You Can’t Always Get What You Want – But If You Make Other People Wait 24 Months You May Get What You Need

In 2011, the NFL decided to lock-out its players. During the dispute, anyone with a TV or an internet connection was subjected to in-depth analysis that covered every angle of the issue. Many of the people subjected to the coverage had trouble picking a side – a fight involving someone who makes 1,000 times a day more than you versus another party that makes 10,000 times a day more than you doesn’t tug at the heart-strings.

Those of us watching from the proverbial sidelines did have one main thought: do whatever needs to be done and then get back to playing. We as a people like football, and a football game is a gateway of sorts to a whole bunch of other stuff that would be hard to justify without the game (standing around in a parking lot drinking beer at 7:00 on a Sunday morning, for example).

Luckily for all involved, the deal was finally struck. We were then subjected to equally in-depth analysis of all of the elements of the deal. Who gave up what? Who won, and who ultimately lost? I don’t know if the two sides got what they actually wanted as much as each limited what the other could do in the future. These limits and restrictions, they believe, will ultimately result in the framework they need.

As hard as it is to drum up a personal connection to a multi-millionaire or billionaire, it’s even harder to come up with a reason to love an insurance company or big bank. It was only a few years ago that the market was in free fall and the big banks and insurance companies were among those that fell the furthest.

The coverage of the financial crisis, its causes, the bailouts and the resulting impact of all of this on consumers will likely continue for many years to come. I focus here on one very small aspect of the financial industry: the 12-month put provision for stable value funds.

We have previously discussed the 12-month put. To summarize, it’s the provision that allows a pooled stable value fund to keep a plan’s deposits up to a year. Those plans that “fire” a stable value fund and move to another will have to offer their participants a blend of the old/new rates until the 12-month period expires. This is a little more work for the recordkeepers involved, but is an accepted, expected practice. Participants that are part of a fund involved in a 12-month put are probably unaware of the details (though they are informed) as the restriction on the plan doesn’t impact their ability to take their money if they quit, retire or have another distributable event.

While participants, and even many plan sponsors, are only somewhat aware of the existing provision, it’s fair to say that the big banks and insurance companies that provide the insurance around stable value funds (called wrap insurance) have been unhappy about it since at least 2008. Why they care is somewhat complex, but the short-hand explanation is that they feel that the ability to hold the dollars for a year doesn’t equate to the interest rate risk they’re assuming with the wrap insurance on the funds.

Why isn’t it equitable? The issue, in the view of the wrap providers, is duration.

With significant apologies for the oversimplification of what I’m about to convey, let’s use duration to explain the issue (please remember that stable value funds are invested in bonds):

Stable Value Fund ABC has a duration of 3. This means a 1% rise in interest rates will theoretically drop the value of Stable Value Fund ABC by 3%. The banks and insurance companies that offer wrap insurance for Stable Value Fund ABC are on the proverbial hook to make sure that the fund doesn’t incur a loss.

If a plan investing in Stable Value Fund ABC fires it and moves to another fund, it is currently forced to wait up to 12 months to receive the proceeds (the 12-month put). This provision protects the fund (and those providing wrap insurance) from a plan simply taking its money when a fund is troubled by rising rates, cash flows or a myriad of other potential issues too complex to convey here.

The crux of the unhappiness of the wrap providers is, in their view, forcing a plan to wait a year to withdraw its funds intact from Stable Value Fund ABC isn’t equitable with the interest rate risk being taken by the fund (a 12-month put doesn’t match the potential of a 3% loss of principal).

The big banks and the insurers took a page from the NFL’s playbook, and, starting in 2008, began a mini-lockout of their own by refusing to offer new wrap insurance. The fans in this case, the plan sponsors and their participants, aren’t able to find a comparable stable value fund that’s open for business.

This situation may be about to change. One of the largest pooled stable providers, Invesco, just announced a move to a 24 month put. The terms of how this will impact the existing investors in the fund will have to be examined, but it’s likely that the existing clients will be allowed a window of opportunity to leave. I suspect that Invesco feels that this change, which will allow it to break the wrap insurance lock-out, is relatively safe as most of its competitors can’t take in any meaningful amount of contributions under their 12-month put contracts (because they lack the wrap capacity).

In the view of the wrap providers, a 24-month put puts the interest rate risk on a much more equitable playing field as it better matches the duration of the typical stable value fund. We know that, in a climate where many stable value funds have closed their doors or even liquidated, at least one new stable value fund was recently launched (it’s not a coincidence that this new fund from PIMCO came with a 24-month put provision). This recent move is noteworthy as it is, to my knowledge, the first time that an existing fund of any size has gone this path to obtain new wrap insurance capacity.

Will the 24-month put give the banks/insurers what they need? I suspect that the marketplace will need to digest the move before we know for sure. Anyone thinking that this move to end the wrap insurance lock-out is certain to lead to happy days for plan sponsors and participants is advised to remember that the NFL finally ended the lock out with its players, but immediately followed that act by locking out the officials.

What will the fans of stable value funds think of this move, and what do they ultimately need? If it’s a pooled product supported by multiple wrap insurers, this added restriction on the payout in return for the substantial boost in returns available versus a money market may still give them what they want.

*Originally published April, 2013.

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