Face amount certificate

What Is a Face-Amount Certificate?

A face-amount certificate (FAC) is a contract between an investor and an issuer where the issuer guarantees payment of a stated sum, known as the face amount, to the investor at a predetermined future date. These instruments fall under the broader category of investment products and are a specific type of debt security. In exchange for this future payment, the investor agrees to pay the issuer a set amount of money, either as a single lump sum or through periodic installment payments. Companies that issue face-amount certificates are known as face-amount certificate companies, and they are regulated as a distinct classification of investment company under the Investment Company Act of 1940.³⁵

History and Origin

The concept of investment companies and pooled investments dates back to the late 1700s in Europe, eventually making its way to the United States.³⁴ In the early 20th century, as the insurance industry expanded, face-amount certificates emerged as an alternative to life insurance policies, offering smaller, more accessible financial products.³³ The significant growth and speculative environment of the financial markets in the 1920s, followed by the Wall Street Crash of 1929 and the Great Depression, highlighted a critical need for financial regulation.³²

In response to these market instabilities, the U.S. Congress enacted several landmark pieces of legislation, including the Securities Act of 1933 and the Securities Exchange Act of 1934.³¹ A pivotal moment for face-amount certificates and other investment vehicles was the passage of the Investment Company Act of 1940. This legislation formally defined and regulated various types of investment companies, including face-amount certificate companies,²⁹, ³⁰ aiming to instill investor confidence by requiring disclosure and regulating operations.²⁷, ²⁸ The Act specifically defines a face-amount certificate as a security representing an obligation to pay a stated sum more than 24 months after issuance, in consideration of either periodic installments or a single lump sum payment.²⁶ While still legally recognized, very few face-amount certificate companies operate today, largely due to changes in tax laws that have diminished their advantages.²⁵

Key Takeaways

• A face-amount certificate is a contract where an issuer guarantees a fixed future payment in exchange for investor contributions, either as a lump sum or through installments.²³, ²⁴
• Issuers of face-amount certificates are highly regulated as investment companies under the Investment Company Act of 1940.²²
• These certificates typically offer a fixed return and a guaranteed payout at maturity, providing a level of financial security.²⁰, ²¹
• Historically, face-amount certificates provided unique tax advantages, but changes in tax law have made them less common today.¹⁹
• The underlying assets of the issuing company often collateralize face-amount certificates.¹⁸

Interpreting the Face-Amount Certificate

A face-amount certificate represents a commitment from the issuer to the investor for a specific future value, making it a predictable investment for long-term savings goals. The "face amount" refers to the specific sum guaranteed to be paid at the certificate's maturity date. Investors can interpret the face-amount certificate as a conservative, fixed-income product designed for capital accumulation with a known future payout.¹⁷ The certainty of the future payment, provided the issuer remains solvent, is a key aspect of its appeal. The issuing company maintains reserves to meet these future obligations, which are subject to regulatory oversight.¹⁶ For an investor, understanding the terms, including the payment schedule (lump sum or installments) and the maturity date, is crucial for financial planning.

Hypothetical Example

Consider an investor, Sarah, who wants to save for a future expense, such as a child's college education, which is 15 years away. She decides to purchase a face-amount certificate with a face amount of $50,000, payable in 15 years. The issuer offers an annual interest rate, which will compound over the term.

Sarah chooses to pay for the certificate through monthly installment payments. Based on the agreed-upon interest rate and the $50,000 face amount, the issuer calculates her required monthly payment to reach that sum at maturity. Sarah commits to these regular payments for 15 years. At the end of the 15-year period, the issuer pays Sarah the full $50,000 face amount, regardless of market fluctuations, provided the company meets its obligations. This predictability offers a clear path to achieving her specific savings goal.

Practical Applications

Face-amount certificates, while less common today, historically served as straightforward long-term savings vehicles, particularly for individuals seeking a guaranteed return. Their primary application lay in providing a disciplined approach to saving for a specific future financial goal, such as retirement, a child's education, or a significant purchase.

These certificates offered a fixed rate of return, appealing to investors with a low risk tolerance who prioritized capital preservation over potential higher gains from volatile markets. The issuer benefited by securing long-term financing at predictable interest rates, often backed by collateral, which could lead to lower borrowing costs compared to unsecured debt.

The rigorous regulatory framework established by the Investment Company Act of 1940, overseeing the operation of face-amount certificate companies, aimed to protect investors. This oversight is part of the broader effort to maintain stability and integrity within financial markets. Policymakers continuously evaluate and adapt financial regulation to foster innovation while safeguarding investor interests and systemic stability.¹⁵

Limitations and Criticisms

Despite their guaranteed nature, face-amount certificates have certain limitations. One significant criticism is their lack of liquidity. Unlike more liquid investments such as savings accounts or certain certificates of deposit, investors typically cannot access their funds easily before maturity without incurring surrender charges or receiving less than their accumulated value.¹⁴

Another drawback is that the returns offered by face-amount certificates are generally fixed and may not keep pace with inflation or higher returns available from other investment vehicles during periods of economic growth. Furthermore, unlike bank deposits that might be insured by agencies such as the FDIC, face-amount certificates are not typically covered by such federal deposit insurance, meaning the investor bears the risk of the issuing company's financial failure.¹³ The decline in their prevalence is largely attributed to changes in tax laws that removed their previous tax advantages, rendering them less competitive compared to modern investment options like mutual funds or diversified portfolio strategies.¹² The regulatory environment, while providing investor protection through acts like the Investment Company Act of 1940, also imposes strict requirements on these companies, as outlined in regulations such as 15 U.S. Code § 80a-28.
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Face-Amount Certificate vs. Certificate of Deposit

While both a face-amount certificate (FAC) and a certificate of deposit (CD) offer a fixed return over a specified period, key differences exist. A face-amount certificate is a contract issued by an investment company, guaranteeing a set sum at a future date in exchange for either a lump sum or periodic payments. ⁹, ¹⁰It is regulated under the Investment Company Act of 1940 and is typically backed by the issuer's assets. ⁸In contrast, a certificate of deposit is a savings certificate issued by a bank, which holds a fixed amount of money for a fixed period, and offers a fixed interest rate. CDs are generally insured by the Federal Deposit Insurance Corporation (FDIC) up to certain limits, providing a higher level of safety against bank failure, a protection not typically afforded to face-amount certificates.
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FAQs

What is a face-amount certificate company?

A face-amount certificate company is a type of financial institution that issues face-amount certificates, which are investment contracts promising a guaranteed sum of money to the investor at a future date. ⁶These companies are highly regulated under the Investment Company Act of 1940.
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Are face-amount certificates considered a safe investment?

Face-amount certificates are generally considered low-risk because they promise a guaranteed payout. However, they are not typically covered by federal deposit insurance like FDIC, meaning their safety depends on the financial stability and solvency of the issuing company. ⁴Investors should review the issuer's financial strength.

How do I purchase a face-amount certificate?

Historically, face-amount certificates were purchased directly from face-amount certificate companies, either with a lump sum or through scheduled periodic payments. While few companies offer them today, individuals interested in such products would need to identify and contact these specific issuers.
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What is the primary purpose of a face-amount certificate?

The primary purpose of a face-amount certificate is to provide investors with a disciplined savings tool that guarantees a specific sum of money at a predetermined future date, often used for long-term financial goals.
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How does the Investment Company Act of 1940 relate to face-amount certificates?

The Investment Company Act of 1940 defines and regulates face-amount certificate companies as a specific type of investment company, imposing strict requirements on their operations, disclosures, and reserve requirements to protect investors.¹