The $12 Billion Question: How To Fix First Executive

Fred Carr, 1980s financial operator par excellence, built a towering insurance edifice on a foundation of junk bonds. You know the next verse: The '80s are over, the junk has sunk, and now, so has Carr's First Executive Corp. It's the largest insurance failure in history, with $12.2 billion in current obligations to thousands of clients.

State regulators, who seized First Executive's main subsidiary in California on Apr. 11 and its smaller New York unit on Apr. 16, are puzzling over how to protect these hapless customers. The sheer size of the debacle makes answers difficult. First, there's the question of valuing the vast junk heap that's supposed to support payments on the policies. Then, there are the lawsuits and investigations that could add millions to the company's liabilities. "Nobody can begin to know what First Executive's assets and obligations really are," says Joseph M. Belth, a business professor at the University of Indiana at Bloomington and longtime First Executive critic. The company had no comment.

SERIOUS NEGATIVES. Precedents are little help in figuring out how to clean up the mess. Fixing Baldwin-United Corp., until now the biggest life-insurance failure, was tough but less complex. Onerous debt from an ill-advised acquisition was to blame for Baldwin's demise, not withering assets. In 1986, Metropolitan Life Insurance Co., led by then-CEO and current board member John J. Creedon, assumed most of Baldwin's $3 billion in obligations.

Regulators are eyeing several options for First Executive. Trouble is, each comes equipped with some serious negatives (table). California Insurance Commissioner John Garamendi wants to sell the entire California unit to a European investment consortium led by Altus Finance, an arm of French bank Credit Lyonnais. Altus says it also is interested in Executive Life Insurance of New York. Met Life is a likely suitor for the New York unit, too.

But policyholders stand little chance of emerging whole from such a transaction. Why? The high returns of First Executive policies will have to be slashed to match the shrunken assets that back them up. During 1990, the market value of First Executive's portfolio plunged by 44%, to $6.8 billion. Thus, a hypothetical $100,000 single-premium annuity might see its payout slashed from 13% to 7%.

The same problem holds if smaller, choice pieces of the insurer are sold off, with the added headache of sorting out which assets to assign to what policies. ITT Corp.'s Hartford Life Insurance Co. is eyeing First Executive's life policies, which are enticing since many belong to high-income folk. The life policies sold last year carried an average face value of $198,000. Warns Chuck Ronson, an analyst with Baird, Patrick & Co.: "No way that Garamendi will let the Hartford cherry-pick out safe government bonds and leave the junk."

LIQUIDATION THREAT. A catastrophe regulators avoid discussing: What if First Executive is in such bad shape that all prospective buyers turn away? Last year, other buyers did that, including Rosewood Financial Partners, the investment arm of a trust for heiress Caroline Hunt. If, like Rosewood, buyers now start running backward, then regulators would be forced to liquidate the company. That would mean an achingly slow process of selling assets and paying off policyholders at as much as half off the cash values of their policies. Other insurers say they'll do almost anything to prevent a liquidation, which would blacken the industry. They'd even likely chip in extra money to aid policyholders.

Victims certainly can't expect state-run insurance guaranty funds to make them whole. California has $2.8 billion in First Executive obligations, but its guaranty fund can furnish a mere $175 million. If liquidation loomed, the pressure probably would build for some kind of federal bailout--a step that state regulators, jealous of their turf, would resist.

First Executive's 350,000 clients face a long period of uncertainty as regulators deal with the mess. It took Baldwin two years to straighten out. For the time being, regulators have frozen First Executive loans and policy surrenders to stop a leakage of cash. In New York, requests to cash out policies surged to 400 a day recently, from 25 a day a few weeks earlier. Eli I. Schefer, a 71-year-old retired engineer from Sands Point, N. Y., depends on a First Executive annuity for 40% of his yearly income. He frets: "I don't know what's going to happen." For those caught up in the First Executive fiasco, the pain is just beginning.


-- SELLING IT OUTRIGHT Favored by the California regulators, who are talking to a French bank about the insurer's biggest unit, based in Los Angeles. Metropolitan Life is interested in the New York unit

PROBLEM: Policy payouts must shrink to match assets

-- SELLING KEY ASSETS ITT's Hartford Life is looking at gaining just life policies, because they're mainly held by wealthy people

PROBLEM: Policy payouts must shrink in line with assets. Also, bad assets must be allocated among myriad buyers

-- FEDERAL TAKEOVER The government's printing press would be welcome, since state-run guaranty pools are inadequate

PROBLEM: States would fight to keep insurance powers. The feds don't need another costly bailout

-- LIQUIDATION If no buyers come forward, state regulators must sell off assets and distribute proceeds to policyholders

PROBLEM: Would take a long time, and policyholders wouldn't get back full cash value DATA: BW

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