New Jersey and New York insurance officials announced an agreement Sunday designed to rehabilitate cash-strapped Mutual Benefit Life Insurance Co. and provide greater-than-expected returns.

The agreement calls for the insurer to give policyholders and investors all promised death benefits and a 5% guaranteed interest rate over a rehabilitation period not to exceed seven years, according to New Jersey Department of Insurance officials.

New Jersey and New York insurance officials confirmed the plan will have no impact on the municipal bonds the company backed with guaranteed investment contracts.

Both states and the insurance company back the proposal, which requires formal approval by company and individual investors. New York's support is key because of the large amount of holdings by investors in the state.

New Jersey Insurance Commissioner Samuel Fortunato announced the plan Sunday at the winter meetings of the National Association of Insurance Commissioners in Atlanta, according to a press release.

Officials said the participation of New York investors in the agreement precludes the insurance company from having to pay them 55 cents on the dollar for their holdings. Even then, Mutual Benefit would have had to transfer $770 million of its assets into its New York fund.

Mary Ann Green, spokeswoman for the company, said the plan and its likely passage will have "no effect on the industrial development bonds" Mutual Benefit backed with GICs.

Mutual Benefit insured 62 tax-exempt bond issues, the majority of which involved industrial development and housing projects.

In July 1991, Mutual Benefit was taken over by state insurance officials for rehabilitation after massive losses in the real estate market, in which it had heavily invested.

Unlike bank deposits that are insured by the federal government up to $100,000, insurance policyholders are paid through a state pool supported by all the insurance companies in that state.

As a result, insurance officials in each state had to approve the company's rehabilitation plan.

In August of this year, Fortunato announced a rehabilitation plan for Mutual Benefit that called for paying most investors a guaranteed 3.5% interest rate over a minimum of 12 years.

Although most states considered that plan equitable, Salvatore Curiale, New York superintendent of insurance, rejected the plan.

Curiale said the 3.5% was too far off the original 6% or higher return investors had been receiving before the insurance company failed. He also said 12 years was too long a rehabilitation period and was in violation of New York state law, which prohibits company rehabilitations over five years.

Fortunato said the initial plan could have been enacted without New York's participation, but that he preferred that both parties work out a better arrangement with New York officials.

New York investors hold $1.4 billion of Mutual Benefit's contracts, the largest single-state holding in the country, Fortunato said.

Fortunato and Curiale reported New York investors will receive a variable rate of interest based on the three-year Treasury bill plus 0.5%. Late yesterday, the interest rate would have been 5.6% under that plan.

The new rates of returns under the plan approved Sunday will apply only to covered contracts. Approximately $2 billion of guaranteed investment contracts the company sold to pension funds and 401(K) plans are not covered. Holders of uncovered investments will receive 3.5% and may have to wait up to 19 years for Mutual Benefit's rehabilitation period to conclude.

Shawn L. Kelly, an attorney for the Morristown, N.J.-based law firm of Riker, Danzig, Scherer, Hyland & Peretti, said that policyholders subject to the lower interest rates under the plan would "have no choice but to seek fair treatment through litigation." Kelly currently represents the Association of Mutual Benefit Life Contract Holders.

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