Check to See if There’s an Investment Safety Net
The past several years have been enough to shatter the confidence of many conservative investors. Banks and thrifts have failed in record numbers. Brokerage concerns have merged and gone under. And now insurance companies seem risky as well.
What is most unsettling to many individuals is their inability to spot signs of trouble. Corporate financial statements are complex and often seem to obscure serious problems. Just last year, First Executive Corp. sent out financial reports that maintained the company’s now-seized Executive Life insurance subsidiaries in California and New York were among the strongest in the industry.
These two massive insurers are now under regulatory control, and the company’s policyholders are worried about losing everything they invested.
Luckily, many of these worries are unnecessary.
Although Executive Life may not have enough money to pay its policyholders, most of these individuals are at least partially protected by safety nets--state-operated life insurance guarantee funds.
And those who put their money in banks, thrifts and brokerage accounts are backed by the protection of guarantee funds as well.
However, these safety nets are not all alike. It can behoove investors to know exactly what kind of a guarantee organization stands behind their financial institution and exactly what it guarantees.
The funds that back bank and thrift deposits are generally considered the safest, largely because the U.S. government has pledged to stand behind these funds to ensure they don’t ever run out of money.
These funds, which fall under the auspices of the Federal Deposit Insurance Corp., cover all types of deposits--from checking and money market accounts to certificates of deposit and individual retirement accounts. However, their coverage is limited to $100,000 per person. Generally speaking, that means individuals can keep only $100,000 in each financial institution without losing some of their federal insurance backing.
There are ways to get around those limits, however. By structuring accounts properly, individuals can maintain insurance coverage on far more money. They can set up revocable trust accounts, for example, which usually allow for an additional $100,000 in insurance coverage per beneficiary. Still, legislators are attempting to find ways to limit this coverage, so there may be fewer options in the future.
Notably, FDIC backing does not guarantee the rate of interest. In other words, if the financial institution you invested in fails or is sold through a federally assisted transaction, the institution that takes over the account has the right to cut the interest rate--even on long-term certificates of deposit where the rate is supposedly guaranteed for the term of the contract.
If the new company opts to do this, it will notify you in writing. If you decide you want to close your account at that time, you can do so without incurring any of the interest penalties that would otherwise apply to an early withdrawal.
Brokerage houses also offer account coverage. This coverage does not, of course, protect investors from losing money in the stock market. But it does protect cash deposits in the event that the brokerage collapses. It also ensures that stock certificates held by a failed brokerage will revert to their actual owners.
However, coverage limits vary greatly from brokerage to brokerage. The reason: The Securities Investor Protection Corp. stands behind deposits up to $500,000 per account. (Only $100,000 of that can be cash. The remaining $400,000 would be in securities.)
But many investment houses provide supplemental coverage, sometimes up to $10 million. Those who want more insurance coverage than is automatically provided can usually arrange it through the brokerage for a minimal cost.
The investor protection that is hardest to generalize about is that backing life insurance policies and annuities. Why? Insurers have no national regulator or national guarantee fund. Instead these companies are watched over by the individual states where they are headquartered. Some states have strong regulation and excellent guarantee fund coverage; others have neither.
There are only three parts of the country that have no life insurance guarantee fund coverage--Louisiana, New Jersey and the District of Columbia. (Colorado enacts guarantee fund legislation July 1.)
All other states have at least some protection for life insurance policyholders. Most commonly, the coverage protects up to $300,000 in death benefits and $100,000 on annuities. Arizona and Arkansas offer only $100,000 protection on death benefits. California’s fund protects up to $250,000 in death benefits and $100,000 on annuities. In New York and Washington state, the coverage limits go as high as $500,000.
Less traditional products, such as unallocated funding obligations (UFOs), which are often used by pension plans to cover future retirees, are often not covered at all.
According to the National Organization of Life and Health Guaranty Assns., only two states fully cover so-called UFOs and GICs (guaranteed investment contracts). Some 14 states limit guarantee fund coverage for these products; California and 12 other states exclude them completely. Another 20 states have not addressed the issue.
If you have a question about whether your insurance annuity is backed by a state-operated fund, contact your local insurance broker. The broker should be able to answer your questions or refer you to either state insurance regulators or to the administrator of the state guarantee fund.
