Establishing Voluntary Excess Deposit Insurance: Results of the 2006 FDIC Study
The Federal Deposit
Insurance Corporation (FDIC) was required by the Federal Deposit Insurance
Reform Conforming Amendments Act of 2005 (FDIRCAA) to study the feasibility and
consequences of privatizing deposit insurance, establishing a voluntary deposit
insurance system for deposits in excess of the maximum amount of FDIC
insurance, and increasing the limit on deposit insurance coverage for municipalities
and other units of general government. In February 2007, the FDIC sent its
report to Congress. The results of the FDIC's findings on privatizing deposit
insurance appeared in a previous issue of the FDIC Quarterly (available at http://www.fdic.gov/bank/analytical/quarterly/index.html).1 This
article summarizes the FDIC's findings on establishing a voluntary deposit
insurance system for excess deposits. The results of the FDIC's study on
providing for increased coverage on municipal deposits will be presented in a
future issue of the FDIC Quarterly.
In 2006, in response to the Federal Deposit Insurance Reform
Conforming Amendments Act of 2005 (FDIRCAA), the FDIC studied the feasibility
of establishing a voluntary deposit insurance system for deposits that exceed
the maximum amount of FDIC insurance. This study concluded that market changes
during the past two decades have lessened the demand for excess deposit
insurance and provided depositors with other options to protect excess
deposits. This article examines the factors that have shaped this new banking
environment. It then looks at two approaches to offering excess deposit insurance and identifies key issues to be resolved should
Congress authorize an FDIC role in the provision of excess deposit insurance.
A Changed Banking Environment
The banking environment has changed considerably since the early
1990s in response to a return to banking industry profitability, technological
advances, and product developments in the private sector. As a result, the demand for various forms of
excess insurance has diminished.
The Banking Industry's Return to Stability and Profitability
The return to industry stability and
profitability after the turbulence of the late 1980s and early 1990s has
reduced the demand for private excess deposit insurance. A number of private
excess deposit insurance plans were implemented in the early 1990s, but
many--such as the Depositsure program, offered by
Centrex Underwriters Inc.--have been terminated. Joseph Carlson, president of
Memphis-based Centrex, stated that the company expected a "blizzard of
applications" for excess deposit insurance when the program was created in
1993. However, when profitability returned to the banking sector, Centrex found
that the demand for the product fell below original expectations, and the Depositsure program ceased operation in 2001.2
Another entrant into this market, Reliance National, a subsidiary of Reliance
Group Holdings, reported being "flooded with inquiries" in the late 1980s. However,
by the time the company developed a product, it discovered that "their timing
was a bit off."3
Examples of firms currently providing excess deposit insurance
are BancInsure, St. Paul Travelers, and Kansas
Bankers Surety Company. BancInsure provides risk management and risk mitigation
services for community banks and other financial institutions and offers excess
deposit insurance bonds to banks that are customers for the company's other
insurance products (http://www.bancinsure.com). St. Paul Travelers
offers excess coverage through a depository bond (http://www.travelers.com),
as does Kansas Bankers Surety Company, a subsidiary of Wesco
Financial Corporation. Kansas Bankers Surety offers these bonds not only to
banks in Kansas
but to banks in many other states (http://wescofinancial.com).
In addition, excess deposit
insurance continues to be provided to state-chartered cooperatives and savings
banks in Massachusetts
by the Share Insurance Fund of the Co-Operative Central Bank (SIF) for
cooperative banks and the Depositors Insurance Fund (DIF) for savings banks.
The SIF and DIF are private, industry-owned excess deposit insurance funds, and
both are backed solely by their own assets. Neither the Commonwealth
of Massachusetts nor the U.S. government
has any liability for these funds' obligations. Both funds insure deposits
above the FDIC limit, in full, dollar for dollar, without restriction
(http://coopcentralbank.com or http://difxs.com).
Recent technological advances have changed
the banking environment by giving customers options for depositing their money
and protecting their deposits, reducing the need for excess deposit insurance.
No longer must depositors physically visit a depository institution to do their
banking. Depositors can shop for financial services and conduct banking
business through the Internet. Rates and terms for deposit accounts offered
locally and nationwide are available through commercial listing services, such
as Bankrate.com (http://www.bankratemonitor.com).4 The FDIC
also has developed a Web-based application (http://www.fdic.gov/edie)
that provides information to depositors about how to keep more than $100,000
fully insured within one financial institution, using different categories of
Recent Private Sector Product Developments
Products developed by the private sector have reduced the demand
for excess coverage. Two of these initiatives have become particularly popular:
deposit-placement services and deposit-sweep programs. In deposit-placement
services, large deposits are split by private companies into smaller amounts
and distributed to participating banks; as a result, the total deposit is
insured by the FDIC. In deposit-sweep programs, a depository institution
"sweeps" demand deposit accounts into nondeposit
instruments, which may result in the avoidance of loss in the event of a bank
Services. Deposit-placement services allow participating banks and
thrifts to insure deposits that exceed the statutory insurance limit while
retaining the bank-customer relationship with their depositors. To show how a
deposit-placement service does this, let us assume that a customer deposits
$500,000 into a participating bank or thrift. The bank originating the deposit
retains $100,000 in an insured account and distributes the remaining $400,000
among four other participating institutions, resulting in the depositor having
full FDIC coverage.5 A deposit-placement
service is a form of brokerage in which the risk associated with the increased
coverage is passed to the FDIC. However, risk is minimized as deposits placed
through this service are considered to be brokered deposits, and therefore only
well-capitalized institutions can participate.6
In 2003, the FDIC responded to an inquiry from a
deposit-placement service as to whether pass-through deposit insurance rules
apply to funds placed with the service. The FDIC responded that deposit
insurance would "pass through" from the agent (the deposit-placement service)
to the owner of the funds provided that disclosure, record keeping, and other
requirements were adhered to in the process.7 Deposit-placement
services became an alternative for customers seeking deposit insurance coverage
of funds in excess of the statutory limit.
Programs. Many insured depository institutions offer customers the
option of "sweeping" funds from a deposit account into an alternative
investment vehicle. In a commercial sweep, the depositor has the option of
sweeping funds held in a demand deposit into a variety of nondeposit
instruments, including money market instruments, money market mutual funds,
Eurodollar accounts, or international banking facilities. Commercial sweeps
began to be used routinely in the 1980s. The primary motivation for developing
this product was to allow commercial demand deposit customers to earn interest
on their balances, but depositors may also believe their money is fully
protected in the event of a bank failure. However, for several reasons, most
sweeps may not actually increase a customer's chance of recovery if the
Options for Federal Excess Deposit Insurance Coverage
If Congress were to decide that the FDIC should play a role in
providing excess deposit insurance, the FDIC could adopt one of two strategies.
First, it could offer excess insurance directly to banks on a voluntary basis,
subject to an additional cost, and either retain the
additional risk not covered by the participating banks' premiums or purchase
reinsurance from a private sector reinsurer for the
additional coverage. A second approach would be to continue to rely on the
private sector for excess deposit insurance. However, to encourage private
sector insurers to enter this market, the FDIC probably would have to act in some
capacity as a reinsurer to private sector insurers.
FDIC Provision of Excess Deposit Insurance: Key Issues
The FDIC has considered how it might provide voluntary excess
deposit insurance. Issues yet to be resolved include the availability of excess
insurance, limits to the excess coverage to protect taxpayers and the insurance
fund, and a price for the excess coverage. Congressional authorization would be
required for the FDIC to play any role in providing excess voluntary deposit
The FDIC might limit the availability of excess deposit coverage to
well-capitalized and well-managed institutions. For instance, it might
institute term policies that would be cancelled if the institution failed to
meet requisite capital standards or if the institution's CAMELS (capital
adequacy, asset quality, management, earnings, liquidity and sensitivity to
market risk) rating declined. A means of informing depositors about this change
in status would need to be established to ensure that depositors received
prompt and adequate notice.
Co-insurance. The FDIC might place a limit, or cap, on the amount of
excess coverage it would insure. In addition, the depositor might share in any
losses on the excess deposit. For example, only 80 percent of the excess
deposit might be insured up to the designated cap. Of course, current law
affects the recovery of excess (uninsured) deposits. First, after 1993 and the
enactment of national depositor preference, uninsured depositors share pro rata with the FDIC in the
liquidation of the failed bank.8 As a result, if only part of an
excess deposit is insured in a system using caps or co-insurance, depositors
may not receive more coverage than they would under the current system,
although excess coverage would give depositors the certainty of at least a
minimum recovery.9 Second, the FDIC Board may authorize the payment
of advance dividends to uninsured depositors soon after a bank's closing.
Advance dividends are based on an estimated recovery of the bank's assets and
provide excess depositors an earlier return on the uninsured portion of their
A decision would need to be made as to whether participating institutions would
pay a uniform premium. One possibility might be to assess a surcharge for
accounts over the insurance limit on an increasing scale; that is, a higher
premium per dollar of excess coverage. Another approach could be to assess a
lower premium on the excess based on an institution's asset mix.
FDIC Provision of Excess Deposit Insurance: The Role of Reinsurance
The FDIC might guarantee its exposure in excess of the statutory
limit with a private sector reinsurer. The FDIC would
continue to provide deposit insurance coverage up to the statutory limit, but
its risk on the excess could be transferred to a competitive market of private reinsurers.
The FDIC explored the feasibility of establishing a private
reinsurance system for deposit insurance in 2001.11 (The study
focused on reinsurance of the FDIC's primary deposit insurance, not excess
deposit insurance, but the findings are relevant here.) The Marsh &
McLennan study found that reinsurers had only limited
interest in engaging in reinsurance agreements with the FDIC on terms
acceptable to the Corporation. Some reinsurers wished
to limit their risk by either reinsuring only the strongest banks or charging
prohibitively high premiums to banks which they determined to be involved in
high-risk activities. Specifically, the Marsh & McLennan study reached the
The capacity of the reinsurance market could theoretically exceed
$5 billion.12 However, that capacity would be available only if all
the major insurance companies or reinsurance companies participated and only
for transactions that had a very low probability of loss.
Reinsurance companies would operate to their maximum capacity
only if the FDIC paid a very substantial first loss. Even if the FDIC took the
first losses, reinsurers would provide maximum
capacity only when the transaction was rated the equivalent of Aa/AA or Aaa/AAA. Multiline insurers expressed interest in higher-risk
transactions (lower-risk transactions would not generate premiums sufficient to
support underwriting costs), but the capacity of this segment of the market was
limited--between $200 million and $500 million.
Reinsurers were not interested in
sharing losses with the FDIC on a proportional basis, even if they received a
proportional share of any premiums. Reinsurance companies advised the FDIC that
if losses were shared on a proportional basis, their capacity would not exceed
Existing transactions would affect a reinsurance company's
decision to participate in other transactions. If a reinsurer
had an existing credit exposure with a particular bank--in the form of bank
debt, credit default swaps, or insurance, for instance--the reinsurer
would likely limit any further transactions with that client. For this reason,
most reinsurers would prefer a transaction that
excluded, or substantially limited, coverage of the 100 to 150 largest banks.
Reinsurers generally preferred not to
be exposed to losses from the failure of any single large bank.
Reinsurers would be more likely to
participate if transactions were bundled and structured with a three- to five-year
term because reinsurers felt better able to evaluate
risk on a portfolio basis than on an individual bank-by-bank pricing basis.
Similarly, reinsurers were uncomfortable assessing
risk beyond a five-year horizon.
of the FDIC's risk would be a function of many factors, including the risk of
the transaction, reinsurers' cost of capital, reinsurers' expense and profit provisions, and supply and
demand. Reinsurers' prices would represent a free
market charge without government support and, as such, could be expected to
exceed prices that the FDIC would charge for the same portion of coverage.13
Privately Underwritten Excess Deposit Insurance
As mentioned earlier in this article, a small number of private
secondary insurers currently provide coverage for excess deposits with either
the bank or the depositor purchasing the coverage. However, most banks and
depositors have not taken advantage of these services. As suggested by the
results of the Marsh & McLennan study, for privately underwritten excess
deposit insurance to be more attractive to potential providers and customers,
the FDIC likely would have to assume some of the risk. The small number of
private businesses currently offering excess deposit insurance reinforces the hypothesis
that some public loss-sharing arrangement is necessary to invigorate this
Loss-Sharing Protocol. If the FDIC were to act as a reinsurer of privately underwritten excess deposit
insurance, it would need to determine how much risk it would assume. The most
critical issue would be the interplay between the amount of risk the FDIC would
retain in such a program and the pricing of excess coverage. The FDIC's share of risk could be minimal--perhaps, in the extreme, as
little as 1 percent of anticipated expected losses--but that retained component
would have to protect the private insurers from extreme events.
A return to stability and prosperity for the banking industry has
weakened demand for excess deposit insurance. In addition, technological
advances and private sector initiatives have changed the banking environment
and provided depositors with many options for protecting their deposits in
excess of the statutory limit. Banks and depositors currently can purchase
private excess deposit insurance from a limited number of providers, and new
banking products and services--deposit-placement services and deposit-sweep
programs--are alternatives to FDIC-provided excess deposit insurance.
If Congress were to decide that FDIC-provided excess insurance
was appropriate, the FDIC would need to resolve availability, co-insurance, and
pricing issues. It also would have to decide whether to retain the risk of the
additional insurance or reinsure this exposure with private sector insurers.
Alternatively, excess deposit insurance could be provided directly by private
sector firms. However, depending on its scope, the price of privately provided
excess deposit insurance likely would be prohibitive without an FDIC
loss-sharing protocol. Private sector interest in providing excess deposit
insurance, as reinsurers of FDIC exposure or as
direct providers of excess deposit insurance, appears limited.
Authors: Christine M. Bradley, Senior Policy Analyst, email@example.com
Valentine V. Craig, CFA, Sr. Program Analyst, firstname.lastname@example.org
authors would like to thank Warren Heller of the FDIC Division of Insurance and
Research and Alicia Amiel of the FDIC Library for
their assistance in writing this article.
Bradley, Christine and Valentine V. Craig.
2007. Privatizing Deposit Insurance: Results of the 2006 FDIC Study. FDIC
Quarterly, Volume 1, Number 2.
5 This example illustrates a one-way sell
transaction. Deposit-placement services also offer reciprocal transactions in
which the money that is transferred out of the originating bank ($400,000 in
our example) is replaced with deposits from other participating institutions
equaling (in our example) $400,000. As a result of a reciprocating transfer,
the originating bank maintains its deposit base.
6 12 U.S.C. § 1831f(a) (2001). An adequately capitalized (but not well-capitalized) institution may apply to the FDIC for a waiver to accept brokered deposits ((12 U.S.C. § 1831f(c)(2001)).
9 This outcome would depend on the percentage of
the excess deposit insured and the rate of return on assets to uninsured
depositors at a given failed institution.
10 Federal Deposit Insurance Corporation (FDIC), Managing the Crisis: The FDIC and RTC
Experience, 1980-1994 (Washington, DC: FDIC, 1998): p. 249.
11 The FDIC engaged Marsh & McLennan to
evaluate the feasibility of private sector reinsurance arrangements,
specifically whether such arrangements could provide competitive-market pricing
information that would assist the FDIC in setting deposit insurance premiums
and in measuring risks to the deposit insurance funds. The final report was
completed in December 2001. See Marsh & McLennan Companies, Reinsurance Feasibility Study (Washington D.C.: FDIC 2001).
12 Figures are not inflation adjusted.
13 Marsh & McLennan Companies (2001).