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FDIC Insurance Limits

Updated on September 15, 2008

FDIC Insurance Limits

As the credit crisis spreads throughout the financial sector, brokerages are suffering their own version of Chinese water torture.

Lehman Brothers filed for bankruptcy protection Monday after making bad mortgage-related bets. Just prior to that, Merrill Lynch, the nation's largest retail broker which has also been plagued by bad mortgage investments, agreed to be sold to Bank of America for $50 billion.

That marked the second big acquisition in the financial sector this year. In March, Bear Stearns was forced into the arms of rival J.P. Morgan Chase (JPM, Fortune 500) for much the same reason.

With all of this uncertainty, it's only natural that you'd start to wonder what would happen if your brokerage failed.

Well, for the most part, you really don't have to worry. Even if your firm goes under, your securities should still be there. That's because brokerages aren't allowed to use your money for their own purposes. Your stocks and bonds and other securities are segregated from your broker's other accounts.

And even if, for some reason, your securities weren't safeguarded, the Securities Investor Protection Corporation, a private nonprofit funded by member firms, will protect up to $500,000 of your brokerage assets (so long as your broker is a SIPC member).

This morning, SIPC issued a statement on Lehman Bros., assuring investors that their personal holdings with Lehman Bros.' brokerage would not be affected by the bankruptcy filing. None of Lehman Bros.' subsidiaries, including wealth management company Neuberger Berman, were included in the filing, and Lehman's clients' assets are unavailable to Lehman's creditors, according to Lehman.

Still, there's a sense of unease largely because many brokerage clients simply don't understand the safety nets that are in place.

Catherine Hetrick, editor of InvesTech Portfolio Strategy, says whenever there's another bad headline about a broker, her newsletter gets calls from worried subscribers asking if their investments are safe.

"We all know what kind of protection banks provide," Hetrick says. "But brokerages are a completely different animal. It's nothing like FDIC insurance."


You probably know that the Federal Deposit Insurance Corporation covers up to $100,000 of your bank deposits per account. Up to $500,000 of your brokerage assets are also protected, but by SIPC.

Unlike FDIC, which is a government agency, SIPC is funded by member firms. And currently SIPC has only $1.5 billion in assets vs. $45 billion for FDIC. Seems like this wouldn't go very far if the holdings of a couple of big brokerages just up and disappeared.

But there's a good reason SIPC's coffers aren't that big: They don't have to be. Brokers function differently from banks. Banks are in the business of investing your deposits - lending out your savings to other customers, who might renege on those loans. Brokerages, on the other hand, aren't supposed to do anything with your securities other than hold them.

In fact, when you buy stocks or bonds, the broker must keep them segregated from its own. The same goes for the funds you've stuffed into your IRA.

"The vast majority of assets are recovered without our funds," says SIPC president Steve Harbeck.

Broker failures are rare

Truth is, despite all the bad news in this economy, few brokers have collapsed. Between the end of 2006 and mid-August, only two firms - a small outfit in Orlando and another in Madisonville, La. - have gone belly up.

And in the case of the Louisiana firm, it was fraud: A principal misused customer funds, leading to as much as $2 million in losses, according to regulators.

Here's some more reassuring news: In its entire 38-year history, SIPC has had to spend only $508 million to recover customer assets. And just 349 customers total have failed to get their entire portfolios back. "It's increasingly rare for anyone to lose money," says Harbeck.

As for the major brokers you've read about in the headlines recently, like Bear Stearns, they made some horrible investments with their own cash, but client assets were never at risk.

How the system works

What would happen if your brokerage defied the odds and went out of business?

If there's no fraud involved - for instance, if it's just a case of the business going sour - SIPC might not even need to get involved. The broker itself might simply transfer your holdings to another firm, where you'd then have access to them.

If it is a case of fraud or if accounts are amiss because of bad record keeping, SIPC would help coordinate the transfer of your remaining assets (most transfers take one to three months). It would also be responsible for replacing missing securities.

When a broker fails, a court-appointed trustee will contact you to let you know how and when to file a claim. Even if you get a notice that your assets have been transferred to another broker, you should still file a claim.

That's just in case there's a problem during the transfer or there's a discrepancy in the records of what you held at the brokerage. And be sure to use registered mail with a return receipt, just in case any errors are made.

What SIPC covers

* Stocks, bonds and funds SIPC will replace up to $500,000 of equities, fixed-income securities and funds for each account. If you held separate accounts at two different brokerages, each totaling $500,000, you'd be fully covered for both (though it would be unlikely that both of your brokers would fail).

* Cash Included in the $500,000 cap is coverage for up to $100,000 in cash. Note, however, that SIPC doesn't consider money-market mutual funds to be cash. They're treated like any other funds, so they would fall under the larger $500,000 limit. Brokered CDs are a special case. If your CDs have gone missing - for instance because of broker fraud - then SIPC would be responsible for replacing your holdings. But if you lost money on the CD because the bank behind it failed, it would be FDIC's responsibility to make you whole.

What SIPC doesn't cover

* Some alternative assets With a few exceptions, SIPC limits coverage to SEC-registered securities. So foreign currency, precious metals and commodity futures contracts aren't protected.

* Bad timing SIPC will replace your shares, not dollar values. So if you own 100 shares of Microsoft worth $3,000 and your broker runs off with them, SIPC will replace your 100 shares - even if they're worth only half as much now because of market gyrations.

* Some outstanding margin loans If your broker fails while you have a margin loan outstanding, SIPC will try to transfer the debt and collateral to another broker. But if no other firm takes on the loan, you'll be on the hook to pay it off to your broker or ultimately to its creditors.

What you need to do

* Check if your broker is an SIPC member Nearly all brokerages are. If yours isn't, consider moving to a more established firm. Also, if you invest through advisers, make sure they're working with SIPC members too. To verify, look for "Member SIPC" at the bottom of the broker's Web site or call SIPC at 202-371-8300.

* Look for excess SIPC coverage If you open a big account, make sure your broker has excess SIPC coverage. Many brokerages buy this insurance to cover stocks and bonds in excess of the $500,000 limit. Your broker or its Web site should be able to tell you if it carries the extra coverage. But remember: This excess insurance covers only those classes of assets SIPC does.

* Maintain good paperwork Check your statement every month to make sure it's accurate, and report any discrepancies in writing. If your brokerage goes bankrupt, SIPC will rely on the broker's records to replace your shares. That means the burden of proof will be on you if you think records are wrong.

Q. Consider me an average young professional without a background in finance and economics. I've read all the articles about Bear Stearns and now Lehman and Merrill Lynch and soon to be Washington Mutual, but I can hardly make sense of it. I realize that these bankruptcies are hurting our economy (and the world economy), but I can't quite grasp how this will affect me, or what all of this means to my economic future. Should I be saving instead of spending? Taking some kind of pre-emptive action? In other words, I don't really understand what the implications of this are - can't anyone explain this in layman's terms??

— Nanako Tamaru, New York

A. At a time like this, people often regret taking any pre-emptory action. There aren't very many of us who can predict with confidence how this will all work out. But for those who are young, it makes little sense to, say, cease your contributions to a 401(k) account or move all the money there into cash. After all, at some point (soon hopefully), the market declines will hit a bottom, and you'll want to be buying then. As for saving instead of spending, that's always a good idea. That said, if you are in an industry with direct exposure to financial services, it would be especially wise to build an emergency fund of some sort in case you were to suddenly lose your job.

— Ron Lieber

Insurance Policies at A.I.G.

Q. Many, many people have life insurance with A.I.G or one of its subsidiaries. What is the impact of A.I.G's financial troubles on potential life insurance payouts? Should we be looking elsewhere for insurance?

— Derek Fried, St. Paul

A. Right now, there is no impact at all. A.I.G. is still in business. Also, the state of New York, where the company is based, threw it a partial lifeline today by allowing it to effectively lend itself $20 billion out of its own (non-troubled) assets in order to bolster its capital.

“We have a very strong message for consumers,” David Neustadt, the deputy superintendent for public information for the New York state insurance department, told me just now. “If you have a policy with A.I.G. insurance company, they are financially strong and solvent. They have the capability to pay on any claims, and our job is to insure that they continue to have the ability to pay.”

But you’re likely also worried about the worst-case scenario, which is the company going out of business. If that happens, an entity called the The National Organization of Life & Health Insurance Guaranty Associations springs into action. Somewhat like the Federal Deposit Insurance Corporation, it oversees state associations that guarantee coverage up to certain limits.

Most states set basic limits of $300,000 in life insurance death benefits and $100,000 for cash surrender or withdrawal value for both a life insurance policy and an annuity. Some, however, may cover more. You can look up your state’s limit here. There’s more information in NOLHGA’s FAQ. Beyond the state limits, policy holders can also file a claim as a creditor against the failed insurance company.

A few caveats: NOLHGA notes that the state associations do not cover non-guaranteed policies or products like variable annuities where the policyholder bears some investment risk. Also, a different organization, the National Conference of Insurance Guaranty Funds, performs a similar function for property and casualty insurance, like auto and home insurance, along with workers’ compensation policies.

As for looking elsewhere, it can be complicated to unwind life insurance policies and expensive to start over with a new company if your health situation has changed since first purchasing the policy. By the way, according to NOLHGA, your continued insurability is guaranteed if your original insurer goes out of business and you didn’t have a policy with a specific end point. Either your state agency would provide your coverage or another insurer would do so.


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    • Lgali profile image


      9 years ago

      nice info


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