Soaring Insurance Costs Strap Brokerage Firms; Faced with Higher Prices for More Limited Coverage, Industry Studies Banks' Captive Insurers
Albert, Andrew, American Banker
NEW YORK -- Fraud and disloyalty aren't as affordable as they used to be for the securities industry. Brokerage executives are cringing as they pay the skyrocketing costs of insuring against those evils.
As instances of fraud, forgery, robbery, and other dishonest acts by employees and outsiders grow dramatically, so does the cost of maintaining fidelity insurance, also known as broker blanket bonds. And there's no avoiding the problem, since fidelity insurance is required of securities firms by the New York stock Exchange and other market regulators.
Searching desperately for ways to minimize those costs, risk managers at brokerage firms are turning to their counterparts in the commercial banking industry, which represents the largest business group covered by fidelity insurance.
Wall Street executives are watching closely as groups of banks band together to form their own priviate insurance companies, known as captive insurers. Many bankers view these risk-sharing arrangements as the only way to guarantee the future availability of insurance at reasonable terms. But not all members of the investment banking community are convinced they want to share in each other's losses.
Today, at a forum sponsored by the Securities Industry Association, experts from the insurance and stock brokerage industries will discuss various ways to cope with the insurance crisis, including the possibility of setting up a captive organization.
Brokers and investment bankers have been rudely awakened by insurance premiums five to 10 times higher than their previous levels.
In addition, fidelity bonds underwritten this year have forced securities firms to assume a far larger portion of their insurance risk. Blanket bonds underwritten in the last several months carry deductible amounts, or self-insurance, that are about 20 times higher than previous levels.
A.G. Edwards' Premium Increases 600%
Like others in the industry, executives at A.G. Edwards & Sons Inc., a large regional broker in St. Louis, were caught off guard by the cost of renewing their $25 million blanket bond, which expired last month. Their inability to negotiate better terms for a new blanket bond typifies the industry's difficult bargaining position in a shrinking insurance market.
The firm's insurer, Aetna Casualty and Surety Co., jacked up the annual premium to $600,000 from slightly less than $100,000. As expected, Aetna also shortened the length of its coverage to one years, compared with the three-year term of the previous bond.
"We were prepared for an increase, but we still ended up [paying] about twice what we expected," said Raymond J. Kalinowski, vice chairman and treasurer of A.G. Edwards.
Perhaps most bothersome to the brokerage house was a whopping increase in the deductible portion of its coverage to $5 million from $250,000. However, as the 19th largest securities firm in the nation, with more than $176 million in capital as of yearend 1984, A.G. Edwards can still manage its higher deductible with relative ease.
For smaller firms, however, the inflated deductibles can spell trouble. "As deductibles increase, it could cause some [smaller] brokerage firms to go into distress and, in effect, shut them down," said Jack Frawley, vice president and director of risk management and insurance for Thomson McKinnon Securities Inc.
Mr. Frawley was referring a New York Stock Exchange rule requiring that any portion of a deductible exceeding a maximum of $500,000 be booked as a liability and charged against a firm's net capital. The threshold is based on size and can slide as low as about $100,000 for smaller firms.
In A.G. Edwards' case, the ceiling was set at about $400,000, which meant it was required to charge the remaining $4.6 million of its deductible against its net capital.
Risk managers at securities firms are hoping the Big Board will provide some relief through its proposed change in NYSE Rule 319, which details the fidelity insurance requirements of member firms. …