State Allegedly Knew Executive Life Was Insolvent in ’83

WASHINGTON —  The chairman of a Senate subcommittee investigating the collapse of Executive Life Insurance Co. said Thursday that the company was technically insolvent long before its troubles with the falling junk bond market, but California officials failed to halt the firm’s rapid growth.

“Everyone thinks Executive Life is in trouble solely because of junk bonds, but this isn’t the case,” Sen. Howard Metzenbaum (D-Ohio) said.

California Insurance Department audits for 1983 and 1987 show that the company was technically insolvent, Metzenbaum said.

Armed with the facts about Executive Life’s problems, California regulators could have forced the company to slow its growth but neglected to impose restrictions, he said.

The state Insurance Department “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 and its investment strategy was novel, unproven and entailed high risk,” according to a memo prepared for Metzenbaum by the staff of his antitrust subcommittee of the Senate Labor Committee.

California regulators seized the company April 11, saying that the firm’s heavy investment in junk bonds had plunged it into financial distress.

Metzenbaum’s distribution of the California audit reports provided the first insight that the company may have been in precarious financial shape much earlier. Metzenbaum said California officials, given that information, should have put the brakes on the company, whose life insurance sales jumped from $3.1 billion in 1981 to $60.4 billion in 1989.

Insurance companies often spread the risk in their business through reinsurance. Under that technique, an insurance company can transfer to another firm both the premiums it has collected and the responsibility for providing the coverage promised in the policy. In effect, the primary insurance company buys itself insurance protection.

Executive Life contended that $188 million in liabilities was shifted from its books through reinsurance arrangements in the three-year period ending Dec. 31, 1983. This enabled the company to claim that its net worth was $110 million.

However, the California audit report, issued in 1985, said the contracts were invalid. The responsibility for the insurance had not truly been shifted from Executive Life, the auditors said. Executive Life’s liability was “basically unchanged,” the audit said.

“At that moment (in 1983), Executive Life was insolvent,” Metzenbaum said.

The auditors said in the 1985 report that Executive Life could not use the same reinsurance technique, involving dubious contracts, in the future. The firm “has agreed not to enter into any new treaties of this type,” the auditors said. “Sufficient time will be allowed for an orderly accounting transition acceptable to the department.”

Regulators imposed no penalties on the firm, although they had the power to order a slowdown or curtailment of Executive Life’s activities in the state, according to Metzenbaum.

The report was prepared by California officials with help from other states where Executive Life was active, including New York, Texas, Tennessee and Missouri.

The next audit, covering the years 1984 to 1987, showed similar financial weakness at Executive Life. In order to give the appearance of a stronger balance sheet, the firm obtained a promissory note from its parent firm, First Executive Corp.

Notes totaling $170 million were issued to Executive Life of California from First Executive, enabling the insurance subsidiary to show a net worth of $135 million. Otherwise, the company would have been deemed insolvent, according to Metzenbaum. This type of note is “as phony an item as I’ve ever seen in the business world,” Metzenbaum said.

Gene Grabowski, a spokesman for the American Council on Life Insurance, said a note from a parent firm is legitimate if the company is healthy.