Final answer:
The statement is true; the Securities Investor Protection Corporation (SIPC) protects customers against the loss of cash and securities in the case of a broker-dealer bankruptcy, akin to how deposit insurance and pension insurance work. Insurance principles dictate these funds cover claims, operating expenses, and allow for profit. An insurance firm charging a uniform premium might risk insolvency if not accounting for varying risk groups.
Step-by-step explanation:
The statement is actually describing a concept similar to deposit insurance or pension insurance, but for the securities industry, the equivalent would be investor protection provided by the Securities Investor Protection Corporation (SIPC).
When a member brokerage firm fails, the SIPC steps in to return securities and cash (up to certain limits) to investors. While the SIPC is often misunderstood to insure against losses due to market fluctuations, its actual role is protecting customers against the loss of cash and securities in the case of a broker-dealer bankruptcy.
Thus, members paying assessments into a fund like SIPC for claims in the event of broker-dealer bankruptcy is indeed true. However, the fundamental law of insurance suggests that over time, payments into an insurance fund should cover claims, operating costs, and allow for a company’s profit.
If a company were to charge an actuarially fair premium to the group as a whole, it might not adequately account for different risk levels within groups, potentially leading to inadequate reserves and the risk of insolvency.
Moreover, in the context of bonds, while bondholders can demand repayment through bankruptcy proceedings in cases where the issuer cannot make payments, it is still important for investors to diversify to mitigate the risk of defaults.