Why do employee benefit plan financial statements present stable-value funds at fair market value with an adjustment to contract value? And what does the adjustment represent? The answer is benefit responsiveness.
Benefit responsiveness is a term used to describe investments that guarantee contract value (or book value) even when the fair market value of the underlying assets is more or less than contract value. This means that when plan participants receive benefits, they’ll receive those benefits at the value specified in the contract—even if the value of the plan’s investments isn’t sufficient to meet the benefit obligation. The fair market value of the plan’s investments will rarely equal but may approximate the contract value.
Benefit responsiveness can be provided through one or more different types of investment contracts. The criteria for benefit responsiveness has been established by the Financial Accounting Standards Board, and all five of the following requirements must be met for an investment to be considered benefit responsive:
- The contract is between the plan and the issuer and cannot be sold or assigned without consent of the issuer.
- The contract issuer must be obligated to either repay principal and interest or provide prospective crediting rate adjustments with an assurance that the crediting rate will not be less than zero.
- The contract requires all participant-initiated transactions to occur at contract value (without any conditions, limits, or restrictions).
- An event that limits the plan’s ability to transact with the issuer and with participants at contract value must be unlikely to occur.
- The plan must allow participants reasonable access to their funds.
Stable-Value Fund Investments
Stable-value fund investments (SVIs) are commonly found in employee benefit plans, particularly defined contribution plans. SVIs can be any one of the following types of investments:
- Pooled separate accounts with underlying benefit-responsive contracts
- Collective trusts with underlying benefit-responsive contracts
- Traditional guaranteed investment contracts (GICs), which are typically benefit responsive
- Synthetic GICs, in which the plan owns the benefit-responsive contracts
- Fixed-interest contracts (those with a deposit administration or immediate participation guarantee), which are typically evergreen (that is, they have no maturity date) and benefit responsive
Accounting standards require that fully benefit-responsive SVIs be reported at contract value on plan financial statements—and that is the relevant value, since it’s the value at which these investments are bought and sold by plan participants. But accounting standards also require that all plan investments be presented at fair market value, which is why there is an adjustment from fair value to contract value for fully benefit-responsive investments contracts on the plan financial statements.
Benefit responsiveness provides preservation of principal and a stable crediting rate by amortizing gains and losses over the duration of the portfolio, smoothing market volatility. This smoothing is triggered through the rate reset mechanism and insulates a portfolio against day-to-day volatility, as modeled in the following diagram:
Obtaining SVI Fair Market Value
It’s the plan sponsor’s responsibility to determine whether the fair market valuation is appropriate, and in many situations this can be a challenging process.
The fair market value of SVIs that are held in collective trusts can be obtained from the audited financial statements of the collective trust, which means those values are readily available. The fair market value of SVIs that are synthetic GICs can generally be obtained from the manager of the synthetic GIC investment, so those are also readily available. Insurance company–provided SVIs have less transparency, and the fair market values are not as easily obtained. It may be possible to obtain an annual summary of the underlying investments in pooled separate accounts that will show the contract value and fair market value of the underlying investments; however, that doesn’t happen in all cases. An evergreen insurance product will typically be valued at discontinuance value and can be provided by the insurance company. The fair market value of traditional GICs may be provided by the insurance company; however, many are providing support that the fair market value equals contract value. In these cases, the plan sponsor should look at discounted cash flow methods to determine fair market value.
In all cases, information obtained from the SVI should include all of the following elements to help plan sponsors determine the appropriate fair market values:
- Crediting rate
- Benchmarks for stable-value fund
- Fund fees, which typically comprise management fees, subadvisory fees, and investment contract premiums
- Average credit quality of assets in the underlying portfolio
- Average duration of the stable-value fund
- List of stable-value contracts that includes their individual credit quality and the stable-value fund’s overall exposure to each stable-value contract
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For more information on SVIs and benefit responsiveness, or to learn more about managing your responsibilities as a plan sponsor, contact you Moss Adams professional.