Stable value industry: Either boom or bust

For many companies in the stable value market, the glass is either half-empty or half-full when it comes to the industry.

Since the beginning of the year, at least three companies have entered the wrap and fund markets, saying industry conditions have stabilized sufficiently. At the same time, several others have dropped out, citing uncertainty or what they view as adverse conditions.

“There will be other entrants in the wrap market over time,” said Matthew Gnabasik, managing director of Blue Prairie Group, Chicago, a retirement and investment consulting firm, referring to the insurance products that guarantee the book value of the underlying bond investments.

Among wrap providers, Bank of Tokyo-Mitsubishi UFJ, Tokyo, and Reinsurance Group of America Inc., Chesterfield, Mo., entered the market this year, while J.P. Morgan Chase, New York, is getting out. American International Group, New York, which had been drastically reducing its wrap business in recent years, is now trying to grow it.

Among the stable value fund providers, Charles Schwab and Union Bank, both of San Francisco, liquidated funds. Pacific Investment Management Co. LLC, Newport Beach, Calif., recently launched a fund.

“I think it's improving,” said Karl Tourville, managing partner of stable value and fixed-income management firm Galliard Capital Management Inc., Minneapolis, referring to the wrap market. “We have had some more (wrap) issuers, and some providers are expanding.”

Mr. Tourville said the wrap provider market's composition is changing as insurance companies take a more prominent role while banks are pulling back. “The banks have really withdrawn from the market and are concentrating more on traditional lines of business,” Mr. Tourville said.

Following the economic crisis of 2008-"09, the amount of available wrap coverage declined. Although some firms have entered the wrap market in recent years, consultants and providers say there is still room for more coverage.

“The market for wrap capacity continues to be challenged,” said Sue Walton, a Chicago-based senior consultant with Towers Watson Investment Services Inc., a subsidiary of Towers Watson & Co. “There is an excess of demand.”

New wrap providers and those expanding their business are encouraged because fees are higher than they were several years ago. They also have been able to insist on stricter contracts, implementing, for example, tougher rules for sponsors' offering competing investments such as money market mutual funds or short-term bond funds.

Other examples of the more conservative approach dictated by wrap providers include portfolios with shorter bond durations and higher overall portfolio credit ratings than in the pre-crash years, Mr. Gnabasik said.

“No one loves tighter wrap contract provisions,” said Winfield Evens, director of HR outsourcing investment strategy at Aon Hewitt, Lincolnshire, Ill. “But if it's that (accepting a strict contract), or giving up the option, sponsors accept it.”

Surveys conducted every two years by Aon Hewitt show that stable value remains a popular choice among DC plans. Eighty percent of the plans in Aon Hewitt's 2011 survey offered a stable value option, and of those plans, an average 20% of a plan's assets were in stable value.

Mr. Gnabasik added that his defined contribution plan clients' use of stable value is “strong and healthy,” representing 20% to 25% of total plan assets.

Perhaps the most intriguing change in the market this year was American International Group's decision to start seeking clients for its wrap product following several years of dramatically reducing its wrap coverage business.

An AIG spokesman told Pensions & Investments in December 2010 that the company was getting out “in an orderly fashion with minimal disruption to the stable value market.” However, the company “never really got out per se,” said Jonathan Novak, Los Angeles-based president of the institutional markets business for AIG Life and Retirement, in a recent interview. AIG Life and Retirement is the life insurance and retirement savings division of AIG.

At its peak, before the financial crisis of 2008-"09, AIG was writing about $50 billion in wrap insurance, Mr. Novak said. Now, it's at around $15 billion.

“AIG re-evaluated the business,” he said. “We looked at our book of business and focused on risk management and shrunk the book.”

At the end of the first quarter of 2012, AIG decided to “regrow the business because now is a pretty attractive time,” said Mr. Novak, adding AIG doesn't have a specific dollar goal. “We're looking for prudent growth.”

Reinsurance Group of America decided to enter the wrap market for the first time after having spent two years “carefully researching” the landscape, said Mark Gilbert, senior vice president for stable value transactions for the RGA Reinsurance Co. His company issued its first contract during the second quarter.

“Stable value wrap contracts enable RGA to further diversify our risk profile and fit within our strategy to build the institutional segment of our asset-intensive business,” Mr. Gilbert said in an e-mail.

“Demand remains strong for the product even as terms have tightened in favor of the wrap provider, and fees have reset to higher levels.”

RGA has corporate approval to write $10 billion in wrap contracts.

Another new wrapper is Bank of Tokyo-Mitsubishi UFJ, which confirmed in April that its initial sales goal was $10 billion in wrap coverage.

Multiple industry sources said J.P. Morgan is getting out of the wrap business, although spokeswoman Elizabeth Seymour declined to comment.

Among stable value funds, Charles Schwab liquidated its $7.6 billion Charles Schwab Stable Value Fund in April, citing low interest rates and difficulty in securing adequate wrap capacity for its decision.

In July, Union Bank liquidated its Union Bank NA Stable Value Fund. According to a termination notice issued to clients in March, Union Bank said the proceeds of the liquidation would be reinvested in, among others, registered money market mutual funds and “short-term fixed-income securities issued by the U.S. government or its agencies.”

Jane Yedinak, spokeswoman for Union Bank, declined to provide information on the size of the fund or the reason for her company's decision.

And on May 1, SEI Investments Co., Oaks, Pa., told clients the SEI Stable Asset Fund would close on Nov. 30 because of a low-yield environment and “the inability to get replacement wrap coverage,” Robert Muse, a vice president of SEI Trust, said in an interview. The fund had about $2 billion in assets at the time of the announcement.

SEI is the trustee of the fund, and Dwight Asset Management is the investment manager. Dwight was acquired by Goldman Sachs on May 15.

However, SEI hasn't left the stable value fund business. It's the trustee for the PIMCO Stable Income Fund, launched in March. “We got better wrap coverage with PIMCO,” Mr. Muse said, adding the fund had assets of $120 million by July 1.

Given the ebb and flow of wrap and fund providers, the next watershed event for the stable value industry could be in the hands of regulators, said Alison Salka, corporate vice president and director of retirement research for LIMRA, a Windsor, Conn.-based financial research and consulting firm.

“A lot will depend on whether or not stable value contracts are defined as swaps” by the Securities and Exchange Commission and the Commodity Futures Trading Commission, she said.

“If they are defined as swaps, they're subject to greater regulation,” she said. “Making sure they're in compliance would likely increase costs to the provider, which could make the funds more expensive. Also, wrap providers could be named fiduciaries, which would make them think twice about the business.”