When you see a meteor crash through your neighbor's house, bounce out his picture window, roll over his car and finally come to rest atop his lawn gnome, your first thought is to wonder if everyone's OK. Your second thought is, "Gosh! Do I have meteor insurance?"
Actually, most homeowners' policies cover meteor damage, though it's always a good idea to read the fine print. After the failure of IndyMac Bank, though, you might be wondering if other financial institutions, such as brokerages and life insurers, are also covered by some form of insurance. The answer is yes, but the coverage is a bit more complex than federal deposit insurance is.
The Federal Deposit Insurance Corp. covers bank deposits of up to $100,000 per person per bank. It also insures retirement account deposits for an additional $250,000. So you could have $100,000 in your checking account and $250,000 in an IRA certificate at the same bank, and all your money would be insured. You can obtain additional coverage according to how your accounts are titled. To help you figure out what's covered, the FDIC has an online deposit insurance estimator that you can use at www.fdic.gov/edie/index.html.
When the FDIC acts, it usually arranges for a healthy bank to acquire a failing bank. In an acquisition, deposits typically continue to earn interest at the same rate as before. (In the case of IndyMac Bank, the FDIC created an entity called a bridge bank, which acquired IndyMac.) In fairly rare cases, the FDIC liquidates the bank outright and gives depositors a check for their insured deposits, including interest paid up to the time the bank failed.
But what happens if your brokerage fails? Brokerage failures aren't common, but they do happen. In February, a New Orleans brokerage, Hanover Investment Securities, failed after authorities discovered that as much as $2 million had gone missing. The Securities Investor Protection Corp. (SIPC) then stepped in. It's now working to sort out the mess at Hanover and help make investors whole.
SIPC covers you if your brokerage fails and can't return to you all the cash or securities in your account. If, for example, you had 100 shares of IBM in your brokerage account and your broker failed, SIPC would make sure your 100 shares were restored to you.
Unlike FDIC insurance payouts, which typically arrive the next business day, SIPC action can take awhile often one to three months. If the price of your securities has gone up between the time the brokerage fails and when you receive your securities from SIPC, all the better for you. If the price declines while you're waiting for your securities well, that's a shame. SIPC doesn't protect you against price fluctuations. Nor would it protect you in the highly unlikely case that your money market mutual fund posted a loss.
SIPC also doesn't protect you against shysters who sell you penny stocks that turn out to be well, penny stocks. Neither does it cover limited partnerships or commodities futures contracts.
SIPC covers cash assets up to $100,000 and replaces up to $500,000 of securities, such as stocks and bonds. (You could receive more if SIPC recovers enough of the firm's assets in legal proceedings.) To get your SIPC claim covered, though, you need to prove which securities you owned when the brokerage failed. So be sure to keep copies of your brokerage statements and confirmation slips.
Suppose, however, you have a whole life insurance policy, with $50,000 in cash value. Let's say your insurance company dies before you do. What happens then?
In that case, you have to contact your state's guaranty association, which insures life and health policies. Each state's guaranty association is slightly different, so you should look up your state's rules. Some set higher limits than those discussed below.
Typically, though, state guaranty associations cover $300,000 in insurance death benefits per insured life. In other words, if you have three insurance policies with a failed company for $200,000 each (or a total $600,000), your guaranty association will provide $300,000 in death benefits.
For whole life policies, which offer insurance as well as a cash build-up, state guaranty funds typically insure up to $100,000 in paid-up cash value per insured life. They also cover individual annuity contracts, usually up to $100,000.
Typically, a state guaranty association won't cover guaranteed investment contracts, or GICs, which are common features in 401(k) savings plans. If you have questions about what is and isn't covered, you'll have to contact your state association.
Unfortunately, no insurance will cover stock tips from your Uncle Ralph, or for choosing a mutual fund based on its past 12 months' performance. But should catastrophe strike your financial institution, you won't have a large smoking crater where your savings once were.