Behind Executive Life’s Fall : Regulators Are Taking the Heat for Letting the Insurer’s Problems Go On, Entrapping Thousands of Its Policyholders

In April, the insurance empire created by Fred Carr, a soft-spoken, white-haired super-salesman, crumbled. First Executive Corp. filed for bankruptcy, and its two big insurance subsidiaries were seized by state watchdogs.

But the regulators’ actions were too little, too late. In fact, today some critics charge that the laxity of state regulators, particularly in California, contributed to the collapse of Executive Life Insurance Co. in California and Executive Life Insurance Co. of New York.

California regulators realized four years ago that Carr, the one-time go-go mutual fund salesman, and his associates were overstating Executive Life’s financial health and demanded that the company raise more cash as a cushion against losses. In New York, regulators --incensed by regulatory violations, fudged financial statements and evasive answers--ousted three of the insurance unit’s top executives.

The actions in both states should have raised red flags that would have warned hundreds of thousands of consumers to steer clear of the Executive Life units, industry experts say. Yet the flags were never hoisted.

California regulators did not require Executive Life of California, which operated in all 50 states, to notify other state regulators of its problems. New York regulators agreed not to tell anyone--including regulators in the other 22 states that Executive Life of New York operated--that three of the insurer’s top officers were banned from working for the company.

People continued to buy policies, annuities and other products from the Executive Life units. When the insurers ultimately were seized--making them among the largest life insurance failures ever--they had more than 400,000 policyholders and $13 billion in assets.

Now, as regulators try to pick up the pieces by salvaging what is left of the Executive Life units, regulators’ actions are being questioned by legislators, industry experts, policyholders and annuitants, some of whom stand to absorb huge losses.

Five months after the seizure, there is plenty of blame to go around. Some point the finger at Carr and his junk bond buddies. Others say the rating agencies are culpable for not spotting the problems earlier. Still others, in part, fault the regulators and legislators.

“(Regulators) failed to exercise responsible regulatory control to protect the policyholders and the public by allowing the company to experience spectacular growth even though the company’s financial position endangered existing policyholders,” said a memo prepared in April by the staff of Sen. Howard M. Metzenbaum (D-Ohio), chairman of the Senate Labor Committee’s antitrust subcommittee, which has investigated the failures.

California Insurance Commissioner John Garamendi, a Democrat, maintains that his Republican predecessor made some big mistakes. Policyholders would be far better off if Roxani Gillespie, who served as California’s insurance commissioner from July, 1986, to last January, seized Executive Life far sooner--possibly years ago, he said.

“The Insurance Department dawdled and waited and went back and forth and never blew the whistle,” Garamendi said. “Hundreds of thousands of people were shafted because the company was allowed to continue selling policies. I’ve got three municipalities here in California that are out $30 million dollars, and they bought their policies in 1989--one in November of 1989--only months before this went into total chaos.”

Other regulators, however, disagree. They maintain that state law didn’t give Gillespie the power to seize Executive Life or stop it from investing in the junk bonds that eventually caused the company to unravel. And Gillespie maintains that she paved the road that Garamendi eventually took.

“There is a right time for government to take over an insurance company, and there are plenty of wrong times,” Gillespie said in a statement. “John Garamendi moved to take over Executive Life at the right time. He followed the course that had been prepared for him during my administration.”

Some blame the system, an inconsistent patchwork of rules and regulations that varies from state to state and is so secretive that regulators are often unaware of actions taken by their peers. Others contend that the parochial nature of insurance laws and regulation allows insurers to influence the rules that govern their industry.

“Getting a law passed requires a tremendous amount of effort,” said one regulator who asked not to be named. “You have to sit nose to nose with the industry and argue very technical issues point by point. If you go through this several times and the legislation doesn’t go anywhere, after a while you just stop suggesting things. You can’t just keep beating your head against the wall.”

Such criticism is giving life to the first viable efforts to create national safety and regulatory standards for the insurance industry, which is now solely supervised by state authorities. U.S. Rep. John D. Dingell (D-Mich.) and Metzenbaum--spurred by the Executive Life debacle--have proposed separate bills that would force insurers and their regulators to meet minimum requirements.

Maverick Genius?

The saga of Fred Carr and First Executive, revealed through a review of thousands of pages of public documents, lawsuits, industry reports and dozens of interviews, underscores the problems of regulating insurers.

In 1974, Carr hooked up with First Executive, a troubled West Los Angeles insurance company. By the early 1980s, he was fueling exponential growth at the insurance holding company by selling a new product called single-premium deferred annuities.

To sell these annuities, which promise investors a hefty payment in the future for a relatively small amount today, Carr’s companies offered unusually high returns to investors. And they could, because Carr backed the policies with an investment portfolio stuffed with high-risk, high-rate junk bonds that generally yield far higher investment returns than high-quality bonds.

From the outside, Carr looked like a maverick genius. In the early 1980s, the firm posted tremendous gains in profitability and net worth. It earned high marks from all the big insurance rating firms. And Carr, who left his previous job shortly before the mutual fund he was managing collapsed, became the subject of glowing articles in magazines and newspapers.

Some knew Carr was taking a big gamble. He was investing policyholder funds in junk bonds--a largely untested investment vehicle. And he was buying heavily into private offerings where there was little market for the securities other than that made by Michael Milken, the young junk bond wizard who worked for the highflying securities firm Drexel Burnham Lambert Inc.

But Carr maintained that he was managing the junk bond investments so deftly that the risks were insignificant. And, on the surface, he appeared to be right.

What was less known was that Carr was already running into skirmishes with state regulators. On several occasions California officials contended that Executive Life’s net worth--a key measure of a financial institution’s health--was off by tens of millions of dollars.

In 1986, regulators forced the company to slash its reported net worth by $180 million, leaving Executive Life with less than $90 million in the bank. Nevertheless, the insurer remained awash in new business, and Carr was taking home million-dollar paychecks.

Regulators Low-Key

Investors, for the most part, were unaware of the regulatory wrangling. Publicly held insurance companies file two annual reports: one based on generally accepted accounting principles (GAAP), which goes to stockholders; the other based on regulatory accounting principles (RAP), which is sent to state regulators.

Those who sold Executive Life insurance policies were quick to send out First Executive’s GAAP financial statement, which revealed little about the regulatory disputes.

And regulators were surprisingly low-key about the issue. California’s examiners forced Executive Life to correct the statements it filed in the state, but they did not require the company to amend financial statements filed in any other jurisdiction where the company did business, said Joseph Belth, editor of Insurance Forum, a respected industry newsletter.

By 1987, some of the junk bonds that backed policies at the Executive Life units in California and New York were going into default. Investors learned that Milken was under investigation in a massive securities probe. And state regulators were beginning to wonder whether junk bonds were such a good idea for insurers’ investment portfolios.

Regulators also began to more closely scrutinize First Executive’s insurance subsidiaries. But because state regulators are unfettered by national standards, their actions varied widely.

First Executive’s biggest subsidiaries were headquartered in California and New York, so what regulators did in these states was of paramount importance. Regulators in the other states where these two big companies operated generally relied on examinations and actions taken by insurance commissioners on the two coasts.

In New York, things were getting dicey. New York regulators’ 1987 exam found that Executive Life had taken millions of dollars in credits for reinsurance, in which one company passes part of its risk to another company for a fee. The reinsurance proved to be improper or phony, regulators later said.

Insurance officials were livid. They started an investigation and interviewed top company officers. In the end, New York slapped a $250,000 fine on the company, forced it to boost its capital and barred three executives from signing financial statements issued by Executive Life of New York.

New York regulators also pushed in 1987 for a bill that would limit insurers’ investments in junk bonds to 20% of their assets. The legislation was controversial. Milken and other junk bond advocates flew in to testify about the need for these bonds and the damage the New York law could do--not only to the junk bond market but also to the U.S. economy.

Nevertheless, the bill passed. Executive Life of New York was not required to sell off its junk bond holdings, which amounted to nearly half of its assets, but was barred from adding to the total.

A similar bill was also introduced in the California Legislature in 1987, when Executive Life had about 45% of its assets in junk bonds. Then-Assemblyman Patrick Johnston (D-Stockton), who had just been appointed to head the Committee on Insurance and Finance, was its sponsor. Johnston asked then-insurance Commissioner Gillespie for information and for help in drafting the bill.

California’s Help

Gillespie never provided the committee with information or staff support, and she never testified on the bill’s behalf, Johnston, now a state senator, said in an interview last week. Gillespie would not comment on the episode.

In the end, the bill died in Johnston’s committee after receiving support from only four of the committee’s 20 members. When Executive Life of California failed, more than 65% of its assets were in junk bonds.

Meanwhile, California regulators were also examining reinsurance deals at Executive Life of California. And they also had objections. But according to a financial statement filed by First Executive in 1987, the California regulators did not disallow the reserve credits taken by Executive Life of California. Instead, the Insurance Department told the company not to do it again and to reduce the amount of the credits taken over time.

Executive Life of California also was allowed to give its New York-based sister company the $151 million it needed to satisfy capital demands of New York regulators. A few years later, the California company contributed an additional $50 million to Executive Life of New York, New York regulators said.

California regulators, who were slashing Executive Life’s reported net worth by the tens of millions, also wanted the firm to boost capital. The company did so by getting about $175 million in cash and $170 million in IOUs from its parent, First Executive Corp. First Executive raised the money by borrowing it from investors. Thanks to the contribution from First Executive, Executive Life of California was able to report $204 million in net worth at the end of 1987.

But the the $170-million IOU was not delivered to Executive Life until February or March of the following year. California regulators have since said they knew that the company essentially falsified its year-end financial statements. However, they said they thought that this falsification was “insignificant.”

“The fact that it was done in February or March instead of December did not have a bottom-line impact on the financial health of the company,” said one ranking regulator, who has since left the Department of Insurance.

Insurance rating services also largely ignored this issue--as well as several others--maintaining that they were “technical violations” that had little impact on the company’s financial health.

By 1988, however, Executive Life’s finances were so tight that the company knew it had to boost capital or stop writing new business. It attempted another accounting maneuver designed to free up money set aside in loss reserves by transforming a $700-million pool of junk bonds into collateralized bond obligations--an investment-grade security.

Looking Bleak

California examiners, who learned about the bond swap in 1990, decided that the transaction was bogus, and they forced the company to unravel the deal.

By now, things were really looking bleak. The investigations into Milken and the junk bond market were making headlines. Drexel had agreed to pay a record fine for securities violations. Milken was fired, indicted and eventually sent to prison after pleading guilty to insider trading charges.

The junk bond market fell through the floor. And for 1989, First Executive posted the biggest annual loss in its history thanks to a $1-billion writeoff in the company’s quickly souring investment portfolio.

News of the staggering loss sent policyholders into a panic. They swamped Executive Life’s headquarters demanding their funds. Before it was all over, policyholders had withdrawn more than $3 billion from the teetering giant.

Suddenly, state insurance supervisors nationwide were demanding financial information from First Executive and its insurers. California regulators wanted data on “surrenders”--the term for cashing in an insurance policy--on a daily basis. By mid-January, California regulators had placed examiners in Executive Life’s offices to monitor the situation firsthand. New York followed a similar tack.

Within weeks, the National Assn. of Insurance Commissioners formed a committee to gather and disseminate information about Executive Life to the interested state insurance commissioners. The group’s first meeting was held Feb. 27, 1990, in Chicago.

For a year, state officials simply monitored the situation; they commissioned studies, waited, watched and worried. All the studies, including three completed by Milliman & Robertson, a prominent actuarial consulting firm, came to the same conclusion: the company could survive, insurance regulators said.

California and New York regulators placed stiff operating restrictions on the company. By July, a few states had barred the firm from writing new business, and New Jersey was asking for a $500-million cash deposit to cover the Garden State’s policyholders. In October, Gillespie hired Stewart Economics, a consulting firm, and the Los Angeles law firm Rubenstein & Perry to conduct yet another study and make recommendations about what to do. Salomon Bros. was also hired to study the status of Executive Life’s junk bond portfolio.

But before all the studies were complete in 1991, First Executive posted another whopping year-end loss, which spurred a second run on the bank. Garamendi, California’s newly elected insurance commissioner, seized the firm and froze its assets. Company customers were barred from cashing in or borrowing from their policies.

Painful Lessons

He recently announced a proposed $3-billion buyout of Executive Life by a French consortium that should pay most policyholders 81 cents on the dollar. Guaranty funds are expected to kick in the difference for those with cash value policies worth less than $100,000.

However, those with larger accounts and some Executive Life investors--specifically those holding municipal bonds backed by the insurer’s guaranteed investment contracts--stand to lose substantial sums.

And even if losses to policyholders are kept at a minimum, many experts agree that the Executive Life debacle offers painful--but valuable--lessons that, if heeded, should prevent such an episode from recurring. Foremost among these lessons, industry critics say, is realizing the risks inherent in trying to monitor a national and even global business at a local level.

“The idea of a regulatory system without formal national oversight is inconsistent with a business that operates nationally and in many instances, internationally,” said editor Belth.

Executive Life’s Failure 1974: Fred Carr joins First Executive Corp., an ailing Los Angeles-based life insurance holding company.

1978: The company begins to sell single-premium deferred annuities and starts to grow rapidly.

1980: California insurance regulators, after a regularly scheduled audit, force the company to reduce stated net worth by $3.6 million.

1986: Company starts claiming huge credits for surplus relief insurance, which are later disallowed by regulators in California and New York. California forces the company to reduce stated net worth by $180 million because of disagreements about these reinsurance treaties.

March, 1987: New York regulators investigate Executive Life of New York’s reinsurance deals and determine that at least $119 million of them are bogus or inappropriate. They fine the company $250,000, force it to boost reserves by more than $151 million and oust three top-ranking company officers.

June, 1987: New York passes a new law that restricts insurers from investing more than 20% of their assets in junk bonds. A similar bill is introduced in California, but it dies in committee.

December, 1987: California regulators require Executive Life to boost capital. It does so by borrowing $170 million from parent First Executive. The firm reports the $170 million as an asset in its Dec. 31 financial statement, but regulators later acknowledged that the company didn’t get some of the money until the following year.

November, 1988: The Securities and Exchange Commission and the U.S. Attorney for the Southern District of New York begin to investigate First Executive’s potential involvement in a massive securities scandal involving Drexel Burnham Lambert and its junk bond chief, Michael Milken.

December, 1988: Executive Life swaps $700 million in junk bonds for Collateralized Bond Obligations--securities backed by a pool of identical junk bonds--and takes a credit on its balance sheet for reducing the riskiness of its portfolio.

March, 1989: Michael Milken is indicted. Junk bond market is a shambles. First Executive is cooperating with the regulatory probe into the junk market, which is also being investigated by special congressional subcommittees.

December, 1989: Regulators learn about the bond swap and force the company to unravel the deal.

January, 1990: First Executive announces it will post a loss for the fourth quarter, thanks to massive losses in the company’s junk bond portfolio. Executive Life policyholders begin to submit surrender requests. Regulators launch company audits.

February, 1990: The National Assn. of Insurance Commissioners forms a committee to disseminate information about Executive Life’s financial condition.

March, 1990: Securities and Exchange Commission launches an investigation into First Executive’s financial reporting practices. A myriad of additional governmental bodies--including the Pension Benefit Guarantee Corp., the California Legislature’s Assembly Committee on Finance and Insurance, the Department of Labor and the Louisiana Department of Justice--launch investigations.

March--December, 1990: Regulators continue to monitor Executive Life of California and Executive Life of New York on a daily basis, trying to determine whether a run on the company’s assets will kill the ailing firm. They hire Milliman & Robertson, a prominent actuarial consulting company, to look at various bond default rates and surrender rates to see if the company can survive. All the studies say Executive Life will live. But policyholders pull more than $3 billion out of the ailing insurer.

January, 1991: California Insurance Commissioner Roxani Gillespie leaves office, turning the helm over to the state’s first elected insurance commissioner, John Garamendi.

March, 1991: First Executive posts another devastating loss. Policyholders again swamp the company with surrender requests.

April, 1991: Regulators in California and New York seize the Executive Life companies and place temporary bans on policyholder loans and surrenders. First Executive files for bankruptcy.

August, 1991: Garamendi announces that a consortium led by a French life insurer will buy Executive Life Insurance Co. of California in a deal worth about $3 billion. Policyholders are expected to get at least 81 cents on the dollar.

Ensuring Regulation

Insurance regulators in California and New York played key roles in monitoring the health of Executive Life Insurance Co. and Executive Life of New York. Below are the key figures.

California:

Roxani Gillespie, insurance commissioner from 1986 to January, 1991. Consistently disagreed with Executive Life’s accounting and forced the company to restate its net worth time after time. However, she allowed the company to continue to operate relatively unhampered until its fortunes sharply deteriorated in 1989. Stationed regulators inside Executive Life’s offices to monitor company operations. Commissioned several studies about the company’s viability.

John Garamendi, insurance commissioner from Jan. 7 of this year to present. Seized Executive Life Insurance Co. on April 11 after news of further losses at the troubled firm prompted a run on the company’s assets. Arranged the sale of the company to a consortium of investors led by MAAF, a French life insurer. Policyholders would receive about 81 cents on the dollar under this buyout plan.

New York:

James P. Corcoran, superintendent of insurance from March 8, 1983, to Jan 26, 1990. In March, 1987, after a department audit and investigation, he slapped a $250,000 fine on the firm and required it to boost reserves by $151 million. Ordered three top officers to stop doing business in the state. Pushed junk bond regulation through New York Legislature. The bill, called Reg. 130, went into effect June 24, 1987. Amendment on Feb. 21,1991,set limits on the lower-grade junk bonds.

Salvatore R. Curiale,* superintendent of insurance from June 30, 1990, to present. Seized Executive Life Insurance Co. of New York in April of this year when the seizure of its sister firm, Executive Life of California, caused a devestating run on the company’s assets. * Wendy E. Cooper, first deputy superintendent, acted as New York’s superintendent of insurance in the six months between Curiale and Corcoran.