Guaranteed Insurance Account |
| Liquidity | Generally, liquidity is the degree to which an investment can be easily sold or converted into cash, especially without affecting the investment's price. In a stable value context, it means a participant's ability to access funds without market value risk or other penalty. |
| Liquidity Buffer | Investments, typically a money market fund or STIF, in a stable value investment option that may be used as a first source of liquidity to cover immediate cash flow needs without requesting withdrawals from other stable value investment option assets. Synonyms: Buffer Fund |
| Market Value Adjustments | The adjustment to an investment contract's market value due to employer-initiated events, impaired securities, or market value events. Alternatively, for some traditional GICs, the adjustment (sometimes known as a surrender charge or surrender value adjustment) to a GIC's market value due to termination prior to the stated maturity date. Synonyms: Surrender Charge, Surrender Value Adjustment |
| Market Value Event | Any event or occurrence outside the normal operation of a plan that may be expected to have an adverse financial effect on the issuer of a stable value investment contract. When such an event occurs, some investment contracts require benefit payments to be made at the contract's market value or surrender value, rather than at book value. These market value adjustments occur when the withdrawals exceed the book value corridor provision which is a typical contract feature. Other investment contracts may require a book value adjustment. |
| Maturing | A stable value investment strategy that employs a portfolio of actively managed assets but the associated investment contract either may have a defined maturity date or may not have a defined maturity date but allows periodic payments of principal and interest from the assets for liquidity purposes. |
| Maturity Date | The date the principal amount of an obligation is payable. |
| Net Crediting Rate | The crediting rate after adjusting for some or all expenses and any special provisions of the product, expressed as an effective annual yield. |
| Non-Participating | A characteristic of certain investment contracts, such as a traditional GIC, such that the contract's crediting rate is not affected by the contract's cash flow experience or the performance of the associated assets. |
| Participant | An active employee who has met the eligibility requirements of the employer's retirement plan, a former employee (such as a retiree or terminated employee) who previously met such eligibility requirements and maintains a balance in the former employer's plan, a beneficiary, or an alternate payee. (Note that beneficiaries and alternate payees are technically "beneficiaries" rather than "participants" as defined under ERISA, but the term "participant" is commonly used in investment contracts to refer to both categories.) A participant may sometimes be called an investor because the participant of a plan directs allocations among a plan's investment options. Synonyms: Investor, Beneficiaries, Alternate Payees |
| Participant-Directed Cash Flow | In a stable value investment option, contributions, withdrawals, loans, or transfers that are controlled by a plan's participant. |
| Participant-Initiated Withdrawals | Withdrawals or transfers requested by participants without any influence, inducement, or prompting by the plan sponsor or other plan intermediaries. |
| Participating Contract | An investment contract characteristic such that the contract's crediting rate varies with fluctuations in the investment earnings of the associated assets based on changes in asset values, reinvestment rates, and cash flow experience. Participating contracts participate more fully in asset and liability risks than other types of investment contracts and transfer these risks from the issuer to the stable value investment option. Synonyms: Experience Rated |
| Plan-Initiated Withdrawals | A withdrawal requested by a plan sponsor, trustee, or contract-holder, or agent thereof, of some or all of a plan's investment in a stable value investment option or investment contract. Plans that wish to terminate their participation in stable value commingled funds or some insurance company guaranteed insurance accounts and receive book value may be subject to a deferral period. Any deferral period is outlined in the investment documentation (also known as a put option). Other commingled funds or insurance funds may offer a different deferral period, a series of book value payments over a period of time, or no deferral period and instead offer a lesser of book or market value payment option. During any deferral period participant directed transactions will continue to be made at book value. |
| Pooled Fund | A fund, typically offered by a bank or trust company that combines the assets of unaffiliated plans into one large group. With respect to a stable value investment option that is a pooled fund, the fund would purchase stable value investment contracts and other investments on behalf of the invested, unaffiliated plans. Synonyms: Commingled Funds, Pooled GIC Funds, Bank Pooled Funds, Collective Investment Funds, Bank Collective Trusts, Commingled Investment Trusts, CITs, Group Trusts |
| Pooled GIC Fund | A stable value investment option, typically offered by an insurance company, consisting of a group annuity contract that covers many, usually smaller plans. |
| Put Option | A stable value term (unrelated to derivatives) that describes the ability of a plan to exit a stable value commingled fund at book value, subject to a specified notice period. A put option may mean either (1) a provision under the fund documentation that an invested plan can exit the fund at book value by the end of a notice period or (2) a provision that many investment managers of stable value commingled funds request in their stable value investment contracts, allowing them to remove invested assets at book value for purposes of funding plan-initiated withdrawals within the put period. |
| Rate Reset | The change that periodically occurs to the rate of the interest earned (also known as the crediting rate) on a stable value investment contract, as may be agreed to in the terms outlined in such contract. |
| Risk Charge | The cost embedded in every stable value investment contract to cover the risks assumed by the issuer. Typically, the charge is based on the risks associated with the specific plan and/or assets involved. |
| Separate Account GIC | A stable value investment contract that is first supported by associated assets in a segregated separate account held by the issuing insurance company and then, to the extent necessary, by the insurer's general account assets and surplus. The crediting rate on a separate account GIC resets periodically based upon the earnings of the separate account assets. The securities held in the separate account are owned by the insurance company but are held for the exclusive benefit of the plan or plans participating in the separate account. If the investment contract stipulates, if the insurance company becomes insolvent the separate account assets may not be used to satisfy any of the insurer's other liabilities. |
| SOP 94-4-1 | At the request of Financial Accounting Standards Board (FASB), the American Institute of Certified Public Accountants (AICPA) issued SOP 94-4-1. This document defines the rules under which book value accounting may be used for the investment contracts issued to non-governmental defined contribution plans. This guidance was reaffirmed in FASB Staff Position (FSP) AAG INV-1 for the use of book value accounting for investment contracts in 2004. |
| Sponsor | The entity, usually an employer, that has established a retirement plan, selected the type of plan and investment options, and determined the method of funding plan benefits. Synonyms: Plan Sponsor |
| Spread | A spread is the difference between the actual earnings on the assets backing some investment contracts offered by insurance companies, such as traditional GICs, and the crediting rate that is declared and guaranteed by the insurance company for a given period. While there is no certainty an insurance company will earn a targeted spread, the anticipated spread is used to compensate the insurer for risk charges, capital charges allocated by regulators, and other expenses. An issuer attempts to earn a spread using assumptions based on many factors such as the magnitude and timing of deposits, participant cash flows, investment performance, rate environment, and potential credit impairments. |
| Stable Value | Stable value is a unique asset class available only in corporate and governmental tax-qualified defined contribution plans, as well as some tuition assistance plans. When offered as an investment option in such a plan, stable value seeks to offer capital preservation, liquidity, and returns typically higher than other options focused on capital preservation, such as money market funds. Stable value investment options may be offered by investment managers, trust companies, or insurance companies in various structures, such as separately managed accounts, commingled funds or guaranteed insurance accounts. Sometimes a stable value investment option will be managed by a plan sponsor. While stable value investment options may be managed or structured in a variety of ways, the important similarity is the use of stable value investment contracts, issued by banks, insurance companies, and other financial institutions, which convey to the investment option the ability to carry certain assets at book value. These investment contracts are what enable a stable value investment option to maintain principal value and minimize return volatility. The investment options that typically purchase or offer stable value investment contracts are commonly named Fixed Income Fund, Capital Preservation Fund, GIC Fund, Interest Income Fund, Stable Interest Fund or Stable Value Fund, among others. |
| Stable Value Manager | Refers to an investment manager, typically a QPAM (Qualified Professional Asset Manager), responsible for management and oversight of a stable value investment option. The stable value manager may manage all or only a portion of the associated assets of the stable value investment option, with the remaining assets managed by third-party fixed-income manager(s). |
| Statement No. 53 | GASB Statement No. 53 defines the rules under which book value accounting may be used for certain investment contracts issued to governmental defined contribution plans. |
| Surrender Charge | Any payment required for terminating an investment contract, typically a guaranteed investment contract, prior to its scheduled maturity date. Surrender charges are typically associated with general account products and not traditional or synthetic GICs. |
| SVIA | A non-profit organization dedicated to educating retirement plan sponsors and participants about (1) the importance of saving for retirement and (2) the contribution that stable value investment options can make toward achieving retirement security. Synonyms: Stable Value Investment Association |
| Synthetic GIC or Book Value Wrap Contract | A stable value investment structure that offers similar characteristics as a guaranteed investment contract, i.e., pays a specified rate of return for a specific period of time, is benefit-responsive, and offers book value accounting. The contract includes an asset ownership component and a contractual component that is intended to be valued at book value. The associated assets backing the contract's book value are owned and held in the name of the plan or the plan's trustee. Such associated assets typically consist of a diversified fixed-income portfolio, including but not limited to treasury, government, mortgage, and/or corporate securities of high average credit quality. To support the book value obligation, the contract-holder relies first on any associated assets and then, to the extent those assets are insufficient, the financial backing of the wrap issuer. |
| The stable value investment contract "wraps" a designated portfolio of associated assets within a stable value investment option to provide (1) preservation of principal and accumulated interest for that portfolio, (2) of payment of an interest rate, which will not be less than 0%, for a specified period of time (the crediting rate) on that portfolio, and (3) that participant-initiated withdrawals and transfers out of the assets of the portfolio will occur at book value subject to the terms of the contract. Wrap contracts can be issued by banks, insurance companies, or other financial institutions. The selection of the wrap issuer is usually made separately from the selection of an investment manager's services investing the associated assets. Synonyms: Wrap Contract, Synthetic, Synthetic Investment Contract | |
| Wrap Fees | Expenses paid to the issuer of the wrap contract. |
Knowledge Check
0 of 13 answeredAnswer all 13 questions to mark this section complete.
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What does amortization refer to in the context of separate account GICs or synthetic GICs?
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What are Associated Assets in the stable value industry?
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Which term matches this definition: "The adjustment to an investment contract's value due to employer-initiated events, impaired securities, or market value events"?
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Which term matches this definition: "A characteristic of certain investment contracts where the crediting rate is not affected by cash flow experience"?
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Which term matches this definition: "An active employee or former employee who directs allocations among a plan's investment options"?
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Which term matches this definition: "The cost embedded in every stable value investment contract to cover assumed risks"?
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What is the 'Net Crediting Rate'?
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Which of these terms describes a stable value investment strategy with a portfolio of actively managed assets without a defined maturity date?
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What does 'Immunization' refer to in stable value investment context?
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What is the role of a 'Stable Value Manager'?
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Which of the following is NOT a form of 'Participant-Directed Cash Flow'?
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Which entity is responsible for regulating fiduciary standards for pension plans and plan reporting on Form 5500?
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In the context of stable value investment options, what is a 'Wrap Contract'?
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