What Is a Guaranteed Investment Contract (GIC)?
A guaranteed investment contract (GIC) is a contract between an insurance company and an investor, typically a pension fund or an employer-sponsored retirement plan, such as a 401(k). The investor agrees to deposit a sum of money with the insurer for a specified period of time, and the insurer promises to pay the investor an agreed-upon interest rate, as well as to return the principal.
Employees who participate in a 401(k) or similar plan often have GICs as one of their investment choices. GICs are sometimes called funding agreements.
Key Takeaways
- A guaranteed investment contract (GIC) is an agreement between an investor and an insurance company, typically used in retirement plans.
- The insurer guarantees the investor a certain rate of return in exchange for holding the deposit for a specified period.
- GICs typically appeal to investors who are either risk-averse or looking for a conservative investment to balance out the more volatile portion of their portfolio.
- GICs pay a relatively low rate of interest, putting them at risk of inflation.
How Guaranteed Investment Contracts (GICs) Work
A GIC works a bit like a certificate of deposit (CD) from a bank, although GICs are typically purchased by institutions rather than individuals and often come in much higher denominations. Like CDs, GICs are considered a relatively low-risk investment. They also provide a lower rate of return than many other investments.
In retirement plans, GICs typically appeal to risk-averse investors or those who want to balance out their portfolios by putting some of their money into a low-risk account. GICs are often offered to retirement plan participants as part of a stable value fund or similarly named conservative investment option.
Most GICs have either a fixed interest rate or a variable interest rate that adjusts periodically based on a particular index.
What Does "Guaranteed" Mean With a GIC?
The word “guaranteed” in the term “guaranteed investment contract” comes with a caveat. While the insurance company guarantees that it will pay the agreed-upon interest rate and return the investor’s principal, that guarantee is only as solid as the insurer itself.
When the federal government bailed out the huge insurance company AIG during the 2007–2008 financial crisis, it said one reason was to keep AIG from defaulting on its GICs.
As officials of the Federal Reserve Bank of New York later testified, “Pension plans that had placed funds in AIG guaranteed investment contracts, or GICs, which function much like deposits in a bank, would have experienced significant losses, losses that would be passed along to retirees or to others whose aspirations to be retirees would surely have been changed.”
Since GICs pay relatively low rates of interest, it can be easy for inflation to outstrip their performance.
GIC investors face interest rate risk. And inflation is also an issue. For example, if a GIC pays 4% annual interest over its 10-year term, but inflation averages 6% during that same period, the purchaser will lose money in terms of purchasing power.
What Is a Synthetic Guaranteed Investment Contract (GIC)?
The U.S. Office of the Comptroller of the Currency defines a synthetic guaranteed investment contract (GIC) as “a diversified portfolio of fixed-income securities that are insulated from interest rate volatility by contracts (wraps) from banks and insurance companies. In this arrangement, the 401(k) plan and its participants own the underlying invested assets (the portfolio of fixed-income securities that supports the stable value fund).” With a regular GIC, by contrast, the insurance company owns the underlying assets as part of its general account.
What Is a Guaranteed Investment Certificate?
Not to be confused with a guaranteed investment contract, with which it shares the acronym GIC, a guaranteed investment certificate is a financial product in Canada. Guaranteed investment certificates are sold by Canadian banks, credit unions, and trust companies, often to individuals for their retirement accounts. The Canadian GIC is more like a U.S. CD than a U.S. GIC.
Are Guaranteed Investment Contracts Federally Insured?
No, there is no federal insurance for guaranteed investment contracts, unlike certificates of deposit (CDs), many of which are covered by either the Federal Deposit Insurance Corp. (FDIC) or the National Credit Union Administration (NCUA).
Some insurance products are covered by state insurance guaranty associations. However, many of those associations do not extend their coverage to include GICs.
The Bottom Line
Guaranteed investment contracts (GICs) are contracts between an insurance company and an investor, typically a pension fund or an employer-sponsored retirement plan, such as a 401(k). Employees who participate in a 401(k) or similar plan often have GICs as one of their investment choices, sometimes as part of a stable value fund. Because of their low interest rates, GICs are especially susceptible to the risk of inflation.
