Guaranteed Investment Contract (GIC)
What Is a Guaranteed Investment Contract (GIC)?
A guaranteed investment contract (GIC) is an insurance company provision that guarantees a rate of return in exchange for keeping a deposit for a certain period. A GIC requests to investors as a replacement for a savings account or U.S. Treasury securities, which are government bonds guaranteed by the U.S. government. GICs are otherwise called funding agreements.
How Guaranteed Investment Contracts Work
A GIC is sold in the U.S. what's more, is like a bond in structure. GICs pay a higher interest rate than most savings accounts. Nonetheless, they stay among the lowest rates that anyone could hope to find. The lower interest is due to the stability of the investment. Less risk compares to lower returns on interest payments.
A U.S. issued GIC varies from a Canadian guaranteed investment certificate, which has a similar abbreviation. The Canadian certificate, sold by banks, credit unions, and trusts, has various traits.
Insurance suppliers offer GICs, which guarantee the owner a repayment of principal alongside a fixed or floating interest rate for a predetermined period. The investment is conservative, and maturity periods are most frequently short-term. Investors who purchase GICs frequently search for stable and predictable returns with little variances in price or low volatility.
Buyers of Guaranteed Investment Contracts
An insurer as a rule markets GICs to institutions that fit the bill to receive good tax situations with as houses of worship and other strict organizations. These organizations are tax-exempt under section 501(c)(3) of the tax code, due to their nonprofit and strict nature. Often the insurer will be the company that deals with a retirement or pension plan and offers these products as a conservative investment option.
Frequently, the backers of pension plans will sell guaranteed investment contracts as pension investments with maturity dates going from one to upwards of 20 years. At the point when the GIC is part of a qualified plan as defined by the IRS Tax Code, they might endure withdrawals or be qualified distributions and not cause taxes or punishments. Qualified plans, which allow an employer to take tax deductions for contributions it makes to the arrangement, incorporate deferred payment plans, 401(k)s, and some individual retirement accounts (IRAs).
AIG utilized a portion of the emergency funding it received from the Federal Reserve in 2008 to pay out GICs it sold to investors, as per a New York Times report.
The Risks of Owning Guaranteed Investment Contracts
The word guaranteed in the term guaranteed investment contracts — GIC can delude. Similarly as with all investments, investors in GICs are presented to investment risk. Investment risk is the chance that an investment might lose value or even become worthless.
Investors face similar risks associated with any corporate obligation, for example, with certificates of deposit (CDs) and corporate bonds. These risks incorporate company insolvency and default, which is the inability to pay back the investor. Should the insurer blunder assets or declare bankruptcy, the purchasing institution may not receive the return of principal (the initial investment) or interest payments.
The GIC might have asset backing from two likely sources. The insurer might utilize general account assets, or a separate account apart from the company's general funds. The separate account exists only to give funding to the GIC. No matter what the source giving the asset backing, the insurance company keeps on possessing the invested assets and remains at last responsible for backing the investment.
Inflation or rising prices and deflation are different factors that might impact the value of the guaranteed insurance contract. Since these investments are low-risk and pay lower interest, it is simple for inflation to exceed their performance. For instance, in the event that the GIC paid 2% interest over the 10-year life of the product, yet inflation found the middle value of 4%, the purchaser would lose money.
Real World Example of a Guaranteed Investment Contract
Suppose biotech firm URobot Inc. needs to invest in its employees enrolled in the company's pension plan and concludes it needs to buy a guaranteed investment contract (GIC) from New Year Insurers. New Year Insurers offers GICs that guarantee URobot gets its initial investment back and furthermore pays out either a fixed or variable rate of interest through the contract's end.
URobot can decide to either have a separate account, where New Year Insurers will deal with their money all alone or have a general account, where New Year Insurers will intermix URobot's funds with that of its other general account customers. URobot picks the general account. Assuming that interest rates are probably going to remain low, until further notice, URobot consents to a fixed rate of interest through the contract's end.
Tragically, during the holding period, the economy picks up speed, making the central bank raise interest rates to assist with directing the pace of growth. Since URobot picked a fixed rate of interest, it won't benefit from the increase in interest rates. It will in any case see the return on investments it was guaranteed at the fixed interest rate, yet it will miss out on the greater returns it would have seen in the event that it had rather selected a variable rate of interest.
Features
- A GIC is a conservative and stable investment, and maturity periods are generally short-term.
- The insurer guarantees the investor a rate of return in exchange for holding the deposit for a period.
- Investors drawn to GICs frequently search for a replacement for a savings account or U.S. Treasury securities.
- A guaranteed investment contract (GIC) is an agreement between an investor and an insurance company.
- GIC values might be impacted by inflation and deflation.
