banks vs insurance campany deposits

The vast majority of Americans regard their banks as a safe and secure place to keep their money – and with good reason. They are among our most familiar and basic service institutions and have held a place in our culture as the cornerstone of any community since the founding of the country. In addition, most banks are backed up by FDIC insurance which adds another layer of confidence. However, banks do not hold the exclusive rights to claims of safety and in many regards, take a back seat to another age-old financial institution in America – the insurance industry. 

Banks are primarily lending institutions. They borrow money from their depositors and loan it out (or back to you) at a higher rate of return than what they pay. The rate at which they lend money and even the amount of money loaned is determined in large part by federal monetary policy (the FED). There are two primary tools of the monetary policy: the prime interest rate (the rate banks charge each other for short-term loans) and the minimum reserve requirement (the required minimum amount of money from deposits the banks may NOT loan). 

Banking Industry Safety Record 

During the 20th century, the banking industry suffered two catastrophic losses. 

The first occurred following the stock market crash of 1929 and was the cause of the Great Depression. Prior to the market crash, people (and financial institutions) were buying investments on borrowed money (called margin). Then as the value of those investments grew, investors borrowed more to buy more, etc. When the crash came (“Black Tuesday” – October 29, 1929), the lenders demanded repayment of the loans to pay off their own debts. What followed was a run on the banks to withdraw cash that essentially did not exist. In fact, the amount of money demanded for loan repayment actually exceeded the amount of printed money in circulation. The banks failed and the Great Depression began. 1933, several steps were initiated to help extricate the country from the crisis. Among those was the establishment of the Federal Deposit Insurance Corporation. The FDIC was set up as an independent operation of the federal government but established and maintained by its member banks. Other parallel organizations (e.g., Federal Savings and Loan Insurance Corporation – FSLIC) were also established. Following a concerted effort of reassurance (including President Roosevelt’s radio “fireside chats” wherein he reassured the public that their money was safe – “The only thing we have to fear is fear itself.”), the banking industry regained its reputation for safety. 

The second banking catastrophe began in 1980 when Savings and Loan institutions began to fail. By 1982, the entire industry was insolvent, and the debt owed by the S&Ls was about four times that of the reserves held by the FSLIC. Over the next ten years, the insolvencies were paid off – some of the burden being passed to the FDIC, but the bulk being assigned to the Federal Home Loan Bank Board (FHLBB). As with the failure of banks in 1929, the underlying failure resulted from the lack of 100% capital reserves (the institutions had promissory notes on money to which they did not have direct access). 

Insurance Company Safety Record 

Like banks, insurance companies offer savings accounts that are fixed and guaranteed. Where banks offer CDs, savings accounts, etc. insurance companies offer annuities. One of the great misconceptions about annuities is that they are all stock market investments that have fees and can lose value. This is true of variable annuities, but that represents only one segment of the industry. Fixed annuities are savings accounts with the same advantages as bank deposits: no fees, no risk, etc. 

However, unlike bank deposits, insurance industry deposits are required by federal law, to always maintain a minimum reserve of 100% (industry average is about 115%). Simply put, this means that any deposits made in a fixed annuity cannot be loaned out. Furthermore, insurance companies are not permitted to buy investments on borrowed money. All of their investing must be done with actual dollars and federal regulations restrict how those investments can be placed; with the vast majority invested in government securities (e.g., 10-year treasury notes). What this means to a depositor is that the money deposited is never “out of sight.” This is why bank depositors had to recover from two financial catastrophes in the 20th century while insurance industry depositors have never experienced a similar problem. 

Backing Up Your Money 

Currently the FDIC insures up to $250,000 per depositor (not per deposit) in certain, but not all bank accounts. For example, moneys held in checking, savings, money markets and CDs at the bank all fall within that sing $250,000 limit. Certain other accounts such as IRAs, etc. have their own insured limit. However, anything above those limits is not insured should the bank fail and not be able to repay its debts. Conversely, deposits held by insurance companies are insured 100% without limit. In addition, most insurance companies are themselves insured against excess claims or default. This is called reinsurance. Therefore, should an insurance company fail, the safeguards established by the insurance/reinsurance arrangement will fully protect any amount without regard to an arbitrary limit. 

If insurance company deposits are so safe, why have I not heard about them more often? This is a common question with an obvious answer. Banks are on every corner. We pass them dozens of times each day in our normal lives, and we enter them regularly. Each time we do, we are greeted by a host of people there to serve us and extol the virtues of banking, even if in the most subtle ways. Insurance companies are housed in large office buildings, usually in or around major cities. Their operations and employees are not as visible to us simply because the average person is not stopping by their “neighborhood insurance company” every week. Perhaps an easier way to appreciate the difference is the following. Insurance companies sometimes purchase banks, but banks do not purchase insurance companies. Surprisingly, when an insurance company buys a bank – even a very good one – that acquisition can cause the insurance company’s financial rating to be down-graded. No financial institution ever had their ratings scores lowered by their acquisition of an insurance company. 

None of this is intended to detract from the safety if the banking system. Banks ARE safe. It is just that where maximum safety is desired, insurance company accounts are more so in my opinion. 

Diego A. Viera 

President & CEO 

AXIOM DIVERSIFIED, CORP. INSURANCE SERVICES