Shearson, State Reach Pact on Failed Insurer
Shearson Lehman Bros. said Tuesday that it has reached an agreement with California insurance regulators to buy First Capital Life Insurance Co. in a $50-million deal that promises to salvage investments of 250,000 policyholders nationwide.
The deal, which must be approved by Los Angeles Superior Court Judge Kurt Lewin, proposes paying policyholders 100% of the money they invested. It also would provide a guaranteed minimum 4% return on their investment.
But Shearson, one of the nation’s major brokerage firms, would make full payment only to customers who keep their policies with the insurer for the next five years.
The agreement sets in motion a formal process to rescue First Capital, which has about $4 billion in assets and 190,000 policyholders and 60,000 annuity holders nationwide. The San Diego-based company was seized by regulators in May in one of the largest life insurer collapses ever, as its junk bond losses mounted and customers abandoned the firm.
“Last year, policyholder fears about the deteriorating financial condition of First Capital led to one of the largest runs ever experienced by a California insurance company,” said state Insurance Commissioner John Garamendi. “Today, only nine months later, we have a rehabilitation plan that protects every policyholder dollar.”
Insurance regulators said they expect the rehabilitation plan to gain court approval within three months. Meanwhile, other potential buyers will be allowed to bid for First Capital and creditors can raise objections to the sale in state court.
If other bidders emerge, Garamendi will weigh their offers on the basis of how much money, security and liquidity they provide to policyholders. No other bidders have yet come forward, said an insurance department spokeswoman.
The recapitalization proposal is the second of a major California-based life insurer announced in the last two months. A French investor group was given approval in December to buy Los Angeles-based Executive Life Insurance Co. in a $3.55-billion transaction.
The rescues are considered important steps to restoring consumer confidence in the insurance industry, which was shaken last year by a wave of failures related to risky investments in junk bonds and real estate.
In making the agreement, Shearson is attempting to protect its investment in First Capital and settle costly class-action litigation with its customers, many of whom were sold policies by the New York investment house between 1986 and early 1991.
Many First Capital policies were sold througF. Hutton & Co., which Shearson acquired in 1987. Shearson, a unit of American Express Co., continued selling policies; in 1990 it was responsible for as much as 80% of First Capital’s new policy business.
“From the outset, we wanted to resolve this in a way to protect the policyholders, many of whom are our customers,” said Shearson Chairman Howard L. Clark Jr.
American Express owns 28% of the stock of First Capital Holdings, the Los Angeles-based financial services concern that owns First Capital Life and Fidelity Bankers Life in Richmond, Va. The deal announced Tuesday does not affect the holding company, which filed for Chapter 11 bankruptcy nine months ago, or Fidelity Bankers, regulators said.
The plan calls for the recapitalization of First Capital Life, a commitment to reduce its huge junk bond portfolio to less than 20% of assets and the assumption of management by Shearson and American Express. The plan could take five years to fully implement.
Shearson’s $50-million cash infusion into First Capital Life would bring the insurer into compliance with regulatory rules for ensuring policyholder safety. The money is a loan, which will be repayable only after all policyholders get their due. Other creditor claims will be subordinated to Shearson’s note.
American Express will guarantee that all policyholders who stick with the company through a five-year rehabilitation period will receive 100 cents on the dollar plus interest. The exact interest rate is not yet known, but it will not fall below 4%.
Those policyholders who want to cash out may do so immediately after the plan is approved. However, they will be forced to pay a surrender fee amounting to 25% of their account value. The surrender charges will decline in subsequent years: 23% in the second year; 20% in the third; 10% in the fourth, and 5% in the fifth.
All policyholders who had cashed out in the months before First Capital failed will be allowed to reinstate their policies and recover the surrender fees they previously incurred. Garamendi said roughly 36,000 individuals fall into this category.
Those who surrendered their policies but do not want to reinstate them may apply for partial recovery of their surrender fees through Shearson. The exact amount these former policyholders might get back has not been determined, but a source close to the proceedings says it will be a fractional amount.
Continuing policyholders will be allowed to borrow up to 10% of their account value each year. They also can withdraw up to 10% of their account value once annually without incurring surrender fees, Shearson officials said.
In addition, certain hardship cases will be exempt from plan restrictions on withdrawals.
Shearson has pledged to reduce the junk bonds in First Capital’s portfolio to less than 20% of total assets before the end of the rehabilitation period. That process, which would bring the insurer into compliance with California law, is already under way and possibly could be completed within a year.
Junk bonds have declined from 42% of First Capital’s portfolio when it was seized to about 30%, Garamendi said. The junk bonds’ book value is about $1.2 billion, with a majority of the bonds still paying interest.
The deal is subject to the settlement of a class-action lawsuit by First Capital policyholders last year. Filed in June in New York federal court, the suit alleges that Shearson underplayed the riskiness of First Capital annuities to its customers.
The plan calls for the formation of a three-member rehabilitation committee by Shearson and American Express to manage First Capital Life’s operations. The company will not underwrite any new business during the rehabilitation period unless state regulators approve.
The agreement with Shearson is seen as a coup for Garamendi, who was criticized by industry officials for public comments that led to a rush of policy surrenders. At the time, Garamendi was negotiating for a cash infusion from Shearson and American Express.
He said the capital was needed in order for the company to survive.
“If membership has its privileges, then ownership has its responsibilities,” he said, in a play on words of a well-known American Express advertisement.
But the talks broke down. On May 10, Garamendi issued an order prohibiting First Capital Life from writing new business and making payments to its parent. The order also put a moratorium on policy loans and cash surrenders.
On May 14, Garamendi placed the insurer in conservation to protect the company’s assets. First Capital Holdings subsequently filed for bankruptcy, but said Tuesday it expected to file a reorganization plan “in the near future.”
First Capital’s Rescue
Shearson Lehman Bros. and the California Insurance Department have reached an agreement for the rehabilitation of failed First Capital Life Insurance Co. Here are the deal’s basic terms:
* Shearson will inject $50 million cash into First Capital.
* American Express, Shearson’s parent company, will guarantee that policyholders who stick with the company through a five-year rehabilitation period will receive 100 cents on the dollar. They will also be guaranteed a minimum 4% annual investment return.
* Those who opt to cash out immediately will have to pay a surrender fee amounting to 25% of their account value. The surrender charges decline in subsequent years.
* The 36,000 policyholders who cashed out in the months before First Capital failed will be allowed to reinstate their policies and recover any surrender fees they incurred. Those who surrendered their policies but do not want to reinstate them may apply for partial recovery of their surrender fees through Shearson.
* Continuing policyholders will be allowed to borrow up to 10% of their account value each year. They also can withdraw up to 10% of their account value once a year without incurring surrender fees.
* First Capital’s junk bond portfolio will be reduced to less than 20% of total assets to bring it into compliance with state law.
Hot Line for Policyholders
Policyholders with questions can call (800) 735-5535.
SOURCE: Shearson Lehman Bros. and California Department of Insurance
