In today’s fluctuating interest rate environment, discussions about how these shifts affect stable value products in retirement plans are becoming increasingly important. Stable value products, typically issued by insurers, are designed for long-term retirement savings, particularly within defined contribution and defined benefit plans. As interest rates change, these products, which are primarily based on fixed-income securities, can be impacted, particularly when it comes to sponsor-initiated exits from these accounts.

Why Interest Rates Matter Now

Interest rates have been relatively stable and low for many years, but that changed dramatically starting in March 2022, when the Federal Reserve began raising rates to counteract pandemic-driven inflation. By July 2023, the effective federal funds rate (EFFR) had risen to 5.33% and is expected to stay there until at least September 2024. This shift in interest rates has caused volatility in stable value products, especially affecting the withdrawal conditions tied to these accounts.

These products typically involve fixed-income securities, which are sensitive to interest rate changes. The faster interest rates rise, the larger the gap between the book value (net value after expenses and withdrawals) and the market value (the gross value that can be realized if assets are liquidated). This difference, known as the market-to-book ratio (M/B ratio), can lead to challenges when a sponsor wishes to withdraw assets, particularly in cases like plan mergers or acquisitions. Often, these withdrawals are subject to conditions like market value adjustments (MVAs), which may result in a liquidation value that’s less than the book value.

How the Interest Rate Environment Affects Withdrawals

Stable value products are structured to offer competitive returns and daily liquidity for participant-initiated withdrawals. However, sponsor-initiated disbursements, such as those that occur during mergers or plan terminations, can be impacted by the relationship between book and market values. This can lead to conditions where the liquidation value falls below the book value, especially in an environment with rising interest rates.

While these fluctuations might not have been as significant during periods of stable or low interest rates, they are now a concern for many plans. When market value adjustments occur, retirees and sponsors may experience delays in accessing funds or receive less than the expected value from their withdrawals.

Will Interest Rates Decrease?

Experts are cautiously optimistic that interest rates may begin to decline soon, although the timing is still uncertain. Key indicators, such as job market reports and inflation trends, suggest that a rate cut may occur as early as September 2024. However, Federal Reserve Chair Jerome Powell has emphasized that the decision will depend on various evolving economic conditions.

If rates do decrease, it could help reduce the gap between market and book values, improving the market value adjustment environment for many stable value customers. This could make it easier for plans to manage exit provisions while reducing the financial impact of withdrawals.

Available Solutions for Stable Value Withdrawals

When interest rates are high, and the market-to-book ratio is unfavorable, plans may face restrictions on withdrawals, such as disbursements being paid over time or being adjusted by the market value. However, when rates decrease, these conditions may improve, making it easier to access the full book value.

One solution offered by some stable value providers is a “book-up” arrangement. In this case, when a plan’s assets are transferred, the insurer may take over the assets at book value, but the crediting rate is typically discounted. This option helps stabilize the plan’s value during times of market volatility.

It’s crucial for plan sponsors to work closely with their financial advisors and providers when managing stable value contracts, especially when major events, such as mergers or terminations, are on the horizon. By consulting with experts, sponsors can explore the most suitable options—whether it’s installment payments, liquidation values, or book-ups—based on the current market conditions and the plan’s specific needs.

Conclusion

While the current interest rate environment may present challenges for stable value products, there are strategies available to help mitigate the impact on retirement plans. By carefully managing market value adjustments, understanding the timing of Social Security and other distributions, and working closely with financial advisors, retirees and plan sponsors can navigate the complexities of withdrawals and ensure their retirement savings remain on track.