Well, clearly the point of the insurance isn’t to eliminate credit risk—which would be too good to be true—but to eliminate interest-rate risk, which is more realistic.

I don’t see the perverse incentives that you suspect here with regard to bond selection. The insurer doesn’t gain anything from a credit downgrade on one of the bonds it picked. The fund’s investors bear the full credit risk—just as they would if they invested in a non-insured bond fund that included the downgraded bond. Even if there are any ways for the insurer to profit from selecting the bonds in the fund’s portfolio, the exact same tricks would be available to anybody managing a bond portfolio for a third party.

What would probably be best to understand is what’s in it for the insurance company—how they expect to come out ahead by providing this insurance. Interest rate volatility cuts both ways—just like bonds’ market values go down with higher interest rates, they also go up with lower ones. Presumably the insurer gets to keep any gains that come from falls in market yield.

MyPFJ – The expense ratio is often provided (mine is 0.60%), but for comparison purposes the stable value fund provides a guaranteed return net of fees.

The key thing I am curious about is what the expense ratio is on the stable value fund compared to the Vanguard Intermediate-Term Bond Index Fund Investor Shares?

If it is much higher, that might also factor in to the decision making process.

Great post though!