GIC strategies for the '90s.

• Author: Hughes, Bernard R.
• Position: Guaranteed investment contracts - Benefits

Participants in defined contribution plans, when offered a choice of investment products, typically have chosen the book value GIC investment option. Depending on what study you look at, GIC investment options account for anywhere from 60 to 80 percent of total plan assets.

No wonder. These funds have a number of attributes plan participants want.

* Stable Returns: GIC funds are not subject to the volatility associated with most other investment products, so a well-managed portfolio of GIC investments generates returns that gradually rise as interest rates go up and gradually decline as interest rates fall. Plan participants can understand the relationship between the earnings rate credited to their accounts and the current level of interest rates.

* Book Value Withdrawals: Participants can get distribution of their assets at book value regardless of the investment environment. With employment so insecure during the past few years, older and younger participants alike have chosen this option because they know exactly what they'll get from the plan should they leave.

* Competitive Return: Throughout the years, the investment returns associated

with GIC options have been attractive, and, in fact, many defined contribution plan sponsors still support blended rates above 8.5 percent, a very good rate in the current environment.

Safety of Principal: Until recently, participants assumed that investment in a GIC meant that their principal was safe and the rate of return guaranteed. They have not understood that the guarantees are only as good as the insurance companies that issue them. While most plan sponsors have made a point of delivering this message to participants during the past two years, there has not been a major exodus from this investment option.

Even when Executive Life and Mutual Benefit were taken over by the State Insurance Department, only a small number of participants moved into other products.

We should point out that even though GICs have been popular and generally successful investment options for participants, we recognize that participants who invest heavily in them are not necessarily doing the right thing. Perhaps education will encourage participants to accept more risk and invest more heavily in equities to obtain higher returns. The majority of participants so far have voted with their feet and have directed most of their money into conservative options, such as GIC and money market funds.

MANAGING THE CREDIT RISK DILEMMA

With the credit risks now apparent in traditional GIC products, some plan sponsors have decided to stop using GICs and their attendant book value accounting. But, while this solution may be appropriate, a plan sponsor needs to make certain that any replacement has the attributes participants want most--those attributes we've already discussed.

During the past few years, a new product structure has evolved that offers participants these attributes and, at the same time, satisfies the plan sponsor's need for diversification of investment credit risk. The most recent of these products is the synthetic GIC offered by insurance companies, banks, and investment management organizations. We estimate that as much as 50 percent of both new money and maturities have been placed...