From the July 2007 issue of Investment Advisor • Subscribe!

Stable Value or Not?

Stable value as a default option debated

As the Department of Labor prepares to finalize its proposed regulation on qualified default investment alternatives (QDIAs) in 401(k) plans, the debate rages on as to whether stable value funds should be included as a default option.

DOL has proposed three QDIA options--life cycle funds, balanced funds, and managed accounts; the QDIAs are designed to allow employers to select default options for plan participants that are suitable for long-term investing. DOL has said it hopes to finalize the regulations by late June or early July.

While DOL has been steadfast in opposing a stable value option, some industry groups and members of Congress are urging DOL to change its mind. One idea being vetted now, says Peggy Howell, senior compliance analyst at The Principal Financial Group, "is to allow stable value as a default for a short period of time (for example, six months), after which the funds must be transferred to one of the three other options." Another possibility would be to allow stable value but not give the same fiduciary protection as the other three options, she explains.

Because stable value funds are capital preservation funds, they are very conservative investments and do not reflect equity market rates, Howell says. "Some people prefer stable value as a default since they are relatively secure investments, normally have low expense ratios, and are liquid." However, she notes, "the IRS does not think stable value is a good investment option over the long term since it inhibits asset growth that may be available using an investment option that includes equities." Those who support a stable value investment argue that it's a good option for some participants--for instance, older participants with few years for asset accumulation, Howell says.

Right now, there's a tussle between the life insurance and mutual fund industries over the inclusion of stable value. The Investment Company Institute (ICI), the mutual fund trade group, argues that including stable value would be inconsistent with measures set out in the Pension Protection Act to facilitate automatic enrollment in 401(k) plans. ICI sent a letter to the Office of Management and Budget (OMB) recently challenging the American Council of Life Insurers' (ACLI) request to OMB that it return for further review any final regulation from DOL that failed to include stable value. ICI's letter, which was penned by the trade group's chief economist, Brian Reid, and its assistant counsel for pension regulation, Elena Barone, argues that when it comes to the importance of automatic enrollment and default options, "research has shown that higher contributions rates and default investments with equity exposure make a positive difference in generating adequate retirement savings."

Until now, Reid and Barone wrote, "the majority of plan sponsors favored low-yield, low-risk default options--which save money rather than invest it--largely to shield themselves from litigation by a defaulted participant whose account might have lost value." But Congress and DOL believed this status quo needed to change, they noted, with DOL crafting its default investment reg before the PPA was enacted. In today's litigious environment, Reid and Barone wrote, "employers may gravitate toward the most conservative option available," therefore, including stable value "would result in retention of the status quo and render the PPA's default investment provision ineffective in enhancing retirement savings for participants."

The ACLI also believes, the ICI letter states, that a stable value option is needed because some employees change jobs frequently and cash out their retirement plan balances. The insurance trade group argues that because these and other defaulted employees may be risk averse, ICI's Reid and Barone wrote, employers should be able to choose a principal-protected default option like a stable value fund or a guaranteed investment product. But ICI believes this stance "runs counter to the fundamental goals of automatic enrollment--encouraging the accumulation of retirement savings." The purpose of a 401(k) plan, they wrote, "is not to encourage workers to withdraw and spend their savings when they change jobs."

Reid and Barone also noted that PPA mandates that default investments include a "mix of asset classes" to receive fiduciary relief. Stable value funds, they said, include only one asset class.

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