Policyholders May Lose Big if Ailing Insurer Should Fail

Many policyholders of Executive Life Insurance Co. may not be covered under California’s fledgling life insurance guarantee fund, which could leave consumers with devastating losses if the troubled company fails.

Insurance regulators say the guarantee fund, which was only established in January, excludes coverage for customers of companies that were “insolvent or impaired” when the fund was launched.

Insurance regulators will not discuss specific companies and would not say whether Executive Life is considered impaired. However, officials knowledgeable about the state’s guarantee fund maintain that coverage for the company’s policyholders is in question.

Moreover, the guarantee fund specifically excludes coverage for guaranteed investment contracts, which make up a substantial portion of the Executive Life’s business. Guaranteed investment contracts are used by many companies as an alternative to a more traditional pension fund.

Bill Adams, spokesman for Executive Life, said the company believes that its policies are backed by the state’s insurance guarantee fund.

The issue of coverage by the insurance guarantee fund has been raised in the wake of the latest financial report by Executive Life’s parent company, First Executive Corp. of Los Angeles. On Monday, First Executive revealed that its financial condition had deteriorated, and its independent auditor said its survival was uncertain.

In a report filed with the Securities Exchange Commission, the company said a laundry list of problems had “created substantial uncertainty” about whether the company meets regulatory capital requirements designed to ensure policyholder safety. Moreover, these problems boost chances for a regulatory takeover, the company said.

The company blames its woes on its massive portfolio of high-risk, high-yield junk bonds, which have plunged in value during the past two years. Problems with these investments caused First Executive to post staggering losses of $1.3 billion in the last two years. It has also spurred nervous policyholders to withdraw more than $3 billion from First Executive accounts during the past year, First Executive revealed in a regulatory filing.

Moreover, new business has come to a virtual standstill, the company said in its report. First Executive’s claims-paying ability also has been downgraded by major rating firms.

However, the company says its insurance subsidiaries still have a substantial amount of cash. The biggest subsidiaries are in California and New York.

First Executive said it is also attempting to transfer its insurance business to a more highly rated carrier. And insurance experts note that typically, when an insurer gets into trouble, regulators have been able to persuade another insurer to assume the failed carrier’s business, which protects policyholder funds.

Nevertheless, if the company were to be taken over by regulators and liquidated--the worst case scenario--policyholders could suffer devastating losses because of limitations in California’s guarantee fund.

The fund covers only 80% of the policy amount up to a limit of $250,000 for life insurance death benefits and to a limit of $100,000 on cash values and annuity benefits.

Moreover, it severely limits the rate of interest policyholders can earn. These limitations are complex, but they essentially work like this: If a failed insurer was paying 9% interest on a policyholder’s funds, the guarantee association would recalculate the value of that individual’s account. The new calculation would provide for a much lower interest rate--currently about 4%--and would effectively reduce the amount the consumer could claim from the guarantee association.