What is a Guaranteed Investment Contract (GIC)?
A guaranteed investment contract (GIC) is an agreement between a contract purchaser and an insurance company whereby the insurance company provides a guaranteed rate of return in exchange for keeping a deposit for a fixed period of time.
How Does a Guaranteed Investment Contract (GIC) Work?
Let's assume Company XYZ buys a GIC from the ABC Insurance Company on behalf of the employees enrolled in the Company XYZ pension plan. ABC Insurance Company guarantees the return of Company XYZ's original investment and pays either a fixed or variable rate of interest until the end of the contract.
Because this GIC is a general account, ABC Insurance Company will commingle Company XYZ's money with the funds of its other general account GIC customers. If ABC Insurance Company does not manage its funds well or declares bankruptcy, XYZ Company may not receive the contracted return or the original principal.
A general account GIC can be contrasted with a separate account GICs. This type of GIC keeps the underlying assets in separate accounts that are actively managed by the issuer. The issuer receives a fee for this management, and each account is affected by the market value of the underlying assets, although there is usually some guaranteed minimum return.
Why Does a Guaranteed Investment Contract (GIC) Matter?
A general account GIC's return typically increases with the length and size of the investment. However, general account GICs with fixed rates are vulnerable to inflation--for example, there is a possibility that purchasing a five-year general account GIC will eliminate the opportunity to earn higher returns if interest rates rise during the holding period.
Because of the lack of collateral and reliance on the issuer's creditworthiness, general account GICs typically return more than savings accounts and Treasuries. However, they are still usually considered relatively safe investments.
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