Either have I and I am in the insurance business, but this was a black hole insurance carrier set up by 14 of the largest banks to offer unlimited account coverage for failed brokerage firms, on top of SIPC coverage. The new York Times had a good piece on the firm and raised some interesting questions. The primary reason for the construction of such an insurance company was because forms like Travelers stopped offering such coverage because it was difficult to calculate the risk.

Lloyds of London does offer such insurance, but only up to $150 million per account with a firm maximum of $600 million. Other insurers in the US stopped offering coverage because the risk was too difficult to calculate. This, apparently, was unacceptable to our financial institutions who decided to start Capco and provide unlimited coverage to accounts if a firm failed.

This was done to attract hedge fund and institutional clients who would lose billions if a firm collapsed. The reason other insurers gave for dropping coverage is apparently 100% correct. Capco will likely have issues and possibly fail because of the collapse of Lehman. It is reported that the firm, who keeps their books private and the policy owners, i.e. brokerage firms, are the owners of the company, has only $150 million in assets, but about $11 billion in claims from Lehman.

I guess this just goes to show how smart our leading banks are and how shady some of their dealings can be. This was probably a pretty sweet deal at first, offer coverage to brokerage houses for a nice fee and the likelihood of a failure was low. No one expected Lehman to collapse, that is for sure, but clearly this firm did not have actuaries working for them, otherwise they would have much more than $150 million in reserve.

The firm was contacted, but said they are fine and they will have no problems. However, their main number, when called, goes to a nonworking Morgan Stanley line. Considering this insurer moved to Vermont from New York makes it suspect. New York has strict laws for insurers and Vermont has a less restrictive insurance regulator so the move made sense, especially if pesky customers want financial information.

Their lawyers came out with this statement:

Dewey & LeBoeuf, the law firm that represents Capco, said in a statement that Capco had no current policies outstanding and was “preserving all assets to address claims that might arise out of the insolvency of Lehman Brothers Inc. and Lehman Brothers International (Europe).”

The law firm called worries about Capco’s potential exposure to Lehman “speculation.”

Capco, which is private, is something of a financial mystery. Its members include Wall Street giants like Morgan Stanley and Goldman Sachs, banks like JPMorgan Chase and Wells Fargo, smaller brokerage firms like Robert W. Baird & Company and Edward Jones, and Fidelity, the mutual fund giant.

Other firms such as Schwab , UBS and Merrill didn’t go for such policies because Capco did not furnish their financials to them. As they put it, they did not pass their smell test ad it seemed suspect to say to clients that here is an insurance policy and by the way we are part owners f the company. Clearly there was a problem with the firm and I am sure they will make headlines in the near future. However, they did stop selling policies earlier in the year, I wonder why.

The masters of the universe are not smarter than insurance companies and had no business setting up this firm. Insurers know what risk is and how to manage it and investment firms do not know anything about risk, clearly the last 12 months told us that. This thing is likely to get very ugly as here is what foreign pension funds had to say:

Owners of the assets tied up in Lehman’s London unit, including pension funds and university endowments, believe they may have claims against Capco if all of their money is not returned by Lehman’s liquidator. If Capco can’t pay out the claims and files for bankruptcy, several customers said they would bring lawsuits against the other brokerage houses.

Is this a systemic risk? No, but I am sure we will see some type of bailout because it is a moral hazard or some other nonsense. After all, S&P which helped create our disaster first gave the firm high ratings, then downgraded them to junk before ceasing coverage earlier this year. Because of that fact alone there should be no bailout of talk of a bailout, but I digress.

It goes to show how careful you need to be when you hear something that is too good to be true.