What Protection Do I Have If My Insurer Goes Bust?

Posted on: 27 October 2008 by Gareth Hargreaves

Investors will be protected against banking and insurance collapses explains Independent Financial Adviser Peter McGahan.

Investors will be protected in the event of an insurer collapse, such as AIG.

I am concerned about what protection I may have in the event my insurer goes bust.

I have a pension with my bank, an investment with AIG and I was ready to pull it out. The truth is, even if I did pull it out I wouldn't know where to put it as banks are not safe.

Have you any views on this?

What interesting times we are living in. Once regarded as one of the largest financial institutions in the world, AIG dropped to their knees. In fairness they must be there for a reason, them along with the other institutions who made atrocious investment decisions. I can only wonder at whom thought buying bad securitised debt was a good idea as an investment.

Remember if it had gone well they would have taken the credit. Now it's gone badly, it’s the fault of the credit crunch. I am heartbroken!

Left in their trail of casino-like investments are the bemused investors who somehow have to work out how they can protect themselves. Up until now, the bank was as safe as bricks and mortar, now after the housing falls it still is!


Firstly there is a Financial Services Compensation Scheme (FSCS) which protects you.

An investment into bank deposits affords you protection of £50,000 protection per person, not account. Ensure you do not spread your capital between a bank and a subsidiary as the protection will only apply once.

The FSCS also cover 100 per cent of the first £30,000 and 90 per cent of the next £20,000 for mortgage advice for business conducted after October 2004, and also the same total for certain investments like unit trusts for example.

Long term insurance such as pensions and life assurance offer 100 per cent protection for the first £2,000 plus 90 per cent of the remaining claim. Whilst for deposits the rules also allow for a share of savings above the £50,000 following distribution of assets by the insolvency practitioner, it's not something you should rely on.

As you can see an investment outside of cash offers much more protection.

This is the end of the simple bit. And I really mean that, so you will have to see if you are affected below and if confused, contact me.

Any policyholder protection will depend on the jurisdiction in which any life company or fund provider operates and more importantly on who is the buyer of the investment. Remember Jersey and Guernsey have no compensation scheme although they are reviewing it.

Let's look at a few examples. A client who invests in an offshore bond and accesses insured funds operated and managed by that provider will be protected under FSCS as above as long as they are habitually UK resident at the time they purchased the bond.

An investment however in an external fund, not directly managed by the provider is not covered by FSCS, something not a lot of people know. It is expected by the FSA that 'large' companies do due diligence on fund groups and providers would be classed as large companies.

Therefore if an external fund provider goes out of business or is insolvent, the FSCS does not come into play.

Firms have the responsibility and regulatory duty to ensure they have appropriate procedures in place to ensure the customer is protected. They should ensure the external fund manager is financially strong and evidence it.

Any pooled investment such as unit trusts or Oeics should also appoint a custodian to ring fence the customer's assets from the assets and liabilities of the firm itself. This effectively protects the customer's investment by 100 per cent assuming there are no irregularities.

In the case of an external fund, the provider would have legal access to the surrender value of the underlying investments so that protection is well worth remembering.

One of the biggest concerns is if a bank or building society based in the UK defaults within an investment bond there is no FSCS protection as the 'large company' rule applies again.

The reason is because the provider rather than the individual is the investor. If you are sitting in cash within a bond in an attempt to protect the cash you should be very careful indeed as no protection is afforded.

And finally, all those invested in structured contracts within a bond should also remember this falls into the large companies rule and as such have no protection, other than the offer of a surrender value of the assets.

The surrender value of structured contracts can be considerably less than their actual value.

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