A resurgence of demand for investment options featuring guarantees is arising from the recent wreckage of the retirement portfolios of members of capital accumulation plans.
Plan sponsors are re-establishing guaranteed investment accounts (GIAs), the insurance industry cousins to guaranteed investment certificates (GICs) offered in the retail banking sector, and they are re-examining default investment options which were trending away from money market funds and GIAs towards balanced and asset allocation or lifecycle funds in recent years. There are also new group investment products to consider, that feature life underwriting guarantees or financial guarantees on maturity of funds.
My purpose in this column is to examine the offering of GIAs – how they work and two different models for their implementation – through pooled GIA or individual GIAs.
Before delving into that topic, a general observation on guarantees is called for. Financial institutions are generally enamoured of these products, as the guarantees help bind deposits, and therefore CAP clients, to the institution. Either guarantees are lost or penalties are likely to apply when the CAP sponsor wishes to transfer their business to another institution. Penalties or the risks to plan members on the loss of guarantees are often sufficient to dampen sponsor enthusiasm for a change in providers that might otherwise make good economic and fiduciary sense.
Individual GIAs have a long tradition in the insurer-dominated CAP services marketplace. Prior to the 1990s some insurers offered only GIAs to their CAP clients, and the high interest environment of the 1980s meant that GIAs were the most popular investment category even among those insurers who offered in-house managed segregated funds. Everything changed during the 1990s as investment choice proliferated, but even now it may be possible to find a defined contribution pension plan sponsor holdouts that restrict investments to 5-year GIAs.
The operation of individual GIAs under a CAP is actually quite complex when you consider that deposits occur at monthly, twice monthly or bi-weekly intervals. When a member selects a 5-year GIA investment option, his (or her) account ultimately consists of up to 60 (monthly deposits), 120 (twice-monthly) or even 130 (bi-weekly) interest rate and maturity terms. Although GIA terms generally permit early withdrawals, penalties will almost certainly apply. On early withdrawal (except at death of a member), contractual terms will specify lesser of book value or adjusted market value, with the latter often based on current interest rates less up to 0.5% per annum as an additional penalty – thus almost certainly assuring the latter will come into effect relative to at least some interest/maturity terms in the account.
These operational issues beg the question of whether CAP members actually understand how GIAs in their CAP plan differ from the GICs they are familiar with in the retail banking/trust/credit union market. In the latter case, lump sum deposits are the rule, rather than periodic deposits (for a number of reasons, most significant the minimum GIC deposit requirements which do not apply to GIAs), thus making interest credits transparent and easily verifiable. In addition, the terms of retail GICs around early withdrawals will be quite clear.
This is not the case for GIAs – although not impossible, it is exceedingly difficult for members to verify interest credits, and the negative impact of adjusted market value on early withdrawal may be buried relative to maturities where the book value remains lesser. Further the basis of GIA market value adjustment calculations is seldom disclosed to plan members.
Individual GIAs have also received relatively little scrutiny by CAP sponsors and their advisors in recent years, as they have had low popularity consequent to a low interest rate environment while other asset classes performed reasonably well. The result has been erosion of terms favourable to investors, including the removal of book value on termination and (to a lesser degree) retirement, increases in penalty loads added to adjusted market values, and removal of contractual pegging of base rates to external measures.
Pooled GIAs/GICs are not a new concept, but with the lack of popularity of GIAs in general, the concept is not well understood. A pooled GIA operates similar to a money market fund, with the underlying investments consisting of GIAs which can be issued on specific or varying terms as determined by the CAP sponsor. The fund as a whole is unitized, usually at a fixed value ($10), with income accrued to member accounts on a periodic basis, usually monthly, through the allocation of additional units.