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Industry Study of FCM Customer Protection Finds Insurance Firms Open to Indemnifying

Tuesday, November 19, 2013
By Richard Hill

Nov. 15 --The National Futures Association released an industry-sponsored study Nov. 15 that found that some insurance companies had an interest in offering financial protection for customer losses from the failure of an undersegregated futures commission merchant.

The concept of insurance for FCM customers took on some urgency in the last two years following the failures of Peregrine Financial Group and MF Global Inc. The latter FCM initially left its customers more than $1 billion in the lurch, though much of that has been recovered in bankruptcy court.

The study, conducted by Christopher Culp of consulting firm Compass Lexecon, investigated four possible models for insuring FCM customers. It was commissioned by NFA, the Futures Industry Association, the Institute for Financial Markets, and CME Group Inc. (CME)

According to the study, insurance companies rejected two of the models as too costly and they received little discussion in the study. Another model that was studied in depth would be similar to coverage provided by the Securities Investor Protection Corporation. However, that model would take nearly 55 years to fully fund at $2.5 billion, according to the report, assuming no losses in the interim, with the funds coming from mandatory annual payments from FCMs. Because of the time involved, the model likely would require a government “backstop,'' the study said.

Captive Company
The most promising model--the one favored by some insurers--would create “customer asset protection insurance” for FCM customers.

Under this scenario, several FCMs would jointly form an FCM “captive” insurance company that would provide CAPI to the FCMs' customers. The FCM captive would be liable for “first-loss risk exposure,” with claims being absorbed by all the non-failing FCMs. Reinsurance would cover claims in excess of that first-loss retention.

A group of eight reinsurance companies created an informal proposal for purposes of the study for a CAPI program that would initially cover up to $300 million in claims.

The first $50 million in losses would be covered by a deductible funded in part by participating FCMs. The additional $250 million would be provided by the insurance companies, with a maximum payout of $50 million per FCM.

The total annual cost of such a program was estimated to be between $18 million and $27 million.

Proposal Called 'Restrictive.'
On a phone call with reporters, Culp described the reinsurers' proposal as “a bit restrictive and costly,” and said further negotiations with affected parties might yield better terms.

According to the report, the model assumes an initial group of four to 10 participating FCMs, most with less than $1 billion in customer assets, but some with up to $5 billion.

Premiums would be assigned to FCMs pro-rata based on potential claims. The report observed that premium prices could be passed on to customers.

The other viable model would be a universal, government mandated insurance program with an entity similar to SIPC at its center. Under this model, a Futures Investor and Customer Protection Corporation would provide up to $250,000 of protection to all customers of every FCM. The protection would be funded by payments of up to 0.5 percent of each FCM's annual gross revenues until reaching a target of $2.5 billion.

Assuming no claims, the target would be met in 54 years, likely necessitating a government “backstop” during the interim. Culp said that “in the short-term it might not be perceived as credible to many customers” without such a backstop.

The report also concluded that such a model would be unfair to larger FCMs as their customers would be providing, proportionally, the greatest amount of funding.

Meanwhile the rejected models would have provided CAPI to FCM customers in two ways: either by primary insurance carriers or by individual FCMs that purchased insurance on behalf of all of their customers.

Reinsurers considered those scenarios too costly, according to the report. Specifically, they were concerned that administrative and underwriting costs were too high relative to the potential number of customers and possible risk.

An FIA spokesman told Bloomberg BNA that the study would start a dialogue and “will help policymakers and the marketplace in assessing the economic feasibility of creating additional protection through various types of insurance programs and the potential costs of such programs.”

To contact the reporter on this story: Richard Hill in Washington at

To contact the editor responsible for this story: Phyllis Diamond at

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