This Rescue Is Raising More Questions Than Cheers

"It's a tremendous victory for policy holders," declares Victor H. Palmieri with an air of euphoria. Palmieri was appointed chairman of Newark (N.J.)-based Mutual Benefit Life Insurance Co. after it was seized by regulators in July, 1991. It was the largest insurance company failure ever. On July 13, along with New Jersey Insurance Commissioner Samuel F. Fortunato, an industry consortium, and a state regulators association, Palmieri announced a bailout plan. "It removes policyholders' anxiety and guarantees them their principal and a minimum interest rate," he says.

But the celebration could well be premature. Some 42 other states where Mutual policyholders reside must approve the plan. And Palmieri must persuade a balky New Jersey Assembly to pass legislation that will put Mutual's policyholders before creditors. Several creditor banks are fighting the measure.

Mutual's 800,000 holders of policies and annuities have other reasons to wonder how much of a victory has been fashioned. For a full year, Palmieri, executives from other insurers, and regulators haggled over the bailout. At times it was far from clear that any deal could be arranged. During that period, money belonging to policyholders was frozen while they were required to keep making premium payments.

ROOM FOR IMPROVEMENT. Even under the new plan, policyholder assets will continue to be frozen for 7 years, except for hardship, death, and disability payments. The payout to others could be even longer. "I was going to use my money for retirement. Now that's out of the question," says Clara Markovich, a 66-year-old former hospital secretary who has $14,000 tied up in a Mutual annuity. Under the new plan, she will get a minimum interest rate of 3.5% and be able to withdraw only 10% a year.

With the specter of further large insolvencies hanging over the troubled industry, Mutual Benefit serves as a cautionary tale. The lesson is that there is vast room for improvement in the current system of state regulation of life insurance companies. Before and even after a rescue, policyholders are often suspended in a never-never land of uncertainty over their assets. They have few rights and are at the mercy of powerful interest groups. "The state regulation of the insurance business has very serious shortcomings," says Joseph M. Belth, professor of insurance at the University of Indiana.

Regulatory lapses began even before Mutual's seizure. Like many insurers, the company went big into the guaranteed insurance contract (GIC) business, where it agreed to pay customers a fixed return on their assets. It then invested the assets in real estate, often at lofty prices. Today, some 63% of Mutual's estimated $8.5 billion in assets is locked up in the now depressed real estate market. Its assets are $800 million less than its liabilities.

POSSIBLE RUN. State regulators were slow to catch on to Mutual's problems. Financial examinations are made only every five years. Mutual's latest report, in mid-1990, covered 1982 through 1987. "The financial examinations are so complex and take so long, by the time you get the report, it's outlived its usefulness," admits Commissioner Fortunato.

Fortunato only found out about Mutual's problems when the company told him in April, 1991. Mutual officials warned of a possible run by pension customers if Mutual's credit rating was downgraded. That's just what happened, which forced the state seizure.

Regulators were unprepared. New Jersey, home of some of the U.S.'s largest insurers, was one of only two states without a guaranty association. The legislature quickly passed legislation to establish a fund the day Mutual was seized.

Most Mutual policyholders in other states were covered by their own guaranty associations. Yet these are patchwork arrangements with widely varying provisions. Unlike the Federal Deposit Insurance Corp., which insures bank deposits, the state associations can't reimburse policyholders immediately. When an insurer fails, other insurers must then be assessed for the money. They usually don't have to pay until a bailout has been arranged. "State guaranty associations haven't been triggered yet, one year after Mutual Benefit failed," says Belth. "The idea that somebody puts his life savings into a life insurance policy and is unable to get his money is unacceptable." Belth favors some prefunding of state guaranty associations so money would be available right away.

After long, arduous negotiation, Palmieri worked out a deal with other states so that policyholders could deal directly with Mutual and the states would guarantee the cash value of their policies, regardless of the individual state limit. "It cost us another four to five months, but it was worth it to remove the gaps in coverage," he says.

`SIGNIFICANT LITIGATION.' There were other hitches. Unlike 43 other states, New Jersey had no legislation that gives policyholders priority over other creditors. Passage of such legislation is now crucial. The state's major insurers, which spent months working on a bailout plan to avoid pressure for an FDIC-type rescue mechanism for insurers, have agreed to guarantee Mutual GIC holders' principal. Optimistic insurers don't expect this to cost them anything. Most of the estimated $200 million to bail out policyholders will be paid by state associations. But the agreement is conditioned on passage of the legislation, which has already stalled once in the Assembly. Without the legislation, the consortium might have to bail out creditors before policyholders. "If it fails, the agreement we reached with the industry consortium and the state guaranty associations goes up in smoke," says Fortunato.

The result: a massive lobbying battle between New Jersey's Democratic administration and a team-up of the Republican-controlled Assembly and Mutual's biggest creditors--Citicorp, Morgan Guaranty, and Bankers Trust. The banks have as much as $114 million tied up in interest-rate swap contracts with Mutual. This is a fraction of the $8.25 billion in claims owed to policyholders, but bankers worry they'll get nothing if the bill is passed. "We don't think it's fair to screw the creditors to save the policyholders," says bank lobbyist Wesley S. Caldwell. "No matter what happens, there's going to be significant litigation over all these issues." If the bill isn't passed soon, Fortunato threatens to implement a bailout using only Mutual's assets, which would reduce account values and annuities by 12%. Policyholders and annuitants would be seeing losses if their various guaranty funds didn't make up the difference.

Everything could turn out well. The real estate market may turn around, allowing Mutual to regain its health and pay off policyholders without recourse to the guaranty associations. Palmieri even plans to start looking for a buyer soon who could salvage part of the company's customer and agent base. Yet questions may persist about whether the elaborate ad hoc maneuverings and iffy state regulatory apparatus that bailed out Mutual Benefit are the best way to deal with large insurance failures.

Palmieri backs that state system. He believes, along with the rest of the life insurance industry, that the Mutual Benefit bailout plan is proof that the state system works. It did avert a potential disaster, such as total liquidation. "It's like the dancing bear. The wonder is not that it dances badly, the wonder is it dances at all," says Palmieri. But from where many Mutual Benefit policyholders sit, the bear is stumbling badly.

      Benefit exam was filed in mid-1990 for the period 1982 to 1987
      BOLSTER STATE GUARANTY ASSOCIATIONS Mutual Benefit is not expected to get 
      guaranty funds to pay off policyholders until more than a year after its July, 
      1991, collapse. Policyholders will not get full reimbursement for seven years
      Mutual Benefit bailout plan is stalled until the New Jersey Assembly passes 
      such a law
      DATA: BW