“The marketplace for wrap coverage has completely dried up,” said Edward Lilly, executive director of the $7.9 billion, Albany-based New York State Deferred Compensation Plan, at a conference in New York late last month.
Lilly, who was not available for an interview, noted the plan had recently hired a new stable-value manager but was still negotiating with wrap providers. “It’s very difficult to get wrap capacity right now,” he said, “and it’s more difficult than in the past to bring a new manager on.”
The wrap market has gotten “very tight,” as some providers have left the market while others are not expanding their existing businesses, says Keith Overly, executive director of the $6.8 billion Ohio Public Employees Deferred Compensation Program in Columbus. “Wrap providers have generally become more risk-averse and are renegotiating fees and terms and conditions.”
Wraps are contracts provided by insurers, banks or other financial companies that protect stable-value funds’ bond portfolios from wild swings in interest rates, guaranteeing participants will receive the funds’ book value even if the market value falls. They are used by stable-value managers and sponsors of plans that offer stable-value funds as an investment option. Large plans often arrange the contract directly with the wrap provider, while smaller plans usually buy collective trusts from large money managers, which have the insurance contract with the provider.
But as insurers and other providers look to shore up their balance sheets and reduce risk, they are reluctant to provide additional wrap coverage.
One area of concern: The market value of underlying securities has fallen in many stable-value funds, increasing the pressure on wrap providers to make up the difference. The average stable-value fund tracked by research firm Hueler Analytics had a market value that was 95.6 percent of its book value as of March 31, compared with 99.4 percent at the end of 2007, says president Kelli Hueler.
Plan participants had about $642 billion in stable-value funds through 167,000 defined-contribution plans as of year-end 2008, according to Gina Mitchell, president of the Stable-Value Investment Association in Washington.
As of March 31, stable-value funds accounted for 35.6 percent of DC plan assets, according to Hewitt Associates.
UBS, Rabobank out
UBS and Rabobank Group are exiting the wrap business, while the future of American International Group Inc.’s wrap business remains unclear given the firm’s financial troubles, Mitchell says. Those three companies accounted for an estimated 10 to 15 percent of the market, she says. Representatives from UBS and Rabobank did not return calls seeking comment.
The dozen or so remaining providers—including Aegon Group, JPMorgan Chase & Co., Bank of America Corp. and ING Group—have been reassessing their risk profiles and are demanding more from stable-value funds, including tighter investment guidelines, Mitchell says.
“There’s been so much pressure on liquidity and capital that some wrappers are simply not stepping up to wrap new cash,” says James King, vice president and head of Prudential Retirement’s stable-value markets group in Hartford, Connecticut.
A survey of 10 wrap contract providers by Pacific Investment Management in Newport Beach, California, found that none had capacity at “typical” levels as of the first quarter 2009, and all were uncertain as to when they would be adding capacity.
As a result, defined-contribution plan executives and stable-value managers are having a difficult time replacing wrap providers that have left the business or have stopped accepting new business.
The lack of capacity also has prevented plans from replacing stable-value managers because that might require renegotiating wrap contracts.
“There’s no doubt capacity has pretty much dried up over the past week or two,” says Christopher Tobe, a consultant at Breidenbach Capital Consulting in Louisville, Kentucky.
“I’m hopeful it will slowly pick up again in six months, but right now all the providers are very capital conscious. It’s a really serious problem,” he says.
The Stable Value Investment Association’s Mitchell, however, says that association officials have been in talks with several companies that are interested in entering the wrap market to add capacity, but she declined to disclose their names. “Overall the ice is starting to melt, but it’s a slow process,” she says. “There’s a reassessment of risk at all financial companies, so potential newcomers to the wrap market have internal management hurdles to deal with, as well as regulatory hurdles.”
Metropolitan Life Insurance Co., MassMutual Financial Group and The Hartford Financial Services Group Inc. are considered top candidates for stepping in to provide more capacity, Tobe says.
Rebecca Cohen, a spokeswoman for Vanguard Group, says there is still capacity in Vanguard’s stable-value portfolios and that they are still wrapped. “We do not have to give up that capacity, and can continue to take participant contributions, although new money may be directed into money market securities,” she wrote in an e-mail response to questions. “The tone in the market has improved since March, and we are optimistic that stable-value providers will be able to work with issuers to provide additional future capacity.”
Pacific Investment Management Co. is hoping to launch its PIMCO Stable-Value Trust on November 1, says Steve Ferber, senior vice president and account manager, but he does note that it’s a tighter market for wraps. “We think wrappers are going to continue to be more selective about which investment managers they’ll work with,” he says. “But we’re actively speaking with wrap providers about wrapping our stable-value fund, and are deep in conversations with two companies.”
In the meantime, defined-contribution plan executives can seek alternatives to so-called “synthetic” wraps, in which participants own the invested assets. For example, insurance company separate account guaranteed-interest contracts can offer the same principal protection and similar features as wrap contracts, but are generally more expensive for plans, Tobe says.
Cynthia Mallet, vice president of corporate benefit funding at MetLife in New York, says she has seen an uptick in demand in recent months for such separate accounts.
Hueler agrees. “We encourage plan sponsors to consider the whole spectrum of products, from general account products to separate accounts,” she says. “One structure may be more beneficial than another, depending on the plans.”