Is It Really Guaranteed?

Often making smart investing decisions is more about knowing what not to believe. Take the term “guaranteed.” What does it mean for real investors?

In reality, a guarantee is nothing more than a promise. Unless you’re under the age of five, you are probably aware that promises can be and often are broken.

So, should you believe the guarantees made by those selling investment products? It depends, in large part, on who stands behind the guarantee.

There are various levels of security backing promised financial guarantees. US Treasury securities are backed by the “full faith and credit” of the United States. That’s a guarantee backed by the ability of the US government to tax its citizens. That’s about as good as a guarantee gets. Yet, the US government’s credit rating isn’t a perfect triple-A it’s only double-A.

Bank CDs aren’t incredibly safe because of the quality of the banks guaranteeing the return of your funds. We have seen how fragile that promise can be with the collapse of multiple banks less than a decade ago. What makes bank accounts of all kinds safe is the explicit backing of a US government sponsored insurance account like the Federal Deposit Insurance Corporation (FDIC).

How about the guarantees on insurance investment products like universal life policies or annuities? Who stands behind those obligations? It depends. Your first line of defense are the assets of the insurance company, but they can get (and have gotten) into trouble just like banks. It took decades for some Executive Life policyholders to be made whole after that company’s collapse.

Are insurance investments also backed by the US government? No. Sure, there are state-sponsored insurance guaranty funds. None of which have the resources needed to weather an industry crisis like the one we nearly faced with AIG in 2008. 

Since 1969, there have been less than 600 insurance company bankruptcies requiring a bit less than $30 billion in total state guaranty fund payments, nationwide (NCIGF). It is estimated that the cost of the federal government’s AIG bailout exceeded $170 billion (NYTimes). Should another major insurance firm collapse without a federal bailout, the state guaranty funds could run dry.

Then there’s the matter of state insurance pool’s payout limits. In most states, those holding cash value policies cannot collect more than a maximum of $300,000 (California and New York have higher limits while a few states have a $100,000 cap). Those with substantial cash value in their insurance policies are stuck with only the firm’s promise to return your investment. So, if even these relatively safe products aren’t truly guaranteed what is?