Insurance Firm Operations Cut by Garamendi

Halting what he described as a “run on the bank,” state Insurance Commissioner John Garamendi on Friday placed severe operating restrictions on First Capital Life Insurance Co. but stopped short of seizing the troubled firm.

In his second major action in two months against a life insurer that invested heavily in junk bonds, Garamendi issued a “cease-and-desist” order forcing the San Diego-based company to stop selling new policies and stop honoring a cascade of requests from anxious customers hoping to redeem their insurance policies and annuity contracts.

First Capital Life will continue to honor its other obligations, including death benefits and annuity payments.

The order also prohibits First Capital from making any payments to either its Los Angeles-based parent company--First Capital Holdings Co.--or its affiliates without Garamendi’s approval.

Last month, Garamendi placed Los Angeles-based Executive Life Insurance Co. into conservatorship, after staggering losses from junk-bond investments and adverse publicity caused thousands of policyholders to cash in their policies.

Although the life insurance industry insists that the bulk of its members are strong, industry experts maintain there are still several companies that are in precarious situations because of souring investments in junk bonds and real estate.

“First Capital Life Insurance Co.’s problems are serious and they require immediate attention,” Garamendi, the state’s first elected insurance commissioner, said at a news conference.

Although a large portion of First Capital’s $4.5 billion in assets are held in high-risk “junk bonds,” Garamendi said the company’s financial ailments are not as severe as those of Executive Life, a subsidiary of First Executive Corp. that the department seized April 11. He said he expected the state to formally take over First Capital at some future date but only as a temporary measure.

Garamendi said the moratorium on First Capital’s business practices probably will be lifted in a short time, after the company’s financial condition is stabilized. Asked how long this would take, Garamendi would only say he expected the company to be healthy again “soon.”

“We believe policyholders will receive 100% of contracted benefits,” he added.

First Capital, which has 190,000 life insurance policyholders and 90,000 customers holding annuities in 49 states, will not resist Garamendi’s order.

“We supported the commissioner’s action,” said Charles Perkins, a company spokesman. “We believe that his order will give us the time we need to deal with some of the financial issues before us.” Still, Perkins would not rule out layoffs among its 400 employees at offices in the Sorrento Mesa area of San Diego.

First Capital Life’s parent company, First Capital Holdings, acquired the life insurance operation from E. F. Hutton in 1987. E. F. Hutton was the originator of the “universal” life insurance policy, a flexible contract than enables policyholders to change payments and benefits at different times in the life of the policy.

In a memo to the company’s employees, First Capital Senior Vice President Fred A. Buck said Garamendi “has ended the recent surge of surrender requests which threatened to jeopardize our future. This gives us the opportunity to restore confidence in the company and retain the long-term value of customers’ policies.”

The regulatory action follows apparently fruitless talks with First Capital’s biggest stockholder, Shearson Lehman Bros., which owns 28% of First Capital’s stock and was one of the biggest marketers of the company’s life insurance policies and annuities.

Garamendi traveled to New York last Monday for negotiations with officials of American Express and Shearson, its brokerage subsidiary, to persuade Shearson to pour a “significant capital infusion” into the ailing company. But sources knowledgeable about the talks said Shearson was willing only to help First Capital customers who had purchased their policies from Shearson.

However, Shearson is continuing to negotiate with Garamendi, the company said.

“We commend the California insurance commissioner for acting responsibly throughout the entire period leading up to today’s decision, which reflects his paramount concern in protecting client assets,” said Howard L. Clark Jr., chairman and chief executive officer of Shearson Lehman Bros., in a prepared statement. “We welcome the opportunity to continue working with him to represent the interests of our clients who purchased First Capital Life products.”

Shearson also announced a $144-million charge against earnings on Friday to account for the decreased value of its stake in First Capital, the company’s first acknowledgment that First Capital’s problems were of a permanent nature. First Capital’s stock fell 44 cents to close at 94 cents on the New York Stock Exchange, down from $14 at the end of 1989.

Garamendi said publicity this week about First Capital’s financial problems and his negotiations with American Express and Shearson officials on Wall Street prompted a wave of requests from customers to cash in their policies or take out loans against them.

Although customers must usually pay a penalty to cash in their policies, many apparently were willing to take a partial loss rather than risk losing everything. The value of these “surrender requests,” after averaging $10 million a day last week, soared to $25 million on Monday, $30 million Tuesday, $60 million Wednesday and $100 million Thursday.

“That is a classic run on the bank,” Garamendi said. Rather than customers lining up at the door, the company has had “mailbags full of surrender requests,” he said.

He said some of the surrender requests that came during the past two weeks will not be honored if the checks were not written before his order was issued Friday.

But the run was only a symptom, not the cause of the company’s failing financial health, Garamendi said. He blamed high operating costs, which he said are twice the industry average, and a big junk bond portfolio for the company’s underlying problems.

Garamendi said the firm’s parent company was charging “excessive” fees for managing the insurance firm’s assets. Those charges will be immediately reduced, he said.

The company’s portfolio of junk bonds, the high-risk, high-yield securities that financed the 1980s takeover boom, rose to be 46% of its assets today, from 16% in 1986, Garamendi said. The market for junk bonds crashed last year and the company said in a recent financial report that these assets are now worth $500 million less than the company paid for them.

To satisfy the increasing number of surrender requests from its policyholders, the company would have been forced to sell more and more of its bonds at depressed, “fire-sale” prices, Garamendi said.

Instead, the commissioner wants the company to dispose of the bonds in an “orderly manner” until the securities amount to no more than about 20% of the company’s holdings.

Reducing the company’s operating costs and selling off part of the junk bond portfolio are two steps in a four-point plan Garamendi proposed to return First Capital to sound footing. He also said the company needs an infusion of capital--preferably from American Express--and needs to sell the “universal life” segment of its insurance business. The company had previously hired an investment bank to sell its universal life unit.

Several companies are rumored to be looking at First Capital’s insurance business, including First Colony Life of Lynchburg, Va., and John Hancock Mutual Life Insurance Co. of Boston. First Capital has said it is negotiating to sell the business for about $150 million. Although Garamendi implied that mismanagement, or at least bad judgment, led to First Capital’s problems, he said the department’s investigators have found no evidence of criminal behavior.

“We have no indication any laws have been broken by this company,” Garamendi said.

Still, a San Diego attorney filed suit Friday in Superior Court on behalf of several First Capital policyholders.

“We’re alleging that they (breached fiduciary responsibilities) by taking the proceeds provided for life insurance policies and investing them in junk bonds and things like that,” said attorney Ed Gergosian, who added that he intended to convert the suit into a class-action lawsuit.

Times staff writer Greg Johnson contributed to this story. Weintraub reported from Sacramento, Kristof from Los Angeles and Johnson from San Diego.

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