Employers should read the fine print to understand how the risks of retirement options like guaranteed investment contracts can grow during financial crises
Q: Our small manufacturing company has a $1 million-plus employee profit-sharing account deposited with UBS Financial Services (UBS). We recently received a letter stating that, based on the current illiquidity and volatility of the market, plan-level withdrawals will be put on a 12-month hold. I have 25 employees with questions about their accounts, but I have not gotten a clear explanation. Can you explain if this is acceptable practice for a trust company?
A: The letter you sent along with your question was indeed confusing—and even potentially alarming. Experts typically advise that you take questions like this to your account representative, who should be able to explain the details. But since you did not get a clear understanding after going that route, we asked some experts to look at the letter and also contacted the fund trustee, Wilmington Trust Fiduciary Services (WL). (While the letter went out under the letterhead of UBS Global Asset Management, Wilmington Trust Fiduciary Services is the trustee and overall manager of the fund, says Kris Kagel of UBS media relations.)
The communication you received specifically addressed the guaranteed investment contract (GIC) portfolio in your profit-sharing account, one of several investment options offered to your employees. The key language in the letter involves two words: "participant" and "plan." It confirms that the GIC portfolio does have sufficient liquidity for participant-level withdrawals—which means that your employees can take money out of their GIC accounts or shift that money into other investments within the profit-sharing plan, such as bonds or stock mutual funds.
It is only plan level withdrawals that are being placed on a 12-month hold, says Bill Benintende, vice-president of media relations at Wilmington Trust. "Plan level" refers to your company account as a whole, he says.
"It means if the company decided it didn't want to offer the GIC as an investment option anymore, the trustee—which is Wilmington—can require them to wait 12 months before they drop the GIC option," Benintende says. "But if individuals who participate in this plan are invested in this GIC product and they want to withdraw their money or switch it into another vehicle like a stock fund or a bond fund, they are permitted to do that."
The decision to place a 12-month hold on plan level withdrawals was made because of the "extraordinary events going on in the credit markets, affecting liquidity of short-term investments," Benintende says. If many companies simultaneously dropped the GIC option from their accounts, all those funds would be liquidated simultaneously, which could put a strain on the portfolio, he says, and "nobody wants to have that situation."
The other investment options your plan offers—bond funds, stock funds, etc.—are not affected by this decision. "The GIC's underlying securities are short-term, fixed-income investments that have been under unusually high stress and strain in this market," Benintende says.
But let's go back to basics for a moment: Guaranteed investment contracts are stable value funds that are sold by insurance companies. They are somewhat comparable to a fixed-income annuity. Like a bank certificate of deposit, the GIC's value remains stable rather than fluctuating with the stock or bond markets.
What many small business owners don't realize when they set up their company retirement accounts (BusinessWeek, 4/25/07) is that GICs are not backed by the government, as Treasury funds are, nor are they insured by the Federal Deposit Insurance Corp., as bank-sold CDs are. And, while the U.S. Treasury Dept. has recently instituted a temporary guarantee program for money-market funds, that guarantee does not apply to GICs. In fact, a GIC is guaranteed only by the insurance company that issues it. So if that company goes bankrupt, the GIC might lose some or all of its value.
Kent Smetters, an associate professor of insurance and risk management at the Wharton School at the University of Pennsylvania, says business owners who set up pension plans should be very clear about exactly what options they are choosing for their employees. "Unfortunately, very little attention is paid to the fine print in these contracts and too much weight is given to the slightly larger returns paid by these [GICs] relative to Treasuries. That usually is not a problem…until times like now when you really need the money," Smetters wrote in an e-mail.