Like the high-risk, high-yield junk bonds he blames for the recent failure of two California life insurance companies, Insurance Commissioner John Garamendi's activist regulatory strategy carries the potential for huge benefits and dangerous pitfalls.
At stake is the fate of two companies with more than $15 billion in assets, the life insurance policies and annuity contracts of more than half a million customers, and the political future of Garamendi--California's first elected insurance commissioner and one of the state's most ambitious politicians.
If the two companies he has seized--Executive Life Insurance Co. of California and First Capital Life Insurance Co.--can be rehabilitated and their customers paid in full, Garamendi could emerge as a hero of the consumer movement and become an early favorite for the Democratic Party's 1994 gubernatorial nomination.
But if Garamendi is forced to liquidate either firm and pay policyholders only a portion of what they are due, he could fall prey to the kind of second-guessing that would hinder his movement up the political ladder.
Already, some industry insiders are questioning Garamendi's outspoken style and wondering whether his recent actions are driven more by sound business practices or his desire for higher office.
"Garamendi is jumping in during what might be no more than a blip or an aberration and seizing companies," said one life insurance executive who asked not to be identified. "Don't you wonder whether he is doing what he is supposed to be doing or whether he's just playing to the grandstands?"
Others within the industry are more supportive, suggesting that Garamendi is doing what he must to weed out the weak companies and restore the public's faith in the business.
"My sense is that our membership is pleased with the positive action he's taken so far," said Brad Wenger, president of the Assn. of California Life Insurance Cos. "He's making a good-faith attempt to correct abuses."
Clearly, though, times have changed in the insurance industry since Garamendi took office Jan. 7.
Four multibillion-dollar firms--Executive Life Insurance Co. of California, Executive Life of New York, First Capital Insurance Co. and Fidelity Bankers Life--fell like dominoes after Garamendi announced that a souring portfolio of junk bonds had decimated Executive Life.
Seizing of Assets
In just the first few months of 1991, insurers with $21.9 billion in assets have been seized nationwide; in 1989, seizures totaled $1.35 billion; in 1981, assets seized amounted to $41 million, according to Martin Weiss, president of Weiss Research in West Palm Beach, Fla.
"The chance of being hurt by an insurance failure is 225 times greater today than it was 10 years ago," Weiss said. "And that's assuming that this is the end of it. But, unfortunately, it is not going to stop here."
In the past, when insurers got into trouble, the problems were typically solved in private. Money was raised; businesses were sold; the public was never the wiser. There was never a serious run on an insurer and no one ever lost any of their principal on a life insurance policy.
Consider the recent seizure of First Capital Life and Fidelity Bankers Life, subsidiaries of Los Angeles-based First Capital Holdings Inc. Although both companies had invested heavily in junk bonds, their parent had nevertheless earned a $7-million profit at the end of 1990. The insurers also got high marks from the industry's biggest rating firms.
Indeed, when Virginia regulators seized Fidelity Bankers, they stressed that the company was sound. But because of the publicity surrounding Garamendi's restrictions on the firm's sister company, First Capital, and his unsuccessful attempts to get American Express to pump capital into the insurer, policyholders were withdrawing funds at a dangerous pace. American Express' brokerage subsidiary, Shearson Lehman Bros., owns 28% of First Capital Holdings.
Garamendi concedes that the run on First Capital, in which customers sought to withdraw more than $265 million in less than two weeks, accelerated after word leaked out that the commissioner was on Wall Street trying to put together a bailout plan.
But Garamendi said the only way to guarantee confidentiality is to do nothing. That approach, he said, was taken by his predecessor--Republican Roxani Gillespie--and led to the situation with Executive Life, whose customers probably will be forced to accept less than the full value on their investments.
"My intention is to have strong companies that are capable of withstanding the ups and downs of the economy," Garamendi said in an interview. "We knew that First Capital was a weak company and needed assistance. And we went to the principal owners of First Capital and the principal marketing arm of First Capital and began working with them to refinance their company.
"The alternative is you sit on your hands and don't do anything. That is what led to the First Executive debacle. The Department of Insurance did nothing (in early 1990). The result was in the next year, nearly $4 billion of assets were stripped from the company as the well-informed--usually the powerful and the insiders--bailed out, leaving those who could not bail out or those who did not have the information . . . to sustain significant losses."
State Sen. Patrick Johnston (D-Stockton), a frequent critic of the industry and an advocate of stronger oversight, said Garamendi is taking the right approach. He said Gillespie, who was appointed by former Republican Gov. George Deukmejian, called him twice in 1990 and urged him to back off his effort to investigate the fast-deteriorating Executive Life.
"Gillespie handled solvency issues the way Victorians handled incest--behind closed doors," Johnston said. "The commissioner and other high-level people were willing to let people work their way out of problems."
Gillespie could not be reached for comment.
But Garamendi seems intent on more than just turning an industry around. He has framed the life insurance issue as one of the small investor--"the hard hats and secretaries"--against those who profited during the 1980s from an "ethic of greed."
In his first four months in office, Garamendi probably has held more press conferences than Gillespie did in her entire tenure. In a series of briefings explaining his actions against the life insurers, Garamendi has been part economics professor, part political quipster.
With a degree in economics and finance from UC Berkeley and a master's in business administration from Harvard, Garamendi has led the public through a sometimes numbing maze of regulatory law and policy. But the politician in Garamendi has never been far below the surface.
In populist tones, he accused the IRS of trying to "cannibalize the vulnerable carcass" of Executive Life by seeking payment of $643 million in back taxes and penalties. He noted that the "tax police" moved in as he was trying to salvage the company for small policyholders after "wealthy investors" and traders had taken their millions.
In the case of First Capital, Garamendi has launched a relentless campaign to pressure American Express and Shearson Lehman to help bail out the company because of their ownership interest and the huge commissions obtained from selling First Capital's products for years.
Playing off the American Express advertising line that "membership has its privileges," Garamendi added: "Ownership has its responsibility."
But behind the rhetoric, Garamendi is emerging as a serious policy-maker willing to work with the very financial giants he disparages with the broad brush of his criticism.
Executive Life Strategy
One of his first acts as commissioner was to put together an advisory team--including an investment banker, two insurance executives, a real estate developer and a finance professor--to help him develop a strategy to deal with Executive Life. He has hired a New York investment banker--the Blackstone Group--and four law firms to help him put together a deal to salvage First Executive.
"It's clear he sees that his political future is tied to bashing insurers, and they're not real happy about that," said one veteran industry lobbyist in Sacramento. "But it doesn't appear that he's going to be unduly unreasonable when it comes to sitting down and talking about practicalities."
Garamendi insists that he has not considered what impact his actions will have on his political future. Garamendi ran for governor and controller before winning the insurance commissioner's job in 1990 and is thought to still harbor ambition for higher office.
It may be that there is more risk for Garamendi in moving too slowly on the life insurance issue than in moving too quickly.
"If he has to liquidate a company and the assets are insufficient to pay off the policyholders, there will be down the road grumbling and second-guessing," said Sen. Johnston. "On the other hand, if he didn't move quickly, then this would deteriorate on his watch and ultimately he'd be held responsible.
"The real test is what happens as he provides oversight on the other companies, some of whom may have financial problems, and whether he can effectively provide a prophylactic regulatory environment that prevents the problems we've seen."
Weintraub reported from Sacramento and Kristof reported from Los Angeles.