Administration March 26, 2014

The Risk of Rising Interest Rates for Stable Value Funds

March 26, 2014 (PLANSPONSOR.com) – While retirement plan sponsors will find the market for getting into stable value funds has improved, the threat of rising interest rates poses a risk they need to keep in mind.
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An article from Portfolio Evaluations, Inc. (PEI) explains while most of the concern pertaining to the potential rise in interest rates has been focused on fixed income funds, stable value funds have been significantly impacted as well. Pooled stable value funds are essentially fixed income portfolios supported by insurance wraps or guarantees, so they carry a significant level of interest rate risk. The market value of the underlying fixed income portfolio will decline as interest rates rise. Participants do not experience these market value fluctuations due to the products’ insurance component; however, last year’s rise in interest rates had a potential negative impact on the liquidity for stable value funds at the plan sponsor level.

Marc Lescarret, senior investment analyst at PEI in Warren, New Jersey, and author of the article, tells PLANSPONSOR if plan sponsors use a fixed income instrument and interest rates go up, that will generate a negative return, but stable value funds are a way to protect against negative return. Stable value funds are capital preservation vehicles.

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He explains that stable value funds usually impose liquidity restrictions—if a plan sponsor wishes to terminate a pooled stable value product, they may be required to wait in a put queue which is typically 12 or 24 months depending on the ratio of the fund’s market-to-book value of assets. According to Lescarret, currently many investment managers still have a market value of 100% or just slightly above book value, so they are keeping a loose policy on sponsor liquidity. Many are letting investors out within months now, he says.

However, as interest rates get higher, market value can drop below book value, and managers may have to pay if funds leave, so they are beginning to enforce the puts.

One thing this means for plan sponsors is it is a good time to review their stable value products because if they are unhappy and want to make a switch, now is their opportunity, according to Lescarret. If a plan sponsor adopts a stable value product and becomes dissatisfied, the window for getting out is narrowing.

In addition, he notes in the article, in order to protect against potential rising interest rates, most stable value managers have shortened the duration of their portfolios. These actions lowered the yield on their portfolios, which reduced the crediting rate offered to participants. When deciding whether to get into a stable value product, or when monitoring their current offering, it is important for plan sponsors to understand how stable value funds have been affected by the recent rise in rates in addition to what steps managers have taken to adjust portfolios.

Greg McCarthy, principal and director of the Investment Consulting Group at PEI, tells PLANSPONSOR, just because market-to-book values have improved and products are opening up doesn’t mean plan sponsors can lower their due diligence efforts. “It is important for plan sponsors to remember they have to carry out the same prudent process and due diligence for stable value investments as with any other asset class,” he concludes.

Lescarret’s article is here.

Benefits March 26, 2014

Effects of Increasing Retirements on Employer Plans

March 26, 2014 (PLANSPONSOR.com) – As more employees retire, plan sponsors need to prepare for the impact on their defined benefit (DB) and defined contribution (DC) retirement plans.
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Figures from the Bureau of Labor Statistics show one-fifth of the U.S. work force has either retired or is nearing retirement age (see “Many CFOs Unconcerned About Boomers Retiring”).

When asked about how this decrease in worker population might impact DC plans, possibly reducing economies of scale used to negotiate for products and services, Kristi Mitchem, executive vice president, State Street Global Advisors (SSgA), tells PLANSPONSOR, “Actually, more employees are leaving money in their employer-sponsored retirement plan after they retire. Plan sponsors have found that while only 10% to 15% of employees used to do that, today it’s more like 59% or 60%.”

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Given this trend, the San Francisco-based Mitchem believes the decrease in older workers will “be less impactful than anticipated.” However, she says, plan sponsors still need to make sure they effectively communicate with employees to emphasize the benefits of staying in the retirement plan sponsored by the employer.

They also need to make sure their plan design accommodates employees who wish to leave their money in the plan after retiring, she says. This means adjusting the plan’s investment menus to offer options, such as annuities, that will generate post-retirement income for retirees.

Mitchem adds that revisions to current legislation would make required minimum distributions (RMDs) for employees who leave their money in the plan easier, and several proposals concerning such distributions are in fact being reviewed by Congress. In the meantime, she says, plan sponsors should coordinate with their recordkeepers on the logistics of administratively handling employees that want to invest their RMD balances in other financial vehicles. Mitchem says SSgA and other providers offer such distribution products.

As for the effect of increasing employee retirements on DB plans, Mitchem says, “There will probably be more loss of scale in plans offering lump sum distributions than those DB plans that offer options such as annuities.” She adds that the funded status of most DB plans is still at a favorable level, pointing to the increase in the overall funded status of DB plans during 2013 (see “Pension Funding Up Sharply in 2013”).

To address the issue of increasing participant retirements and loss of plan assets, Mitchem says, “DC plan sponsors can add more automatic features, such as automatic enrollment and automatic escalation, to their plan design. They can also be more aggressive when it comes to contributions, perhaps going as high as 6%.”

She says plan sponsors also need to engage near-retirement employees in a conversation about defined contribution plans and individual retirement accounts (IRAs), specifically about the differences in flexibility and fees. For example, if an employee keeps his money in a 401(k), it may only cost him 30 basis points in fees, while an IRA may cost closer to 100 basis points. Employees may not be aware of such differences, says Mitchem, and need to be educated about them.

In general, good communication with participants nearing retirement is important to foster “a higher degree of security” about retirement, according to Mitchem. “Plan sponsors need to use such communication pieces to help employees navigate the choices surrounding their separation from the plan. Plan sponsors need to communicate about topics like retirement planning as employees near this point of departure into retirement.”

The best way to deliver information to employees can be very population dependent, she says. While posters may work for an employee population that is office-based, the same may not be true for someplace like a trucking company, where employees are constantly traveling. Delivery preferences may also depend on the age of employees and their level of comfort with technology.

However, says Mitchem, there are a few common elements when it comes to information delivery that are valid no matter what the makeup is of the employee population. “First, make sure the message is simple. Second, make sure the message is action-oriented, giving the person a goal to achieve. Third, repeat the message on a regular basis. This continual exposure to the message is more likely to have an impact on employees.”

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