Protecting your money: Banks and insurance

Given all that’s been going on in the financial markets lately, it’s no surprise that I’ve gotten lots of queries from people who are worried about what might happen to their investments and retirement savings should a financial firm they do business with go belly up.

Which is totally understandable. These are scary times, what with the collapse of Bear Stearns and Lehman, the sale of Merrill Lynch, Treasury’s takeover of Fannie and Freddie, the Fed’s bailout of giant insurer AIG, reports that Seattle thrift WaMu is up for sale and concerns whether even icons like Morgan Stanley and Goldman Sachs can weather the storm as independents (and this rundown doesn’t include what may have happened in the last five minutes).

But hard as it may be, it’s important to keep things in perspective in times of crisis. Although we’re definitely going through some crazy and frightening stuff here, you want to make decisions on the basis of facts and reason, not emotion and fear.

Indeed, if you simply start selling assets and pulling money out of accounts in a panic, you may very well end up in a worse position than you were in before.

So to help you get a better sense of how secure your assets are in different investments and types of accounts, here’s a rundown of the safety net that’s in place for the four types of firms you’re most likely to have financial relationships with: banks, insurance companies, mutual fund companies and brokerage firms.

BANKS: The security of bank deposits became a hot issue back in July after IndyMac bank failed, but recent questions about the health of Washington Mutual and the banking sector in general have re-ignited concerns. Just in case you’re not up to speed on what’s covered and what’s not by FDIC deposit insurance, here’s a quick recap.

Essentially, the FDIC insures deposits in several “ownership categories,” which means you may actually be insured beyond the $100,000 limit you most often hear about. For example, single accounts in your name are covered up to $100,000 per bank. Joint accounts are a separate category and also get their own $100,000 of coverage per person per bank.

So if you and your wife have a joint savings account with $300,000 in it, $200,000 of that account is insured. Retirement accounts - which must be an actual retirement account, such as a IRA, SEP, etc., not just an account you consider part of your retirement savings - are covered for up to $250,000.

These limits apply only to bank deposits, however, which include checking, savings, money-market accounts, CDs and certain trust deposit accounts. It does not apply to other investments you may buy at the bank, such as mutual funds or annuities (which are covered in the Insurance section below).

But just because mutual funds aren’t covered by FDIC insurance does not mean you would lose the money you have in mutual fund that you bought through the bank if that bank failed. Mutual fund assets are not part of the bank’s assets - they’re held in separate accounts - so they don’t even come into play when toting up the bank’s assets and liabilities.

As for the value of any mutual funds you acquired through a bank, that would be determined by the market value of their underlying securities, the same as any other mutual funds.

One caveat: if you invest in a bank money-market account, that money is covered by FDIC insurance, since that account is a bank deposit. If, on the other hand, you buy a money-market fund at the bank, that’s not covered by FDIC insurance since a money-market fund is a type of mutual fund.

For more details on bank deposit insurance, you can check out an earlier column I wrote, or you can visit the Deposit Insurance section of the FDIC’s web site.

INSURANCE COMPANIES: The fact that the federal government had to bail out AIG, the world’s largest insurer, with an $85 billion loan naturally has people wondering what will happen to their insurance policies and the money they had invested in annuities if their insurance company goes belly up.

Because insurance is regulated on the state rather than federal level, there’s no exact equivalent of FDIC insurance. But a different sort of safety net - state guaranty associations - can eventually kick in and provide some protection.

Here’s how that backstop works:

When an insurance company can’t meet its obligations, the insurance commissioner of the state where the company is domiciled (or has its legal residence, so to speak) steps in to assume control or appoints a surrogate to do so.

After reviewing the company’s finances, the commissioner then decides what steps must be taken to meet its obligations to policyholders, annuity holders and others. Those steps could include anything from selling assets, getting other insurers to assume liabilities for policies and annuities or even arranging for another insurer to take over the company.

During this time, the insurance company continues to operate. Policy holders would continue to pay premiums and would still have access to cash values in their policies and annuities (although it’s possible the commissioner could institute restrictions).

If the commissioner determines things are too far gone for the company to be rehabilitated, the company would go into liquidation.

At that point, if the value of the failed insurer’s assets weren’t enough to cover its obligations to policy holders and annuity owners, state guaranty associations would step in and try to keep them whole by transferring their policies to healthy insurers.

If that’s not possible, the guaranty associations would cover the shortfall between the insurer’s assets and obligations to policy holders up to certain limits. Most states set basic limits of $300,000 for life insurance death benefits (California has a $250,000 limit), $100,000 in cash surrender values for life insurance and $100,000 in withdrawal and cash value for annuities, although some states offer higher levels of protection.

Regardless of where the insurance company is domiciled, you would be covered by the guaranty association in your state. Learn more here about what state guaranty associations cover as well as links to the guaranty association in your state.

As with a bank failure, it’s possible you could recover more money later on if the failed institution’s assets bring in more cash than expected. But that could take many, many years.

One note on variable annuities: Most money in variable annuities is invested in mutual fund-like stock or bond “subaccounts” that are not part of the insurer’s assets. So to the extent your variable annuity investments are held in such subaccounts - as opposed to the “fixed account” investment option which typically would be part of the insurer’s assets - your variable annuity should remain insulated from the insurer’s problems.

Many variable annuities these days come with a variety of “guarantees,” ranging from death benefits to guaranteed minimum payouts. Those would be subject to the insurer’s ability to pay, although they also would fall under the umbrella of the state guaranty associations.

By the way, just because of all the attention AIG is getting, don’t assume your insurer’s health is in jeopardy. (It was AIG, the holding company, that required the bailout. AIG’s insurance companies, according to the National Association of Insurance Commissioners remain solvent and able to pay their obligations. In any case, you can get a sense of the financial health of your insurer by checking out the insurer ratings at Standard & Poor’s.

And before you make any move, such as pulling money from an annuity, you’ll first want to consider whether it may trigger a penalty. Most annuities, for example, have early surrender charges that can go as high as 20% in some cases.View this Post

Part Two: Mutual funds and brokerages