NEWS ANALYSIS : Executive Life Seizure Stirs Fears of Crisis in Industry : Insurance: The specter of recent banking and savings and loan failures haunts big firms as problems mount.

The seizure of Executive Life Insurance Co.--the largest regulatory takeover of a life insurer in the nation’s history--raises the question of whether a new crisis is brewing in America’s battered financial system.

The nation’s $1.4-trillion life insurance industry is at a crossroad. Net income is falling, investment losses are escalating and some industry experts maintain that more than a third of the industry could fail if today’s recession deepens.

The problems of life insurers--once thought to be pillars of financial stability--prompt concerns that they are following the path of the banking and the savings and loan industries, which have suffered huge losses and failures in recent years.

The woes now surfacing may be only minor stress fractures in an otherwise healthy industry. Nevertheless, they cause concern because millions of policyholders and pensioners have trusted their life savings to insurance firms. And the system of safety nets designed to protect these funds is far more fragile than those that protect deposits at the nation’s banks and thrifts.

Worries about the life insurance industry’s condition have surfaced on Capitol Hill. Hearings are scheduled next month by House and Senate subcommittees on whether federal regulation of the industry is adequate.

“There are plenty of warning flags flying, both with regard to life insurance companies and property/casualty insurers,” said Rep. John D. Dingell (D-Mich.), chairman of the House subcommittee on oversight and investigations.

“There are situations where insurance companies have their portfolios loaded with real estate investments and junk bonds of highly questionable value. And there is concern about the integrity of the regulatory process.”

Nowhere are the signs of crisis so dramatic as at Los Angeles-based First Executive Corp., the parent of Executive Life of California and Executive Life of New York. First Executive, which catapulted into the national spotlight by financing exponential growth rates through purchases of junk bonds, is on the ropes.

The company’s once vaunted high-yield, high-risk junk bond portfolio is now so troubled that the state Insurance Commission took over its Executive Life unit Thursday. The holding company, which lost $1.14 billion in the last two years, itself is facing possible bankruptcy.

But First Executive is not the only life insurer that’s straining. Other industry giants--including Equitable Life Insurance and Travelers Co.--have also posted huge losses in recent months as investment portfolios stuffed with real estate loans and other risky investments began to sour.

Equitable and Travelers are in better shape than First Executive. Although each posted year-end losses nearing $200 million, they still seem to have adequate capital and reserves.

However, these companies’ woes are indicative of an industry in turmoil. Some life insurance analysts now believe that a huge portion of the industry could be crushed by a serious downturn in the economy.

“Right now the industry is close to its bottom in terms of financial health,” said Martin Weiss, president of Weiss Research in West Palm Beach, Fla. “You can look at surplus ratios, capital ratios, exposure to junk bonds, exposure to real estate. Any measure you use comes to the same conclusion. There was a rapid deterioration in financial strength during the 1980s.”

Weiss, who rates the financial health of some 1,700 life insurers, maintains that nearly 37% of them--including some industry giants--probably could not withstand a severe recession. These companies might be able to turn themselves around. But as things now stand, policyholders face growing risks, Weiss maintains.

IDS Financial Services, an investment firm owned by American Express, agreed in a recent report that said life insurers have become far more vulnerable to economic cycles than they were in the past. Between 18% and 34% of the industry’s biggest companies could risk insolvency in a recession, the company said.

But most insurers maintain that the industry’s troubles are not that severe. They strenuously object to comparisons to the savings and loan industry, whose collapse may cost taxpayers $500 billion over the next 40 years.

Industry officials argue that one of the biggest contributors to the thrift debacle was decreasing regulatory oversight. Insurance regulation is currently heading in the opposite direction, with the National Assn. of Insurance Commissioners proposing a wide array of new rules that would give regulators more control, insurers say.

“The steps taken in regulation in the last few years have been to dramatically tighten oversight,” said Earl R. Pomeroy, North Dakota insurance commissioner and past president of the NAIC. “The regulatory response that brought on the savings and loan disaster was the direct opposite.”

However, the NAIC has very limited enforcement powers, and there is no other national regulator for insurers. Consequently, the NAIC acknowledges that much of the industry’s proposed regulatory tightening will be subject to the dictates of state overseers, who can opt to follow many of the stricter rules or ignore them.

Moreover, even if all the controls are put in place, some doubt the regulators are equipped to head off serious threats to company solvency.

“There are not enough capable examiners in the 50 states to catch a slide in a company until it is too late,” said Thomas F. Conneely, president of the Assn. of California Insurance Companies. “That is not the examiners’ fault. It is a system that has not kept pace with the reality of today’s economic system.”

Nevertheless, life insurers maintain that their industry is still, by and large, rock solid.

“There have been a couple companies that have invested in a way that would not be considered prudent,” acknowledged Gene Grabowski, spokesman for the American Council of Life Insurance. “But, certainly the vast majority of insurers have steered away from junk bonds and have diversified. When the recession ends, the insurance industry will probably emerge as the healthiest of all the financial services.”

Still, no one denies that the financial picture has deteriorated for life insurers as a whole. And nearly everyone--from the American Council to Standard & Poor’s, a respected credit rating service--believes that there will be more insurance company failures in the next few years than there have been in the past.

What brought life insurers--once bastions of strength and stability--to this sorry pass? The roots of all the troubles seem to trace back to the early 1980s--the same era that spurred the savings and loan woes.

Like thrifts, life insurance companies operate by taking in money today and paying it back tomorrow. They know that the majority of their policyholders are going to collect eventually, so they price policies based on known death rates. They make their money by investing today’s premium dollars well enough to give both the insurance companies and their policyholders a return.

Historically, they poured premium dollars into conservative investments, such as government bonds and mortgages. But that changed in the early 1980s when interest rates started to skyrocket and individuals began to demand higher returns.

Insurers responded by offering higher-yielding policies, which was easy to do in the early 1980s, when even Treasury bills were paying double-digit rates. But as interest rates began to fall later in the decade, insurers looked around for high-paying investments. They found them in risky junk bonds and speculative construction loans.

At the same time, health insurance policies that they had been writing profitably for years were beginning to sour. New diseases--most notably AIDS--and newly perfected treatments--such as organ transplants--were making health care increasingly expensive. Insurers found they couldn’t raise rates fast enough to keep up.

But unlike the situation with the S&Ls;, there is no federal government standing by to alleviate the losses of each insurance policyholder. Insurance policies, instead, are protected by an inconsistent patchwork of state guarantee funds, which are only as strong as the insurance companies that back them.

“Guarantee funds are a slender reed,” said Robert Hunter, president of the National Insurance Consumers Organization. “If your whole retirement fund is in a life insurance policy and the company fails, you have a problem.”

Most states have life insurance guarantee funds. But each fund has different restrictions and limitations. All limit the amount policyholders can recover and some bar coverage for certain types of policies.

Consider California’s newly instituted life insurance guarantee fund. It promises to pay policyholders a maximum of $100,000 or 80% of their policy amount, which ever is less. Moreover, the final payment to claimants is likely to be decreased even further because of interest caps imposed by the state. Right now, the interest rate failed insurers would pay would be less than 4% annually.

More troubling for customers of Executive Life is that the fund excludes coverage for companies that were “insolvent or impaired” as of last January, when the fund was formed. Knowledgeable sources maintain the definition of impaired is vague enough to make it debatable whether Executive Life’s policyholders would be covered at all. While state Insurance Commissioner John Garamendi says he believes the policies are covered, it is a decision to be made by the fund itself.

In addition, the funds do not cover a wide array of less traditional insurance products. This includes guaranteed investment contracts--which were purchased by many companies to replace more traditional pension plans.

Things could be worse. New Jersey, Colorado, Louisiana and the District of Columbia do not have guarantee funds for life insurance policies, Hunter said. When a life insurer fails in those states, policyholders must look to guarantee funds in the failed insurer’s home state to pay their claims. However, more than half of these guarantee funds are not obligated to pay claims of out-of-state residents.

Moreover, some believe the funds are neither administratively nor financially equipped to handle failures of big companies.

It took regulators three years to pay claimants when Baldwin United Insurance--the largest previous collapse of a life insurer--failed in 1983, for example. And that was a triumph. One state insurance commissioner said at the time that it would take 40 years to pay Baldwin’s policyholders unless they broke some of the restrictions on his state’s guarantee fund.

That catastrophe was averted when regulators were able to sell off big portions of the company to other insurers and convince some companies to kick in more than their fair share. But now, far more big insurers are financially troubled, Weiss said. And there is no assurance that regulators will be able to avert the next disaster.

“The whole guarantee fund concept is based on the idea that only small companies will fail, and that the large companies will be strong enough to cover the losses,” said Weiss. “The moment you start talking about large company failures, the whole concept falls apart.”

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