Are Executive Life's GICs Actually Insurance? Court's Decision Will Affect the Entire Market
The Los Angeles Superior Court today begins hearing arguments to decide the future of Executive Life Insurance Co.'s guaranteed investment contracts, including those backing $1.93 billion of municipal bonds.
At issue is whether the municipal contracts, known as GICs, are "policies of insurance." John Garamendi, California's commissioner of insurance and conservator of the failed life insurer, contends that municipal GICs are actually equivalent to loans and that bondholders are thus "unsecured creditors."
Municipal bondholders, represented by the Bondholders Protective Committee, argue that a GIC is an insurance contract, regardless of whether the purchasing party is a pension fund or a municipality.
Mr. Garamendi would distinguish between the two, satisfying pension holder claims and leaving municipal bondholders out in the cold. He has already made the environment decidedly chilly by refusing to make interest payments on the municipal GICs, sending 11 of 13 issues into default; the remaining two deals are expected to default this week.
The commissioner's stance has serious ramifications for the municipal GIC market. If Mr. Garamendi's proposed rehabilitation is approved, GIC providers, brokers, and users -- the nation's public entities -- can expect a violent change in business conditions.
"If one insurance company doesn't honor its obligations, it will affect the whole insurance business," said Dominick Carollo, vice president at Svenska Handelsbanken, a municipal GIC issuer. "No municipal entity will ever deal with insurance [GICs] again."
An informal survey of market participants by The Bond Buyer found that about 40% of all new issues end up with all or part of the proceeds in a GIC. Based on 1990's volume, $50 billion would be affected on an ongoing basis, not to mention the inestimable number of outstanding contracts. One market participant said it would be "a lethal precedent for the bond market."
Against this backdrop are the various parties competing to buy Executive Life out of conservatorship. At this point, three groups have put forth proposals. Two ignore the claims of municipal bondholders altogether, while a third is from a group associated with the Bondholders Protective Committee.
The bondholders' proposal was assembled by investment advisers RRH Capital Management, which has the backing of investors holding about $925 million of the taxable GIC bonds issued in 1986. The group, anchored to the concept that the bonds are tangible liabilities, offers to put up the taxable total of $1.85 billion as a swap for equity in the insurer.
The proposal also brings to the table the considerable presence of John J. Creedon, former president and chief executive officer of Metropolitan Life Insurance Co. Mr. Creedon knows failed insurers. While with Metropolitan Life, he helped steer the failed Baldwin-United Corp. out of bankruptcy by managing the operating life insurance subsidiaries.
"It resulted in all of the people remaining policyholders," said George Rieger, chief executive officer of RRH.
The bondholders' proposal and a plan outlined by the National Organization of Life and Health Insurance Guaranty Associations -- a confederation of state insurance associations -- maintain that more value can be obtained by managing Executive Life's junk bond portfolio than by selling it outright. The third and oldest proposal is from a French investor group that would sell the portfolio lock stock and barrel.
From the French perspective, the relevant issue is now whether the resurrected Executive Life will have "bonds in or bonds out," according to Jody Powell, spokesman for Mutuale Assurance Artisanale de France -- the French investor group -- and former press secretary for President Jimmy Carter.
"It makes no sense to go through this process and emerge with a company that has much the same risk in the portfolio that it has in the past," Mr. Powell said. "It's highly unlikely you are going to be able to sell new policies with that kind of exposure."
Mr. Rieger counters that the $3 billion French offer, partly financed by a unit of Credit Lyonnais, is "stealing the company." Plowing the "surplus" proceeds from an organized sale or management of the portfolio, he said, is a better deal for all policyholders.
The pension GIC holders, however, may have cause to look closely at the bondholders' plan. Mr. Rieger said such claimants would be given their "account value," or the same amount that would be realized if the pension GICs were surrendered today. This could be more or less than the roughly 81 cents proposed by the French offer. The NOLHGA bid would result in 85 cents on the dollar.
The jockeying for political position, in the long run, is less important to the tax-exempt market than the eventual court decision on whether municipal GICs are "Class 5 policies of insurance." Judge Karl Lewin will be deciding far more than the fate of $1.93 billion municipal bonds.
Mr. Carollo of Svenska Bank raises a simple and crucial point concerning the arguments. When the bonds were issued, Standard & Poor's Corp. rated them AAA.
"They rated these bonds based on their claims-paying ability. Well, now investors are pressing their claims," Mr. Carollo said. "That's insurance."