How to pick a synthetic GIC.

• Author: Krebs, C. Robert
• Position: Guaranteed investment contract

Shopping around for a synthetic guaranteed investment contract? They're not all the same, as some plan sponsors found out the hard way.

Traditional guaranteed investment contracts are the cornerstone of many a pension-fund management strategy. But when a traditional GIC issuer, Confederation Life, recently failed and another issuer, Crown Life, was downgraded below investment grade, many plan sponsors decided a better alternative might be the traditional GIC's kissing cousin -- the synthetic GIC, which offers greater safety through better diversification and the potential for higher returns.

Pension-plan participants have been quick to catch on to those features. Alarmed by current market conditions and negative returns on bond-fund options, they're increasingly demanding stable-value options because they don't want to see volatility in their account values.

While you probably know how a synthetic GIC works, don't make the mistake of thinking they're all created equal. Because of the nature of synthetic GICs -- the plan retains legal title to the assets, which are managed by a professional money manager to help mitigate the risks -- financial executives tend to view the book-value wrapper portion of a synthetic GIC as a commodity. They think all wraps do the same thing for about the same price.

Some large plans with that view recently incorporated market-value assets into their stable-value funds, thinking they could save themselves the cost of the wrap. Many of them subsequently suffered losses in the principal value of their funds and are now converting back to book value. They learned that book-value wrappers are there to insulate plan participants from market volatility and that they're well worth the fee. Also, many plans have learned that with the protection from the wrap, they can safely invest further out on the yield curve.

But even if you're convinced of the value of wrappers, you still need to be able to distinguish among them. The first step is realizing wrappers are definitely not commodities. Many product variations are available, each with different features and characteristics that could affect your plan differently. It pays to shop around, not necessarily for the best price, but for the best fit with your plan's needs.

ACCEPT NO SUBSTITUTES

First, consider the legal issues involved. The most important question is whether the plan retains legal title to the underlying assets. If the contract doesn't allow you to do that, it's not a true synthetic GIC. Some providers market "alternative" GICs as synthetics. They are not.

An alternative GIC usually means a secured-interest or a separate-account product. With a secured-interest product, collateral secures the plan assets. But with a separate-account product, the plan assets are deposited into a separate account where the provider still legally holds title to the assets, which are segregated from the provider's general account.

Under both product types, however, the assets are held in the provider's name, not the plan's. This doesn't affect how the product works, but if the provider fails, asset ownership could become a big issue. You should be able to get your money in the event of insolvency, but it could take months of legal wrangling, and separate-account and secured-interest products may not be treated as originally assumed, depending on the state.

You should also find out who reviewed the product. This question gets at a whole range of important considerations: legality, complexity and regulatory issues. Ask to see a list of the law firms that have reviewed the provider's contract -- not just the provider's own outside counsel, but also the outside...