Just How Safe Are Guaranteed Investment Contracts?

Guaranteed investment contracts (GICs) remain one of the most popular investment options for 401(k) plans and other qualified retirement plans. Backed by insurance companies, GICs offer plan participants competitive rates, often higher than those available through banks, coupled with a guarantee of principal. But recent concerns about the financial stability of the insurance industry have led plan sponsors and participants to re-evaluate the strength of the insurance company behind the investment. This re-evaluation is beneficial because it encourages plan sponsors and participants to become more knowledgeable about the GIC investment and their insurance company.

A standard GIC with ongoing plan deposits in the marketplace today has three critical features: the window period, the maturity period and the guaranteed rate of return. The window period is the period of time within which deposits are made to the contract. The most common window is a plan year, typically from January to December. During that time, the deposits are invested in the insurance company's general account. The investments in the general account primarily are conservative fixed income investments, including corporate bonds, Treasury securities and commercial mortgages.

Once the GIC window closes, the money remains in the contract for a certain period of time, called the maturity period. During the maturity period, which ranges from three to seven years, the money in that contract earns a rate of return, which was declared by the insurance company. When the contract finally matures, the principal plus the interest become available for re-investment in another GIC or other investment.

In a 401(k) plan, for example, the participants frequently allocate a certain percentage of their contributions to a GIC option. These savings are deposited and accumulate in the GIC contract throughout the "open" window period. GIC contracts that are "benefit responsive" have the ability to respond to plan participant changes at book value (guaranteed principal and interest). Such changes include transferring investments into another fund, receiving the retirement benefit, or paying the benefit to the participant's beneficiary at premature death. The window closes until maturity, and when each contract matures, the assets are reinvested, usually in another GIC.

The concept behind the GIC is fairly simple. It becomes increasingly complicated with the different variations of GICs. The most well known is a...