Default coverage for money market funds

Rough Notes, Mar 1999 by McCoy, Thomas A

Zurich and others begin offering protection to money market funds and their depositors

When the infamous bank robber Willie Sutton was asked why he continued to rob banks, he replied simply, "Because that's where the money is."

Today a lot of money-liquid assets of ordinary citizens and businesses-is no longer in banks. It's in money market funds.

Individuals began pouring money into money market funds during the inflation-ravaged early-1980s when interest rates paid by the funds went into double digits. Money funds furthered their appeal to individuals and businesses by introducing checkwriting privileges, and by the time short-term interest rates came down, the funds had become thoroughly entrenched as a savings vehicle. Today there is some $1.45 trillion deposited in money market funds, and the amount continues to grow.

In almost every respect, the money fund phenomenon fits the best American tradition of efficient product delivery. Depositors earn a few percentage points more than they would in banks. Companies and government agencies issuing shortterm paper have a ready supply of money. And the money market funds themselves, more than 1,300 of them, have become an integral part of the booming mutual fund industry, providing a parking place for money coming in and out of equities or bonds.

Perhaps the only potential flaw is the specter of default which hangs over both the money fund depositors and their managers. What happens in the event of a default on any of the obligations that make up the funds' assets? Whereas bank depositors' funds are protected by FDIC-insurance up to $100,000 per account, money market fund depositors' funds are not. If a money market fund manager makes investments that go belly up, it is possible for depositors in the fund to lose principal.

Defaults have been rare, and in almost every case when a money market fund has suffered a default on its investments, it is the fund manager, rather than the depositor, that has absorbed the loss. But money fund users who hear of such situations are reminded that these are voluntary decisions on the part of the fund manager. Their deposits are not insured.

The Rollins Agency of Tuckahoe, New York, which has mutual fund industry clients, has seen one of its money fund clients take a hit. When the money market fund faced a potential default, "The fund company had to pump in $10 million to $15 million of its own funds to protect depositors," says Anthony Fardella who heads the agency's Executive Risk Division. And when a potential default occurs, he adds, "It can turn into an E&O or D&O claim."

Zurich-American Specialties recently introduced a policy that protects money market fund managers against the default risk-in the process also offering protection to depositors. "We believe this product will become a standard coverage for the mutual fund industry within the next two years," says Rob Fishman, executive vice president.

Agents and brokers with mutual fund company clients agree that money market default protection is a product whose time has come. "We think it will be attractive to funds with assets in excess of $1 billion," says Fardella. The agency recently made a mailing about Zurich's policy to lawyers with mutual fund company clients. "They're showing an interest in it," says Fardella.

ICI Mutual, a captive insurer affiliated with the Investment Company Institute (ICI)-a major mutual fund company trade groupalso recently began offering money market default protection. "A number of fund groups have expressed serious interest in it," says Dan Steiner, vice president and general counsel for ICI Mutual, who predicts the policy will catch on in the marketplace this year.

Some of ICI Mutual's business comes directly from members of the ICI and some through the members' brokers.

Marsh McLennan J&H in New York has put together a handful of programs to provide money market funds with default protection. One of these programs was for a major fund company that was forming a captive; others were placed in the commercial marketplace, including one with Zurich.

"We're hoping it will catch on," says Michael Nicolai, a broker with Marsh McLennan. "We think all major fund companies will look at (money market default coverage) by the end of 1999."

At Aon Risk Services in New York, broker Paul Kim says his office is in the process of putting together several default coverage submissions for money market funds. "The recently announced policies from ICI Mutual and Zurich have spurred tremendous interest from the funds and their legal counsel," says Kim. "I believe quite a few policies will be written in the next 12 to 18 months."

Zurich's approach

The Zurich-American Specialties product, which it calls Net Asset Value (NAV) Protection, is offered on an open brokerage basis. "It can provide not only the retail investor but also the institutional investor in money market funds a level of comfort to have the policy backing up that fund in the event of default," says Shelia January, assistant vice president of Zurich-American's Financial Institutions Department in New York.