Banks Vs. Insurance Companies

Whether you’ve moved to a new house, new city, new state, or even new country, odds are you’ve experienced what comes along with a major move. As you know, one of the most important factors in any move is finding the best neighborhood, right? “Best” can mean anything from the safest to the most affordable to the most convenient or all of the above.

Bottom line is, you want the best. Who doesn’t, especially when it comes to a decision that big? The comparison of different neighborhoods is much like the comparison between banks and insurance companies. Just like you want to find the best place for you to live, you need to find the best place for your money to live as well.

There are many major differences you may want to consider before trusting your life savings to one. Among these major differences, and perhaps the most important, is what happens to the investors/depositors if a bank or insurance company fails.

Let’s take a look.

We’ll start with banks…

The first thing you must understand is that, just like every other business in the world, banks can fail. However, it isn’t the same as your favorite pizza restaurant failing. The only thing you’re losing there is a delicious slice of pizza, but you can get that elsewhere. When a bank fails, you’re losing something that isn’t as easily replicable as a slice of pizza… You’re losing MONEY.

To put it into perspective for you, after the crash of 2008, over 400 banks failed! If you had money in one of those banks during that time, it is very likely that you know exactly what I am talking about. You may not have lost all of your money, since banks are backed by the Federal Deposit Insurance Corporation (FDIC), but do you know just how insured banks really are?

Let me first throw the numbers out at you, and then I’ll explain what they mean… Banks currently insure up to $250,000 per depositor per FDIC-insured bank. That is a $150,000 raise from what it used to be (in 2008, the limit was raised from $100,000 to $250,000). However, at the end of the second quarter in 2014 (June), the insurance deposit fund was reported as having $51.1 billion available.

What does all of this mean?

To put it simply, should the banking industry experience a huge financial collapse, the FDIC would not be able to meet the $250,000 insurance. The $51.1 billion currently held by the FDIC is not enough to meet the $250,000 insurance in the event of an enormous financial collapse.

Another thing to note about banks is that they sometimes rely a lot on speculation. For example, if a bank takes $10 million in deposits, it might make $90 million in loans. If only $10 million of those loans default, the bank could exhaust its reserves. When real estate bubbles burst, banks suffer losses on their loans backed up by property values, forcing them to rely on government bailouts where tax-payers’ money has to be used to keep them solvent.

Remember when mega-banks like Bear Stearns and Lehman Brothers were in the news because their financial foundations were threatened and they called for government bailouts? That’s because multi-billion dollar investment banks like that use what is called “leverage ratios” of 30 – 1, and even 40 – 1.

In other words, they will speculate with $300 million when they only have $10 million in reserves. All it takes is a pronounced market reversal to put a large institution such as that on its ear, which is exactly what happened in the market meltdown of 2008.

Insurance companies aren’t able to speculate like that…

The insurance industry is regulated at the state level, allowing for a close watch on insurance companies. Insurance companies can be some of the most highly regulated companies in America, and can be more closely monitored than the banking industry. Because of this, the capital reserve requirements for insurance companies are strict and much higher than the capital reserve requirement for banks.

Unlike banks, insurance companies are required by law to have dollar for dollar in reserves. That means that they have to keep at least $1 in an untouchable reserve account for every $1 of their depositors’ money they have at risk. This automatically provides an added level of security that banks do not, helping to protect anyone from losing money in the rare event of an insurance company failing.

While banks are more focused on making money for their stockholders (thus making risky stock market bets), insurance companies may not have stockholders to please. Because of this, insurance companies can be more focused on helping to ensure that the promises made to policyholders are met.

That being said, it is no wonder insurance companies are much more careful and particular than banks when it comes to where they place their money.

Insurance companies own corporate bonds that can be considered more liquid when it comes to safety. The corporations whose bonds they hold can be some of the largest and safest corporations in the world. These bonds make regular interest payments to the insurance companies who hold them.

Insurance companies can also purchase some of the most highly-rates conservative investments available. A large percentage of the capital of these carriers is placed in U.S. government bonds, which are backed by the United States government.

A much smaller portion of the assets of insurance companies is placed in conservative A-rated investment real estate, such as large office buildings, which are occupied by Fortune 500 companies. Have you ever noticed that when you drive through a major U.S. city the skyscrapers and glass towers are insurance buildings? In many cases, these properties are fully paid for, which serves to add to an insurance company’s financial security.

There are hundreds of different ways you can plan for retirement and it’s important to find the right plan for YOU. That is the only way to help you achieve a more relaxing, stress-free retirement.

 

Image courtesy of Stoonn at FreeDigitalPhotos.net

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