Protecting a legacy

legacy


With $2.4 billion in member assets, the Guaranteed Investment is kind of a big deal.

June 2017

In 1978, the WEA TSA Trust rolled out a Guaranteed Investment account to Wisconsin public school employees as its first 403(b) investment opportunity. Today, approximately 46,000 participants have nearly $2.4 billion worth of assets in the account currently held and managed by Prudential Retirement Insurance and Annuity Company (PRIAC).

It’s kind of a big deal.

Just as Member Benefits monitors our mutual fund investments to make sure they continue to meet our standards, we also monitor the Guaranteed Investment and evaluate PRIAC in their role as manager of the account to ensure the best interests of our participants are being served.

Experts on board

Helping with the due diligence process are Mike Driscoll and Jim King. Both have a vast amount of knowledge in the financial industry as well as personal work experience with the Guaranteed Investment.

Mike, now a consultant, has worked with retirement plans for over 30 years. “In 1987, I worked at CIGNA and was involved when the assets in the Guaranteed Investment were moved to CIGNA from UNUM.”

As Mike indicates, the guaranteed account has not always been with PRIAC. PRIAC actually inherited the account after they purchased the CIGNA retirement business in 2004. Member Benefits has been with PRIAC ever since.

Jim spent 17 years in portfolio management with Merrill Lynch, including stable value (SV) funds (which is essentially what the Guaranteed Investment account is.) He then spent 15 years with PRIAC specializing in SV funds before starting his own SV consulting company. “At PRIAC, I was partly responsible for the relationship with Member Benefits and managed the Guaranteed Investment for over five years, so I know the fund very well. It’s one of the best stable value funds in the country,” he says.

Doing our due diligence

Member Benefits is currently evaluating the Guaranteed Investment. The process began last fall under the direction of Susan Winchester, Vice President of Retirement and Investment Services at Member Benefits. A Request for Proposal (RFP) was drafted and sent to over 30 companies to see what options were available. In the end, seven companies expressed interest and five gave a formal response. Those five responses are currently under consideration.

The RFP will help us determine if the program as offered today is still competitive in the marketplace. “We’ll be looking at firms that can provide a similar program and evaluating their interest rates, fees for service, and the types of portfolios they invest in,” says Susan. “We’ll also do our normal due diligence, including financial strength ratings. In the end, we’ll want to answer this core question: What is in the best interest of our members?”

One of a kind

One thing is clear: The Guaranteed Investment is one of a kind. Its uniqueness started at its inception with the philosophy on which the program was built.

When the account was moved to CIGNA, Mike recalls, “There was a strong belief that the money in the Guaranteed Investment Account was to be protected. The creation of the WEA TSA Trust 403(b) program wasn’t meant for people to chase equity market returns. This was for safe keeping. And that’s why only the Guaranteed Investment was offered in the beginning, and members were not offered an equity fund option early on.”

The founders of our 403(b) program felt the best way for members to get to retirement and have enough saved to support themselves was by putting their money in a safe place, earning a reasonable rate of return, and having a guarantee against loss. “Those three things were important then and they remain a priority for Member Benefits today,” says Susan.

A long legacy

“There are many competitors in the marketplace that have been trying to figure out how Member Benefits has been able to be so successful with this program and offer the guarantee and low fees. It’s because this legacy product has worked really, really well for members over time and it has been impossible for anyone to duplicate,” says Jim.

What makes it so difficult to copy? In part, the success of this program was the timing of when it came together. In 1978, the economy looked very different. Interest and inflation rates were on the rise—both were north of 12%—and, according to Mike, the timing couldn’t have been better to establish a SV fund. “The high interest rates and inflation rates at that time turned out to be a real plus, creating a big tailwind of higher returns supporting the program while the interest rate markets steadily declined over the following 30 years. This is one of the main reasons why other organizations can’t replicate it.”

Mike goes on to explain that the tailwind was created by CIGNA/PRIAC making loans and buying bonds—5-, 10-, 20-year loans or bonds—at 10% or more. “These long-term investments continued to pay back at the high rate over however many years, even as interest rates in general fell. This allowed the credited rates in the Guaranteed Investment Account to remain higher for a longer period of time, and members were rewarded with higher than current market returns.”

However, while the rate was slow to come down and meet the market, rates are also slow to rise when the market goes up. “Stable value funds lag the market, regardless of which direction the market is going,” he adds.


“It’s one of the most seasoned funds in the country.” — Jim King


The Guarantee is the key

A SV fund is comprised of two parts: 1) a portfolio, and 2) a guarantee. The guarantee is on the participant’s principal and net credited interest. In other words, investors will never receive less than what they have contributed plus the accumulated interest credited on those contributions, even though the price of the underlying securities (the bonds and funds in the investment) may go down.

The value of SV funds proved out during the 2008 financial crisis when the stock market tanked. Portfolios that held SV fund investments fared better because of the guarantee. “A stable value fund serves as an anchor,” says Jim. “In a volatile market, it maintains its value and is a buffer for the entire portfolio. Because the Guaranteed Investment has been around since 1978, it’s one of the most seasoned funds in the country.”

The rising cost of a guarantee

To ensure the safety of participant assets, PRIAC is required to hold reserves equal to the assets in the Guaranteed Investment. Jim explains that while the guarantee of SV funds worked as intended in the 2008 crisis, the fact that bond prices decreased significantly put SV managers at a greater risk for loss because the guarantee became much more expensive. “In fact, the price of guarantees in the marketplace almost tripled,” he says.

The increased cost of the guarantee presents a special challenge for PRIAC and the Guaranteed Investment.

Mike adds that since the crisis, actuaries and regulators have taken more of a microscopic look at the risks of SV from the guarantor side. The Financial Stability Oversight Council created by the Feds under Dodd-Frank developed the Systemically Important Financial Institution (SIFI) designation to label companies whose collapse would pose a serious risk to the economy. This is the “too big to fail” list.

In 2013, PRIAC was one of four non-bank companies put on the SIFI list. SIFIs abide by “enhanced” rules that are tougher than the ones that apply to their smaller, less-complex peers. Higher capital requirements effectively limit how much SIFIs can borrow, and can crimp profitability. Defenders of the SIFI process say those stricter regulations are justified because SIFIs pose an outsized risk to the stability of the broader economy.

“For PRIAC, this status is costly and forcing change. The Guaranteed Investment will likely not be immune to these changes,” says Jim.

Diversifying could help

According to Jim, the sheer size of the fund increases the risk for PRIAC, as well as for members.

Why? With PRIAC, there is a single provider of the guarantee. Essentially, we have all our $2.4 billion SV fund eggs in one basket. It’s been this way for 39 years.

However, every fund evaluation poses this question: Is this prudent? In 2012, we examined PRIAC’s products, fees, services, financial strength, financial position, and client management among other things, and compared them to those of other major stable value providers. Mike was a member of the evaluation team, and says the answer to that question in 2012 was yes. “We concluded the relationship with PRIAC was still in the best interest of members. They were still strong and stable and the program continued to be better than anything else available, even with contract changes imposed by PRIAC at the time.”

The evaluation in progress will again have to answer these questions: Is PRIAC the best partner today? Should we continue with a single creditor program, or do we need to start to look at diversifying—spreading the account and the risk to one or more additional firms? If doing so would strengthen the guarantee, that would definitely be a plus.

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The Prudential Guaranteed Investment account is a long-term savings vehicle that assumes the role of a fixed income or bond investment in your asset allocation mix. Learn more at weabenefits.com/pru.

Vetting potential partners

“We use ratings issued by Standard & Poor’s, Moody’s, and Fitch,” explains Mike. “Moody’s rates PRIAC as A1, the fifth highest of 10 investment grade ratings. That’s a good rating, but there are ratings above that, like Aa and Aaa. Some of the interested companies who responded to the RFP are Aaa, which indicates that they are in a slightly stronger financial position today than PRIAC.” Financial strength is a must, but there are other critical considerations as mentioned earlier.

Regardless of who we decide to partner with, at the end of the day, it’s important that members know we have done everything we can to choose a strong financial institution(s) to honor the guarantee.

Predicting the future

After nearly 30 years of declining interest rates, we are in an economic environment in which rates are expected to rise. “In fact,” Jim says, “this last week (June 14, 2017), the Federal Reserve announced a quarter-point interest rate hike.” Interest rate changes are among the most significant factors affecting bond return. When interest rates rise—bond prices generally fall. And that puts the SV fund managers at higher risk to sustain losses.

“In regard to the Guaranteed rate,” Mike suggests, “members will likely see interest rates in the program fall a little further before stabilizing regardless of what changes come from the evaluation. We will also see the impact from the increased cost of a guarantee.

“Further, members currently have the ability to move money freely in and out of the program, but it would not be unreasonable to expect some parameters set around how much can be moved out of an account in a given year.”

Mike explains that the withdrawal parameter may be necessary to protect the account for long-term investment. A large-scale withdrawal from an SV fund could impose a significant adverse impact on all of the remaining investors and potentially result in losses for the SV fund manager.

Most other SV funds do not allow the plans or the participants to immediately receive the book value of the investment, which is contributions plus interest earnings, if the fair market value of the investment is less.

“It’s our responsibility to protect the members and their investment, as well as ensure the viability of this program for long-term investors in the future,” says Susan.


“This program has good bones.” — Susan Winchester


Looking forward

The Guaranteed Investment may look different after the evaluation is complete and decisions have been made, but both Mike and Jim agree that it will still fulfill the original purpose and be in the best interest of members. That purpose includes:

1. Safety (low risk).

2. Earning a reasonable rate.

3. Having a Guarantee.

Susan reflects, “This program has good bones. The fact that it was carefully designed for the benefit of our public school employees is precisely why it has succeeded. We’ve never lost sight of why it was created.”

Some things to expect as we move forward include:

  • The crediting rate may go lower before stabilizing.
  • Flexibility for moving money may change.
  • We are working to maintain the unique characteristics of the program that set it apart from other SV funds, including offering a higher level of protection in different economic environments.
  • We are considering providers that maintain transparency regarding fees and strong financial ratings.

At the end of the day, we want to work with a company or companies that have similar core values to our own and can contribute to the financial security of Wisconsin public school employees. We are working hard to do just that.

Interest is compounded daily to produce the current annual yield prior to the deduction of program administrative fees. Contributions and earnings are held in the general account of Prudential Retirement Insurance and Annuity Company (PRIAC). Principal and net credited interest are fully guaranteed by PRIAC. Such guarantees are based solely upon the financial strength and claims-paying ability of PRIAC. For more information go to weabenefits.com/pru.

Meet our consultants

Mike DriscollMike Driscoll, Managing Director of Sheridan Road

Mike began his institutional retirement plan career in 1980. He spent nearly 17 years with CIGNA Retirement & Investment Services prior to the sale of CIGNA’s retirement business to Prudential Financial in 2004. He was also involved with transitioning Guaranteed Investment assets from UNUM to CIGNA from 1987–1988.

Mike has earned and maintains the Accredited Investment Fiduciary designation. He is a past President of the Board of Directors of the Greater Milwaukee Employee Benefits Council.

He also has a personal connection to and interest in Wisconsin public schools. “My wife Janet was a teacher. She taught in the Cedarburg School District.”

Jim KingJim King, Founder and CEO of King Stable Value

Jim serves as general account investment portfolio specialist and spent 15 years with Prudential Financial. For more than five of those years, he managed the Guaranteed Investment for the WEA TSA Trust and WEA Member Benefit Trust. “I know the guaranteed fund very well,” he says. “It’s one of the best stable value funds in the country.”

Jim is also a past Chairman of the Board for the Stable Value Investment Association.

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