Insurance Regulators Fiddled While Policyholders Got Burned
It's a fast-growing club that no one wants to join. For Margaret Barsocchi, co-owner of a Little Rock blueprint shop, membership came through a $7,500 investment she made nine years ago with a hometown insurance company. Confident that her money was secure, she had no idea her policy was transferred several times, winding up with the ailing Diamond Benefits Life Insurance Co. in Phoenix. In fact, the first she heard of it was when Diamond's receiver notified her and 1,400 other annuity holders that Diamond had gone under. Now, Barsocchi is part of a class action seeking the return of more than $31 million. It could take years to wend its way through the courts.
That club is likely to get much bigger soon. Consider, for instance, the hundreds of thousands of unlucky souls who hold the more than $55 billion in policies and annuities issued by the insurance units of First Executive Corp. Weighed down with bad junk-bond investments, the Los Angeles-based insurer is dangerously close to becoming the nation's largest insurance insolvency ever. State insurance guaranty funds set up to protect policyholders may be swamped by the size of First Executive's losses(table).
How did the plight of First Executive and other floundering insurers become so dire right under the regulators' noses? Insurance watchdogs complain that they are understaffed, underfunded, and hamstrung by weak state laws. But the current crop of failures shows that even where tough laws exist, regulators were often loath to enforce them aggressively. "It's a matter of will, not tools, talents, or resources," says George K. Bernstein, a former Federal Insurance Administrator. "Regulators should know that the time has come and not indulge a company anymore, just put them into liquidation."
'GETTING RELIGION.' These aren't isolated cases. Last year, 67 insurers were declared insolvent. Close regulatory surveillance didn't stop companies such as Mutual Security Life Insurance Co. in Indiana from failing. Mutual Security went under after owner James M. Fail borrowed $35 million in September, 1988, from Mutual to purchase a group of insolvent Texas thrifts that became Bluebonnet Federal Savings Bank. By August, 1990, state regulators had seized control of Mutual and stopped payments on annuities and life insurance claims. The failures leave Mutual's 130,000 customers in limbo.
The rising toll has prompted harsh congressional criticism. A report last year from Representative John D. Dingell's Energy & Commerce oversight subcommittee blasted "an appalling lack of regulatory controls to detect, prevent, and punish" mismanagement and rascality among some insurers. In February, the Michigan Democrat told the National Association of Insurance Commissioners that he would push for federal involvement in insurance regulation.
As a result, says Robert E. Litan, senior fellow at the Brookings Institution, "insurance regulators are all of a sudden getting religion." The NAIC is pushing for uniform standards for declaring insolvency and new rules to accredit state regulators. Another association proposal, aimed at preventing problems like Margaret Barsocchi's, would restrict the transfer of policies among insurers without the customer's consent. "That's good," Barsocchi says. "But I wish they had done it a little bit sooner."
Laws alone can't ensure that regulators will act quickly or forcefully, however. The Pennsylvania Insurance Dept. watched Life Assurance Co. of Pennsylvania's real estate investments deteriorate for five years while several other states barred the company from doing business. "The company thought it could solve its problems," says a spokesman for the insurance department. Finally, after a flood of consumer complaints, the regulators realized LACOP had no cash and began liquidation proceedings in October. Meanwhile, 50,000 policyholders have been left hanging.
That foot-dragging pales in comparison with the rule-bending that California regulators allowed First Executive over several years. Joseph Belth, an Indiana insurance professor who follows the company closely, chronicles at least four instances in which First Executive ran afoul of regulations. In these cases, he says, the California department either gave the company time to correct its mistake, looked the other way, or refused to discuss publicly whether or not it had taken action. First Executive says that regulators did indeed demand corrective action, and the insurer complied.
A spokesman for the California insurance department wouldn't comment on past actions. Insurance Commissioner John Garamendi, who took office in January, issued a statement on Apr. 9, saying that the department would complete its examination of Executive Life within a few days. The agency will act, says Garamendi, "to best protect the interests of policyholders."
New York regulators, who hit First Executive's New York subsidiary with a record $250,000 fine and demanded $151.5 million in fresh capital in 1987, have generally taken a harder line with the company. On Apr. 4, the state demanded that Executive Life of New York set aside an additional $125 million to pay claims and cease issuing new policies. Now, California is catching on. It recently ordered First Executive's other main insurance subsidiary, Executive Life of California, to stop sending cash "upstream" to the parent company.
BEST HOPE. The crackdown, though, has probably come too late. With its own auditor publicly doubting that it can continue as a going concern, First Executive is close to bankruptcy, though it's looking overseas for fresh capital. State insurance guaranty associations cover some, but not all, of the insurer's more than $12 billion in obligations. The best hope for First Executive's customers is that other insurers will buy pieces of its business and that state guaranty associations will help make up the shortfall in assets caused by the company's disastrous investments.
First Executive Senior Vice-President William C. Adams says policyholders shouldn't worry about losing their money or coverage. "Executive Life's insurance business is profitable," Adams says, "so it should not be difficult to locate large and financially strong companies to assume that business."
The changes that regulators are trying to make now will come too late for First Executive and other insurers that slipped through the regulatory cracks during the 1980s. Investors like Margaret Barsocchi have already lost their faith in the security of insurance companies. As for the regulators? "I guess they can't be trusted either," she sighs. Maybe if regulators finally learn to be tough cops, they'll be able to restore the confidence of Barsocchi and the rest of her club before it gets too much bigger.