Final Exam 0 of 25 answered Answer all 25 questions to mark this section complete.
Key Terms — GIC, Traditional GIC: select the correct definition.
A traditional GIC 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. A traditional GIC is typically a non-participating, fully guaranteed investment contract backed by the assets in an insurance company's general account. An investment account, typically preferred by plan sponsors with larger plans, in which the 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, traditional GICs may allow for a degree of customization.
Key Terms — Synthetic, Synthetic GIC, book value wrap contract: select the correct definition.
A Synthetic or book value wrap 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. A Synthetic is typically a non-participating, fully guaranteed investment contract backed by the assets in an insurance company's general account. An investment account, typically preferred by plan sponsors with larger plans, in which the 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, Synthetics may allow for a degree of customization.
Key Terms — Separate Account GIC: select the correct definition.
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. A separate account GIC is typically a non-participating, fully guaranteed investment contract backed by the assets in an insurance company's general account. An investment account, typically preferred by plan sponsors with larger plans, in which the 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, separate account GICs may allow for a degree of customization.
Key Terms — Rate Reset: select the correct definition.
The periodic reset back to the agreed-upon fixed rate of the stable value investment contract. The assignment of the crediting rate which is calculated and assigned at the end of each day to a stable value investment contract. 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.
Key Terms — Crediting Rate: select the correct definition.
The rate paid by the stable value manager to the wrap issuer for insuring the stable value product. 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 (book value wrap contracts), the crediting rate is the mechanism that allows the contract to amortize differences between the book value and market value over time. The rate used by the wrap insurer to discount the stable value fund's average credit quality to determine credit risk.
Key Terms — Put Option: select the correct definition.
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. A distinct derivative instrument within stable value contracts that enables the wrap insurer to exit the wrap contract. 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).
Key Terms — Pooled GIC Fund: select the correct definition.
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. A stable value investment option, typically offered by an insurance company, consisting of a group annuity contract that covers many, usually smaller plans. 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.
Key Terms — Exit Provisions: select the correct definition.
Any payment required for terminating an investment contract, typically a guaranteed investment contract, prior to its scheduled maturity date. 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. 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.
Key Terms — Equity Wash: select the correct definition.
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. The term originated from a flood of equity into Stable Value Funds in the 1980's forcing the industry to form the 'equity wash' fee to offset the additional risk incurred by equities. Additional expenses paid to the issuer of the wrap contract to cover excessive risk from investments such as equities. 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).
Key Terms — Wrap Contract: select the correct definition.
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, these are not group annuity contracts and can be issued to entities other than tax-qualified plans. 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. A stable value investment contract that "wraps" a designated portfolio of associated assets within a stable value investment option to provide an assurance (1) 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.
Key Terms — Cash Flow Risk: select the correct definition.
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. Benefit payments made at book value. Most stable value investment contracts allow book value withdrawals only for participant-initiated withdrawals. The risk of fluctuating prepayments on prepaying securities.
Key Terms — Contract Issuer Risk: select the correct definition.
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. A fund's operating expenses expressed as a ratio of the book value to the value of the stable value fund. 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.
Key Terms — Evergreen: select the correct definition.
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. A stable value investment strategy that employs a portfolio of actively managed 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.
Key Terms — Interest Rate Responsiveness: select the correct definition.
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 rate responsiveness refers to the amount paid or credited by the issuer to the contract-holder expressed as an effective annual yield. 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 interest rates, but with a time lag. 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.
Key Terms — Spread: select the correct definition.
A spread is the difference between the actual earnings on 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. 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. 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 absorb immediate cash flow needs without requesting withdrawals from other stable value investment option assets.
What is the difference between a traditional GIC and a synthetic GIC or book value wrap contract?
A traditional GIC is backed by the assets of an insurance company's general account assets while a synthetic GIC or book value wrap contract is an insurance contract issued by an insurance company or other financial institution which wraps and insures a portfolio of bonds. A traditional GIC and a synthetic are the exact same thing just managed by two different types of entities. A synthetic always provides a fixed rate return whereas a traditional GIC has many different structures it can build into its stable value products for its plan participants.
Who invests in stable value products and what are the benefits of a stable value product?
Anyone can invest in stable value products through the primary and secondary markets. The primary benefits include consistent returns and low risk. Participation in stable value products is limited to participation in defined contribution plans. The primary benefits include consistent returns and low risk. Participation in stable value products is an option for anyone with more than $100,000 to invest and access to the secondary markets. The primary benefits are liquidity and low risk.
How does a stable value product provide principal protection?
It is invested almost exclusively in USD Currency and MMF's, which are stable investments in and of themselves. They are not truly stable investments. They move with the market, but the extremely long and strict exit provisions allow the fund managers to ensure funds are only removed when they are equal to or above par. Stable value products are backed by diversified pools of fixed-income assets and insurance contracts which stabilize the principal value of the fund.
If a plan has $10 million to invest, what type of stable value product are they most likely to choose?
Individually managed separate account GIC. Individually managed synthetic GIC. Pooled fund or collective Fund.
What is one valid crediting rate formula?
Crediting Rate = (Market Value/Book Value) x (Duration) x (1+Yield) – Fees – 1 Crediting Rate = (1+Yield) x (Market Value/Book Value)^(1/Duration) – Fees – 1 Crediting Rate = (Book Value/Market Value) x (1/Duration) x (1+Yield) – Fees – 1
Assuming a market-to-book ratio of less than 100%, will a duration of 2 or a duration of 4 result in the highest crediting rate?
4 2 Duration does not impact the crediting rate formula
How large does a plan's investment generally need to be to qualify for an individual stable value fund?
$20,000,000 $50,000,000 $100,000,000
What does the SVIA stand for?
Stable Value Interest Agreement Stable Value Insurance Association Stable Value Investment Association
What role do insurance companies play in a synthetic stable value fund?
Insurance companies guarantee the principal in stable value funds through "wrap contracts" which are essentially insurance policies for the fund's principal. Insurance companies manage stable value funds internally and back the synthetic trading strategy using their general account or separate account assets. Insurance companies provide outsourced investment operations using their internal trading desks for fund managers of stable value funds.
What are the primary risks associated with stable value funds?
Credit risk, contract issuer risk and cash flow risk Operational risk and regulatory risk Operational risk and reinvestment risk
