Insurance Industry Shows Signs of Crisis, Experts Say : Economy: Policyholders are concerned over risky investments. First Executive lost $1.1 billion in two years.
Janice Bernstein is scared.
She has read about the $500-billion bailout of the savings and loan industry. She has heard about the shakiness of the nation’s big banks as Congress considers legislation to shore up the system.
But all this seemed distant, abstract. Until now.
As a policyholder of Executive Life Insurance Co., a subsidiary of troubled Los Angeles-based First Executive Corp., Bernstein is now experiencing firsthand the impact of a financial crisis. And it does not involve a high-flying thrift or a mismanaged bank, but what many consider the last bastion of safety--an insurance company.
“I feel as if there is no safe investment out there,” said Bernstein, a West Los Angeles resident. “At the time these policies were presented, they were not presented as risky investments. (Executive Life) was an A-rated company. This is very difficult.”
Bernstein is one of about 400,000 consumers who hold an insurance product issued by one of First Executive’s life insurance units--Executive Life in California and Executive Life of New York.
Many of these investors believed that insurance companies were rock-solid. They felt comfortable putting their savings into Executive Life insurance policies, annuities and similar retirement plans. Now they worry that their old-age nest eggs may be in jeopardy.
First Executive’s policyholders are not alone, industry experts say. While they say the system can cope with the current situation, the nation’s once sound insurance industry is showing signs of stress as junk bond, real estate and other investments sour.
First Executive, once one of the nation’s largest and fastest-growing life insurers, is a dramatic example. In the last two years, the Los Angeles-based insurer has lost about $1.14 billion because a risky investment portfolio--mostly loaded with junk bonds--had gone sour.
Now its auditors question First Executive’s chances for survival. Insurance rating services are becoming more pessimistic about the company’s ability to pay claims. And its insurance subsidiaries risk being seized by regulators.
“I am scared stiff,” said Donn Sigerson, a 77-year-old Los Angeles resident. “I am not at a point in my life where I can gamble anymore. This is my retirement money.”
Many nervous First Executive customers have already withdrawn their funds--a costly endeavor. Last year, policyholders paid surrender fees of $142 million to cash in policies worth $3.5 billion, the company said in a recent financial report.
Now, as the picture becomes increasingly bleak, more consumers are weighing the sometimes hefty surrender fees against the risks of losing all if the company fails.
“If I take my money out today, I’ll lose $100,000,” said one retiree, who asked not to be named. “I am sitting here sweating it out, wondering whether to get my money today or wait until my anniversary date (about a month away) to get it all.” The $100,000 amounts to about 20% of this man’s retirement fund.
Other policyholders say that they are willing to pay the cost, but they still have concerns about taking their money.
“Part of my hesitation is that I am afraid I am going from one problem to another potential problem,” a Santa Monica policyholder said. “First Executive was described to me as an extremely sound, highly rated company. How do you really know?”
Most of the nation’s biggest life insurers are healthy, said Gene Grabowski, a spokesman for the American Council of Life Insurance. And even when companies are troubled, consumers don’t usually lose money because of a system of safety nets, called guarantee funds, that pay off the policyholders of failed insurers.
The guarantee fund only comes into play if the company fails and is liquidated by regulators--a worst-case scenario. In most cases, regulators are able to sell or transfer a troubled insurer’s business to a healthier company.
It is currently unclear whether California’s fledgling life insurance guarantee fund will cover Executive Life policyholders. A provision in the law that created the fund excludes coverage for any company that was “insolvent or impaired” at the beginning of 1991 when it was established.
Regulators and industry officials say they do not yet know whether Executive Life would be considered impaired, and thus ineligible for coverage.
Even if the guarantee fund does cover the company’s policyholders, other provisions would severely limit payouts to those with large policies.
The guarantee fund limits coverage to 80% of the policy amount, up to a maximum of $250,000 on death benefits and $100,000 on cash values and annuities. It does not cover guaranteed investment contracts, or a wide array of other less traditional insurance contracts.
Such restrictions make it imperative that consumers buy insurance only from healthy companies, industry experts said.
“Executive Life is an aberration. There are some 2,300 life insurance companies in the United States, and, by and large, they are very sound,” Grabowski said. “(Consumers) just have to shop around.”
Many consumers shopping in the last decade found First Executive an irresistible buy. It fueled rapid growth in the early 1980s by offering policyholders new products with unusually high rates.
The company promoted single-premium deferred annuities. These were policies in which a policyholder paid a single sum and, upon retirement, received a stipulated amount. The firm also sold guaranteed investment contracts to companies. The contracts, typically used to replace traditional pension plans, were promises to pay a set interest rate on an investment.
Money poured into First Executive because it promised to pay more than its competitors. It did that because it put policyholder premiums into high-risk, high-rate junk bonds made popular by Drexel Burnham Lambert’s Michael Milken.
In less than a decade, First Executive, which had $800 million in assets in 1980, was transformed into an industry giant, with assets of $19 billion and more than $59 billion of insurance in force.
But things began to sour in 1987, when securities regulators started to investigate Milken. They maintained that he violated a wide array of securities laws and operated a complicated insider network where a handful of his cronies would buy and sell each other’s debt, creating a market for otherwise worthless securities. Milken pleaded guilty to lesser violations last year and is now serving a 10-year prison term.
First Executive and its chief executive, Fred Carr, also came under regulatory scrutiny, since Carr was one of the biggest purchasers of so-called junk bonds peddled by Milken. However, none of First Executive’s officers have been indicted in the securities inquiry.
Nevertheless, the Milken scandal and increasing defaults on these junk bonds, have battered First Executive’s investment portfolio. The company, which holds nearly $9-billion worth of these bonds, says that the market value of these bonds is now $2.6 billion below book value. And defaults on these bonds contributed to the firm’s staggering $466-million fourth-quarter loss.
In the face of First Executive’s financial crisis, many consumers feel confused and frustrated. With thousands of financial institutions to choose from, consumers complain that they have neither the time nor the expertise to analyze the financial health of every company. Moreover, with a financial institution, the picture can change from rosy to bleak very quickly, and that makes the analysis even more difficult.
“The average person does not have enough information to make a decision,” complained another policyholder. “I am tempted to take my money and run. But I don’t feel as if I have a good alternative. I have no idea what to do.”
There are simply too many choices and not enough regulatory oversight in this era of deregulation, said Harry Snyder, West Coast regional director of Consumers Union in San Francisco. He said that deregulation opened up greater investment opportunities to financial institutions in the 1980s, but also exposed them to greater risks.
“The dirty little secret is a lot of us were wrong about deregulation. We thought it would provide us with better service and lower prices,” Snyder said. “But when you go back and read Adam Smith (the famous free-market advocate), you realize he is talking about a different world--a world where everybody knows who they are dealing with.”
