Though the value of many investments sank in late 2008 when market waters turned perilous, stable-value funds managed to stay afloat, spurring a massive inflow of funds from distressed defined contribution participants.

However, some financial experts are concerned that the stability of these funds may be slipping. (See "In economic crisis, even stable-value funds on shaky ground," from EBN March, available on BenefitNews.com.)

"The economic events have provided a wake-up call for plan sponsors to plan and focus a little bit more on what they've been doing with their stable-value fund," says Cynthia Mallett, vice president of corporate benefit funding at MetLife.

Despite the notes of caution, Mallett believes these funds have preformed swimmingly despite the crushing environment.

"The market events of the last two years, which have been extraordinary and unprecedented, have performed effectively a tremendous stress test on stable-value products along with other sectors of the economy. In our view, they have held up to this unprecedented test remarkably well," says Mallett.

The evidence is there. In 2008, every stable-value fund posted a positive return for the year, according to the Stable Value Investment Association. It's welcome news to retirement plan participants, as about half of all 401(k) plans offer stable-value funds to participants, representing about $520 billion in retirement plan assets, finds the SVIA.

Therefore, experts underline the importance of examining the integrity of the stable-value and its associated guarantees.

Sense of security

Stable-value funds "were designed primarily to preserve principal with the expectation of some small amount of return over time. The way they were structured - by having underlying investment portfolios with a guarantee - created the perception that they are the safest vehicle out there," explains Sue Walton, senior investment consultant at Watson Wyatt.

As such, stable-value funds became the investment of choice when the economy went sour. According to Hewitt's 401(k) Index Report, stable-value funds experienced an all-time high allocation of 35.6% in first quarter of 2009. As of June 30, the total allocation for Guaranteed Interest Contracts Stable Value was at 31.3%, as participants - reacting to an improving stock market - began to increase allocations to equity funds.

Last year, the stable-value funds earned an average rate of return of 4%, while virtually every other asset class experienced double-digit dips, reports a Prudential Financial white paper. Accordingly, over $5 billion were transferred into stable-value products from other investment options within DC plans.

They also outperform other investment funds in the long run. According to research by Dr. David Babbel and Dr. Miguel A. Herce of the University of Pennsylvania's Wharton School, stable-value funds had an average annual return of 6.3% over the span of 1989 to 2008, as compared to intermediate-term bond funds (5.7%) and money market funds (4.1%). They also found the stable-value products to have the highest-value long-term returns with the least amount of variability.

"The appetite for an investment option that protects principal and guarantees interest is so strong that, among 401(k) plan participants who actively elect into investments, roughly one-third of all of the money in 401k plans is allocated to stable-value," Mallett explains.

"The lessons of this economic downturn will stick with people for a long time," she continues. "The sense of having your first level of savings for retirement and for security parked in something safe - there's an enormous appetite for that."

Financial planning for fiduciaries

Stable-value investments may be safe, but the cost for providing guarantees has increased over time, with traditional wrap contracts ranging five-to-eight basis points. Given liquidity and risks, the cost has increased considerably, almost doubling in some cases.

"Even at the higher cost, we still think that stable-value has added value to participants over time and is still an appropriate choice for plan sponsors to include as a conservative option within the investment structure. But it goes back to awareness, education and understanding what you have from a fiduciary perspective," advises Walton.

Mallett concurs: "The only time you have a safety or stability issue is if you're a plan sponsor and you don't understand what you've signed up for," she says.

A lot of that understanding is planning. Plan sponsors can take a hint from the infamous Lehman Brothers debacle. This catastrophe was highly unique in that it happened almost overnight, leaving the company with no time to reach out to wrap contractors, some of whom converted these investments to market value, as stipulated in their contracts.

The take-away for employers is to have a sound plan design that accounts for these types of unforeseen circumstances that the employer initiates, such as terminating a plan, filing for Chapter 7, mass layoffs and mergers.

Nevertheless, despite a negative return of 1.7% for the month of December 2008, Lehman's stable-value funds earned 2% for the year during a time when many other 401(k) investments had negative returns, a testament to the strength of the stable-value, according to SVIA.

"What this unusual situation does do is point out the importance of plan sponsors' and their plan participants' understanding what events can affect their book-value guarantees," Mallett says.

"Stable-value across the board is very safe; it has a terrific track record, it has been amazingly consistent, and it's done a terrific job for plan participants for over 30 years. The headlines, the press and the concerns that have raised the spotlight on stable-value have really served to illustrate most effectively that guarantees matter and how your guarantee is constructed matters. In particular: What are the circumstances that could affect the way your guarantee works? That is the part that people haven't focused on, neither plan sponsors nor participants," Mallett adds.

Stable-value checklist

The economy has provided that insight into what employers should be considering when drafting a wrap agreement. If anything, they should keep in mind that there is no one-size-fits-all.

"That is the biggest lesson learned in the marketplace - that you need to understand what you have when you buy off the shelf," says Walton. "Plan sponsors should be aware of what their contract language outlines in terms of the liquidity that could be provided and they should understand the health of the portfolio today. For example: What is the market-to-book-value ratio and what are the underlying securities that are in the portfolios?"

Prudential Financial provides a checklist for choosing a stable-value product and associated guarantees in its white paper, "The Search for a Safe Way to Save for Retirement":

1. What does the guarantee provide in terms of principal protection and a minimum crediting rate?

2. Are there any conditions under which the guarantee provider can back out?

3. How strong is the guarantee in terms of the level of capital that has been reserved to back the guarantee and the credit ratings of the guarantee provider?

4. What is the safety net in place if the guarantee provider cannot meet its obligations?

5. How accessible are the assets under a range of scenarios, such as the termination of the plan or any distress faced by the guarantee provider?

6. Can the guarantee provider offer full transparency into the underlying investments in its general account or other balance sheet assets that support the guarantee?

7. What are the fees and asset minimums to access the product?

"The driving theme here is that guarantees matter, structure matters and paying attention to fundamentals is important. None of these are really new insights, but it's not a bad thing to have a reminder periodically. Well-constructed stable-value is and has been a great product, and it really has a unique value proposition to a plan participant," concludes Mallett, whose testimony before the ERISA Advisory Council pushed for the adoption of stable-value funds as a qualified default investment alternative.

If the funds were added as a QDIA, participants would be automatically enrolled in a fund with less volatility and guaranteed interest return - a welcome respite from the turbulence of the last year for sponsors and participants alike.