Danger, Will Robinson!

August 9, 2003 2:53 PM

Insurance companies abandon brokerage firms. A brokerage firm would have to have a catastrophic meltdown before insurance would pay the "last" dime to protect investors' accounts, after all other means had been exhausted. In fact, they haven't had to pay a single claim in over 30 years. So why are three major insurers suddenly getting out of the business? (NYT subscription req.)
posted by kablam (5 comments total)

Why insure the brokerage if you can insure each of their incredibly wealthy clients on a case by case basis?

Guess which way is more profitable.

--Dan
posted by effugas at 6:12 PM on August 9, 2003

effugas: As someone who has worked for a brokerage, I can tell you that the million dollar crowd (the "mass affluent"), almost to a one, want to know what happens to dollars 500,001 and up in the event of catastrophe or malfeasance. It was a big help to be able to tell the customer "Every account is privately insured up to one hundred million dollars".

Strangely, I never had a client ask who provided that insurance.

Last, I would argue that more profits could be made by the broker and the insurer by writing each policy individually: "For an extra quarter of a percent per year, sir, you can buy additional insurance so that, in the very unlikely event that something were to happen to our firm, your assets would be covered by AIG, one of America's ten largest companies."

Good brokers could sell that stuff all day.
posted by trharlan at 6:53 PM on August 9, 2003

trharlan--

Lets say you have a ten million dollar portfolio, and want it insured.

Lets say the insurance company has decided there's a 10% chance your brokerage will collapse in the next decade.

Can they provide insurance cheap enough that it doesn't clue you in that they've got no faith in where you've put your money? In other words, if the cost is high enough that they've decided to pull out entirely, perhaps the per-client cost is so high that brokers would rather the insurance companies go away entirely instead of blasting their customers with doubt-inducing rates.

--Dan
posted by effugas at 7:41 PM on August 9, 2003

effugas: First, if the brokerage collapses (and they haven't committed widespread, institutional fraud of some sort), your stocks, bonds, and derivatives ought to be totally unaffected. Your cash, however, could be at risk, if the firm has hypothecated it to other customers so thay may engage in margin borrowing. Even this event is super-super-unlikely-- especially at any remotely reputable firm. The 10 percent number you offer in your hypothetical is probably very unrealistic.

But, since it's a hypothetical, and I'm partially talking out of my ass, I would guess that there's absolutely no way whatsoever that an abnormally high cost of insurance could be missed by an even slightly savvy investor.

I think the gist of the article was that since insurance companies make so little money on these policies, and widespread fraud at Merrill, Solomon, Morgan Stanley, etc could bankrupt even a large insurance company, the insurers have decided that the potential costs outweigh the benefits.

And, if you're really interested, you can (almost) completely remove the risk to your cash by using a treasury money market, and get the benefit of avoiding state income tax. Of course, the rate is usually lower. HTH.
posted by trharlan at 8:04 PM on August 9, 2003

What popped into my mind when I read this was the old trick of creating a shell corporation to underwrite the parent. And while financial institutions have pulled this trick in the past, I've never heard of a brokerage doing it.

Incredibly unethical, I also don't know if they ever did crack down on it and outlaw the practice, or if the one degree of corporate separation was good enough to screw the insured. Anyone know?
posted by kablam at 9:10 PM on August 9, 2003