Op-Ed ¦ October 16, 1989
A Look at the GIC's New Competition: the BIC

By David Langer

The banks won a key victory in Congress in late June: They may continue issuing bank investment contracts to qualified retirement plans with up to $100,000 of FDIC insurance per participant. The banks have about $13 billion in BICs, compared with about $150 billion in the insurance industry's comparable product; that amount is expected to climb now. There is, clearly, a lot of money involved.

It should be noted BICs and guaranteed investment contracts offer similar terms: A bank or insurer receives money from a qualified plan and guarantees a rate of interest for a specified period. A BIC usually will pay a higher rate of guaranteed return than a GIC for the shorter durations.

Should plans therefore invest in BICs instead of GICs, at least for the shorter-term investments, to have the additional assurance of the FDIC guarantee? The answer lies in how one evaluates the nature of the underlying guarantees and the possible long-term consequences to participants of investing in each.

There are two levels of comfort an insurer can provide: conservative investment management, which includes lending assets to solid borrowers, diversification of loans by both geography and industry, and limiting the amount invested in any one company, industry or area; and maintenance of a substantial contingency fund to cover losses of any sour investments.

It would seem an insurer needs to be more involved in maintaining the quality of its investment portfolio. If it does not invest prudently, all it has to fall back on is its contingency fund -- and when that is gone insolvency may result.

Banks obviously have an advantage in marketing the BIC because of the FDIC insurance. Further, should the FDIC run dry for any reason, the federal government likely would pay any additional amounts needed to back up the guarantee. An underlying implication -- which is worth examining -- is that there is little or no need for the investor to be concerned about a bank's fiscal soundness.

Banks are required to set up reserve funds for possible credit losses. Many major banks were hard hit in recent years by substantial defaults on loans made to foreign countries and have had to increase their reserve funds. They are not out of the woods yet and would be vulnerable in other loan areas if the economy were to weaken, perhaps particularly with highly leveraged corporate borrowers.

If there is a concern about the FDIC extending its guarantees to retirement plan participants, it arises in large part from the role of politics in vitiating the federal government's ability to oversee the use of its guarantees at the same time it is providing broad access to such guarantees. This has been demonstrated in the insolvency of so many savings and loan associations, and federal losses emanating from the Department of Housing and Urban Development.

As an illustration of the potential for trouble, there is a bank in the state of Washington that has been lobbying for the continuation of FDIC insurance and individual retirement plan accounts. The Wall Street Journal reports the bank has Standard & Poor's Corp.'s lowest investment-grade rating. If the bank guarantees a high yield based on investments in low-grade high-yield bonds, pays deposit brokers to bring in large amounts of retirement plan money and then fails on its investments, the FDIC will get the bill.

If enough banks do this, the FDIC will run out of assets and taxpayers will pick up the balance, as happened with the S&Ls. Deduct the extra taxes all of us have to pay, and any interest premium that seemed to be there has been reduced.

Furthermore, public confidence in our banking system has been diminished.

Thus, a decision whether to invest in GICs or BICs is more complicated than it seems.

If one, therefore, doesn't want to promote more S&L and HUD-type debacles, then the GICs offered by financially sound insurers may make more sense. If a federal guarantee is desired, Treasury bills, notes and bonds are available, albeit at a lower yield.

While BICs should be considered, the nagging question has to be whether the contracts won't prove counteproductive at a later date.

Hopefully, the FDIC and Congress will rethink this open-ended BIC guarantee. No one needs or wants any bank to be encouraged to engage in questionable practices. Sound banking is a must for all of us.

- David Langer, a consulting actuary and president of David Langer Co., Inc.
New York

Copyright 1989 Crain Communications, Inc., Pensions & Investments, October 16,1989
Reproduced with permission.