Published in: Buying Stocks | Dec. 7, 2018

Brokerage Account Insurance: Is Your Account Safe?

 

Here’s how to check if your brokerage account is insured, and how much insurance you have for your assets.

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In the late 1960s, stock prices were cratering and brokerages were faltering. Americans were beginning to lose trust in the financial markets and the brokerage firms who held their assets, so the Securities Investor Protection Corporation (SIPC) was created to insulate investors from the risk of a brokerage bankruptcy.

The SIPC was designed as a safety net, a form of brokerage account insurance that protected client assets in the event a member brokerage failed. Since then, the SIPC has helped investors dodge billions of dollars in would-be losses. But there have been some losers -- the SIPC does not provide an unlimited amount of insurance, and not all losses are covered.

Here’s what you need to know about the insurance that protects your brokerage account, how it works, and some historical data on past losses so that you can get a good feel for the risks of housing your assets with a brokerage firm.

SIPC insurance limits

The SIPC is to the investment industry what the Federal Deposit Insurance Corporation (FDIC) is to the banking industry. The SIPC provides up to $500,000 of protection, which includes protection for up to $250,000 in cash. Accounts at SIPC member brokerages qualify for their own $500,000 of protection when they have what’s known as “separate capacity.”

The limits on SIPC insurance are best explained by way of example. If you have two traditional IRA accounts at the same brokerage, these accounts are combined and only qualify for $500,000 of protection in all. However, if you have a Roth IRA and a traditional IRA at the same brokerage, each would qualify for $500,000 of protection, since a Roth and traditional IRA are technically different.

Similarly, if you have a brokerage account in your own name, and a joint brokerage account with your spouse, each would qualify for $500,000 of coverage on their own. If you and your spouse also have a custodian account for your child, that account would also qualify for a separate $500,000 limit. Thus, an individual, joint, and custodial account at the same brokerage would qualify for $1.5 million in protection in total ($500,000 each).

Theoretically, you could spread your money around to different brokerages to maximize the SIPC protection, though the administrative work of managing multiple accounts may not be worth the effort, considering the rarity of brokerage losses. Many brokers also have insurance that extends beyond SIPC limits, so most investors are very well protected.

What the SIPC does and doesn’t cover

SIPC protection largely covers assets you might typically use a brokerage firm to invest in, including “stocks, bonds, Treasury securities, certificates of deposit, mutual funds, money market mutual funds, and certain other investments,” according to the SIPC website.

Notably, it doesn’t cover more esoteric investments. The SIPC writes on its website that futures contracts, fixed annuity contracts, foreign exchange trades, and other investment contracts (it uses limited partnerships as an example) generally do not qualify for protection.

Realistically, virtually everything the vast majority of individual investors are likely to own is covered by the SIPC when their broker is a member of the SIPC.

That said, SIPC protection is not a catch-all form of financial insulation. If your stocks lose 50% of their value because of a deep recession or plainly bad stockpicking, the SIPC won’t insure your losses. Likewise, if someone promises you that an investment will return 20% per year, but it only returns 5% per year, the SIPC won’t help you there, either.

The SIPC is only there to insure losses of a member firm in liquidation, not to insure you against bad stock picks or promises made by a financial advisor. You can check to see if your broker is an SIPC member on its website (most household name brokerages are members).

How SIPC insurance works in the real world

Let’s say you have $10,000,000 in assets that are eligible for SIPC insurance (stocks, bonds, etc.) in your brokerage account. Your broker hits a rough patch because it made a few bad billion-dollar trades with some clients’ money it improperly comingled with some of its own money. The SEC, FINRA, and SIPC step in, and the liquidation process begins.

In an extraordinary case where the SIPC has to step in to protect investors in liquidation, only 95% of client assets may be immediately recoverable. Thus, the recoveries would afford a $9.5 million payout to the investor. The SIPC would chip in another $500,000, the max of its limit, to cover the investor’s $500,000 loss. In this case, the investor who had a $10 million brokerage account would have lost nothing, receiving $9.5 million from recoveries from the brokerage liquidation, and $500,000 from the SIPC to cover the shortfall.

But let’s suppose the investor had only received $9 million from the liquidation of assets and $500,000 from the SIPC. Would they have simply lost the remaining $500,000 not covered by recoveries and SIPC insurance as a result of their broker’s bad behavior? Likely not.

In fact, most brokers have protection known as “excess of SIPC insurance” which covers losses over and beyond SIPC limits. At TD Ameritrade, for example, clients have up to $151.5 million of protection in excess of SIPC limits, up to $500 million for all TD Ameritrade account holders. Ally Invest clients have up to $37.5 million of protection in excess of SIPC limits, up to $150 million for all of its customers. I could go on and on, but most brokers buy this excess insurance as an inexpensive way to give their clients peace of mind for a worst case scenario.

Of course, to get to the point where losses eat through the broker’s required regulatory capital and SIPC limits, things would have to go very, very wrong. For losses to then consume all of a broker’s excess of SIPC insurance… well, things would have to go almost impossibly wrong.

To put things in perspective, the SIPC wrote in a recent annual report that of 767,300 claims since inception, only 356 were for amounts in excess of its protection limits. In other words, only about 5 in 10,000 customers who actually had to make a claim (which is itself a very small percentage of the total investing population) had losses in excess of what the SIPC covers. Lloyd’s of London, which is the insurer behind most excess of SIPC policies, likely doesn’t have to pay out on many claims.

The short story is this: There are many ways to lose money as an investor -- betting on stocks you learn about at cocktail parties, buying stocks that are pitched to you in spam emails, and so on -- the risk of loss due to a brokerage bankruptcy is so low it almost rounds to zero.

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