Executive Life Ruling to Cost 3 Communities : Insurance: Temecula, Simi Valley and Whittier stand to be shut out of rehabilitation plan for collapsed firm.

A state appeals court decision in the collapse of Executive Life Insurance Co. could mean losses of nearly $40 million for the communities of Simi Valley, Temecula and Whittier, plus another black eye for California municipal bonds.

Although the 2nd District Court of Appeal on Wednesday upheld nearly all of former Insurance Commissioner John Garamendi’s rehabilitation plan for the failed Los Angeles insurer, it rejected a settlement that put aside nearly $40 million for the communities, which had parked proceeds of municipal bond issues and other funds in Executive Life securities.

Unless the Los Angeles-based court’s unanimous ruling is overturned, the three California communities--plus the city of St. Paul, Minn.--will be shut out of the rehabilitation plan and will lose their total investments. Some opponents of the plan say they will appeal.

Buyers of Temecula and Simi Valley bonds--principally tax-free bond funds--would also be shut out.

The largest loss would be for the Temecula Valley Unified School District, which stood to recover about $25 million under the plan. About $12 million was earmarked for Simi Valley and close to $1 million each for Whittier and St. Paul.

“One obvious ramification of the opinion is that confidence in the California municipal bond market is going to have one more thing to undermine it,” said Jeffery J. Daar, attorney for the Temecula school district. He acknowledged that the setback does not approach the magnitude of the Orange County bankruptcy. But Temecula has already defaulted on its bond issue, he noted, and the ruling leaves the district with no way to repay the investors. The losses will not affect school services, he said.

Daar and attorneys for the other municipalities said they were still studying the decision Thursday.

Aides to Garamendi’s successor, Chuck Quackenbush, also said they were pondering their next move.

Quackenbush himself hailed the ruling as a victory, noting that most of the plan--which involved selling Executive Life assets to French investors--had been upheld. However, the department was clearly distressed by the unintended consequences for the municipalities.

Until now, the four communities have been bit players in the legal battle that began April 11, 1991, when Garamendi seized Executive Life in what was then the nation’s largest-ever insurance failure.

The communities became embroiled in the mess because they had used the proceeds of their bond sales or other municipal funds to buy guaranteed investment contracts--known as muni GICs--from Executive Life. The GICs were supposed to be a safe way to invest the money while the projects for which the bonds had been issued were getting under way.

Temecula, for example, had issued $27.5 million worth of 30-year tax-exempt bonds in 1989 to finance sewer connections and other public projects, many of which were connected with a housing project being built by a private developer, Daar said.

It put the money into Executive Life muni GICs and was gradually drawing down on them to make interest payments to bondholders and cover preliminary expenses connected with the project, Daar said. But when Executive Life was seized, Temecula’s money was frozen and it defaulted on the bonds.

An irony in the communities’ predicament is that the legal theory the court used to freeze them out of the settlement had originally been proposed by Garamendi in an earlier, unsuccessful move against a much larger--and to his mind, less sympathetic--class of Executive Life investors.

Garamendi had argued that a 1988 California law specifically classified muni GICs as “non-insurance” products. He wanted to exclude from the rehabilitation plan all holders of Executive Life muni GICs, but especially a group he regarded as sophisticated Wall Street types holding nearly $2 billion of the investments.

The appeals court initially rebuffed that argument, saying that the group Garamendi was targeting had bought their muni GICs before the law took effect on Jan. 1, 1989, and that it was not retroactive. But in Wednesday’s decision, the court returned to the issue, ruling that the law does exclude post-1988 muni GICs. The only post-1988 holders are Temecula, Simi Valley, Whittier and St. Paul.

The rest of Garamendi’s rehabilitation plan fared better. The court approved the sale of the crippled insurer to a French investment group, which has since reopened it as Aurora National Life Assurance Co.

The court also upheld Garamendi’s controversial auction of the bulk of Executive Life’s huge portfolio of junk bonds.

Critics had said the price was far too low and asked the court to either rescind the sale or force the buyers to rebate $1 billion or more to the policyholders. The court refused. Attorneys on the losing side have vowed to appeal.