Revenue Streams: An Inside Look at Stable Value Funds
A competent advisor should be able to provide their plan sponsor clients with a detailed explanation of all revenue that is earned by their record keeper or service provider. Though this might seem obvious, especially in light of the 408(b)2 fee disclosure regulations enacted in 2012, there are various types of fees and revenue streams that often go unnoticed by employers. One of the more prominent is revenue derived from Stable Value Funds.
Many 401(k) plans today have stable value funds as an investment option, especially if your service provider is an insurance company. What many plan sponsors don’t understand is the structure of these stable value funds and the revenue they provide to the insurance company. Typically, stable value funds are categorized as either General Account Products or Separate Account Products.
The more common yet least transparent are general account products, which are stable value funds (or, guaranteed investment contracts) that invest their assets in the general operating account of the issuing insurance company. These are sometimes also referred to as “spread products” and operate similarly to a bank CD.
When you invest in a CD, you generally don’t pay any explicit fees. You give the bank your money, and they pay you a return on those assets. For instance, if the bank is paying you 1% on your CD, what do you think they make on that money? The easy answer is, “more than 1%.” So, even though they don’t charge explicit fees, they are making money on your money by lending it out or otherwise investing it.
General account stable value funds function very much the same way. The money that participants invest into that stable value fund through their company’s 401(k) plan is then used by the issuing insurance company to make other investments. And, even though the stable value fund may have an explicit expense ratio, the insurance company makes substantially more on those assets than the stated expense. They will then credit the participants with a stated return below what they make on the assets. This is called the “spread.” Many insurance company general accounts earn 5% or more, and for the most part, they are not required to disclose that profit or revenue.
This practice is neither illegal nor unethical. In fact, it is one of the primary ways that insurance companies make their revenue. However, most plan sponsors are completely unaware of the amount of revenue these funds generate for the insurance company. If that insurance company is also your record keeper/TPA, do they have a vested interest in making sure that their stable value fund is part of your plan’s investment menu? Of course they do. And, some providers will even require the use of their stable value fund in the fund menu.
This is when a potential conflict of interest can emerge.
Imagine if your company’s 401(k) plan has $40 million in total assets, and 25% of those assets are in the stable value fund. That means $10 million of your investment is generating upwards of $500,000 in revenue for the insurance company. Some insurance companies will even dial up and down the stated yield on the stable value fund on a plan-by-plan basis depending on the profitability of the plan.
And since the recordkeeping and administration of 401(k) plans has become such a low-margin business, the use of these stable value funds has proliferated.
Certainly there are times when such funds can be a valuable option within your 401(k) plan menu, but as a plan fiduciary, you should absolutely be aware of the revenue created by these funds for your record keeper. If there are any doubts, seek input from a competent advisor with experience in the 401(k) industry for guidance when it comes to the selection and monitoring of these types of investments.