“The entire industry is going to get turned upside down in a short time,” Fred Carr once predicted. Not quite. Last week it was Carr’s insurance empire that was turned upside down as California officials took control of Executive Life Insurance Co. The failure is the largest in U.S. history–and could leave hundreds of thousands of customers with losses.
Executive Life is the latest victim of the 1980s’ financial frenzy. Junk bonds–security judged “below investment grade” by bond-rating firms– comprise almost two thirds of its assets. No one knows their true value. Its parent, Los Angeles-based First Executive Corp., says its bond investment portfolio, carried on the books at $9.9 billion, was really worth $6.8 billion by late 1990. Even that estimate is questionable, since the market for some junk has disappeared. Whatever the firm’s true condition, the insurer lacks the assets to make good on all of its promises to 170,000 life-insurance customers, 75,000 annuity holders and an unknown number of pension-plan members whose money it invested (next page).
Until Carr came along in 1974, First Executive was a tiny and troubled California insurer. Carr, now 60, had made his fortune as one of the hottest mutual-fund managers of the 1960s. Revenue skyrocketed from about $15 million in 1975 to $2.3 billion in 1987, propelled by some unorthodox techniques. One example: Executive Life, which has no in-house sales staff, helped top independent agents form reinsurance companies. If an agent sold a large policy, Executive Life would reinsure part of the policy with the company partially owned by the agent. That gave the agent an incentive to keep the policy on the books.
In the late 1970s, Carr linked up with Michael Milken, 16 years his junior, was far more complex. When Carr wanted to buy a reinsurance company in 1980, Milken’s employer, Drexel Burnham Lambert, helped finance the deal by selling $5 million in First Executive preferred stock to the firms of takeover artists Victor Posner, Carl Lindner and Saul Steinberg. Milken and other colleagues took a large stake in the reinsurer, which subsequently became a big buyer of junk bonds from Drexel. And in 1984, First Executive helped buy the bonds Posner issued to purchase the maker of Royal Crown Cola.
Carr was known for running a lean operation, but he had an eye for innovation. He pushed Executive Life into a controversial new product, the single premium deferred annuity, that let investors accumulate tax-deferred interest for up to 10 years–with the rate for at least part of that period guaranteed. As interest rates topped 15 percent in the early 1980s, wealthy investors lined up to buy. Few knew that only the high returns on Executive Life’s junk bonds stood behind these promises. By 1983, First Executive had become the nation’s largest seller of those annuities and a big player in guaranteed investment contracts, which let pension funds lock in high rates.
Things started to unravel in 1987, when New York officials forced a First Executive subsidiary, Executive Life Insurance Co. of New York, to stop buying junk bonds. “IF California had done the same thing, maybe the result would have been different,” says a regulator. Defaults by bond issuers decimated First Executive’s portfolio–and reduced investment income that accounted for most of its profits. Last year, the firm estimates, lost income from junk bonds in default was a whopping $251 million.
By early 1990, the death watch was on. New York and California clamped down on transactions among First Executive’s subsidiaries. Thousands of customers cashed in their policies and annuities, forcing the companies to sell their bonds at a loss. Officials in New Jersey and Massachusetts ordered them to stop selling policies. The final blow came March 27, when First Executive’s auditor, Price Waterhouse, expressed its doubt that the company could stay in business. Executive Life of New York remains in operation, although state officials may take control as early as this week.
The companies’ affairs will take years to sort out, even if California Insurance Commissioner John Garamendi finds a buyer for the remains. People with conventional policies should come out fine. Those who hold annuities will probably get their principal back, but with only a fraction of promised interest. Those whose pension plans entrusted their money to First Executive will suffer. And what will happen? Promises Garamendi, “The issue of what was done incorrectly or outside the bounds of propriety will be pursued in due course.” Translation: watch for possible civil suits.
Since sales peaked in 1986, the slide of First Executive Corp. has been all but stoppable.
Annuity sales drop. Regulators force Executive Life to reduce stated net worth by $180 million.
Company reaches maximum size, with $60 billion of insurance in force. Junk-bond market collapses.
Loss of $776 million reported for 1989. Owners of $1.3 billion in annuities pull out early in year.
Company reports $336 million loss for 1990. Auditor doubts it can survive. By April, more than 500 policies per day are being redeemed. California takes over Executive Life.
