Guaranteed Interest Accounts Aren’t Risk-Free

When employees have the ability to choose how to invest their own pension assets, they overwhelmingly opt for “guarantees,” according to a number of recent surveys.

Workers, on average, invested 58% of their 401(k) money in “guaranteed interest accounts,” which frequently invest in insurance and bank investment contracts, according to a 516-employer study recently conducted by A. Foster Higgins & Co., a New York-based benefits consulting firm.

A similar study by Greenwich Associates notes that 39% of all plan assets are invested in such guaranteed-rate investments.

However, recent turmoil in the insurance industry and changes in bank deposit insurance coverage are rapidly changing actual and apparent risks in these plans. And that’s altering the way managers handle those assets.

An increasing number are attempting to limit risks in pension plans invested in guaranteed interest options, according to the Foster Higgins study.

“Risks? What risks?” you may ask. “Aren’t these investments guaranteed?”

Not in the way most people use the term--to imply government support or backing.

With guaranteed interest contracts issued by insurers, the rates paid are guaranteed by the insurance company that issues the GIC. In some states, state-operated guaranty associations will pick up the tab for losses in these accounts if an insurer fails, but in many states, these types of contracts get no guaranty fund coverage at all.

The recent failure of Los Angeles-based Executive Life Insurance Co. underscores how much that can cost.

When Executive Life failed, it had nearly $3 billion in these interest contracts. Company pension plans held $1.1 billion of the total.

A rehabilitation proposed for the company promises most policyholders 100 cents on the dollar, but pensioners whose retirement funds are from company-sponsored guaranteed interest plans are expected to get only about 72 cents on the dollar.

And there is a risk that the payout to these pensioners could drop further. The reason is complex, but it has to do with the somewhat uncertain status of what a guaranteed interest contract is and whether all guaranteed interest contracts are alike.

If they are, and they are all insurance policies--as a Los Angeles Superior Court judge ruled--the payout of about 72 cents will hold. But if an appellate court rules that GICs are something less than insurance, they may get relegated to general creditor status, which would reduce the payout to an estimated 30 to 40 cents on the dollar. That’s put a number of pension fund managers on the edge of their seats.

What about those bank contracts? The Federal Deposit Insurance Corp. now covers these contracts up to $100,000 per beneficiary. But the bank reform bill that was recently passed by Congress and awaits President Bush’s signature will phase out insurance coverage of bank investment contracts. That would leave billions in pension assets uninsured.

As a result of this turn of events, the ability of plan managers to reduce risks in these programs is becoming increasingly important.

What are managers doing?

According to the Foster Higgins study, plan managers are taking greater steps to diversify. Most have implemented rules that prohibit them from investing more than 20% of a plan’s assets with one company or bank.

Additionally, 83% of the companies surveyed said they will deal only with insurance companies and banks that meet certain quality standards.

Employers, responding to increased concern about the safety of these investments, have also boosted communication efforts. Two-thirds have either addressed the issue in writing or in person at company meetings.

Workers who want to know more about how their funds are invested--and how safe those investments are--can often find out by requesting information from their employer or pension plan manager.

Often, the manager will be willing to specify what percentage of the plan’s assets are invested in particular companies. A good manager will also have a current investment rating on those companies, which should give workers a clear idea of how safe they are.

However, if the manager does not have current company ratings, you can get them from a number of reference books in public libraries. New York-based Standard & Poor’s does annual ratings on insurer solvency and claims-paying ability. A host of bank and thrift advisory firms also rate financial institutions’ health. Some of the bigger names in the bank analysis business are Sheshunoff and Veribanc.

If you are unhappy with the quality of companies backing your pension investment, ask the manager if he or she plans to switch investments to healthier firms. If not, consider transferring your account balance to another fund. Employers typically allow workers to move assets between investment options at least twice a year.