Worse Than My Worst Nightmare

bloomberg businesweek

By Kathleen Kerwin August 4, 1991

This article appears at the following website: bloomberg.com

For Katie Watson, it was adding insult to injury. Brain-damaged while in the hospital for pneumonia when she was 20 months old and still unable to walk or talk at age 11, the Phoenix girl relies on a $1.4 million annuity from a malpractice judgment her parents won in 1986 to pay for her medicine, therapy, and home care. Unfortunately, that annuity came from Executive Life Insurance Co. of California, which was seized by state regulators in mid-April.

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By May, Executive Life annuity payments were slashed 30%. Coming up $3,500 short that month, Katie's parents, Vincent and Susan Watson, cut household spending to the bone and put their home on the market. They were afraid they might also have to halt Katie's therapy. "In my worst nightmare, I never thought this could happen," says Vince Watson.

Hardship Status

The Watsons join more than 373,000 other Executive Life customers left in the lurch by the collapse of the junk-bond laden Los Angeles insurer. Some were there not by their own doing but because their employers had invested their pension money in Executive Life group annuities and guaranteed investment contracts (GICs). Many, however, sought out the company for the high yields its junk-bond holdings allowed it to pay. Now, they all face the harsh reality of having their future jeopardized by an unprecedented insurance debacle.

Dire as the Executive Life case is, it demonstrates that safety nets do exist. All insurance beneficiaries began receiving at least part of their regular payments after an 11-day halt in benefits following the seizure. Death benefits are being paid in full. And Executive Life customers facing a financial emergency can file for hardship status with the California Insurance Dept. to receive 100% of their monthly payment. Only the interest payments to holders of $1.85 billion worth of municipal bonds, whose proceeds were invested in Executive Life GICs, have been stopped.

So far, 525 hardship requests have been granted, including the Watsons', whose full payments resumed in June. More often, other forms of rescue are emerging. Some companies, such as Pacific Lumber Co., are making up the shortfall in payments on annuities they purchased for pension plans. Pacific Lumber's decision came after pressure from employees and retirees. "I never in my wildest dreams thought I'd have to go to the front office in Scotia Calif. to picket and protest the loss of our pension," says Wiley J. Lacy, who retired from his job as a tax manager at Pacific Lumber in September, 1985.

Regulators, legislators, and the judge overseeing the insurer's conservatorship have also gotten an earful. "I'm not going to let anybody step on me. I worked hard for that money," says Olga Pegelow, a 75-year-old Chicago widow with an Executive Life annuity. She testified in Washington in mid-July at a congressional hearing about insurance failures. Like many Executive Life customers, she worries about what will happen in the long run. California regulators are negotiating the sale of Executive Life to avoid a liquidation of assets that would leave it with too little to pay customers. Guaranty funds in 49 states are supposed to cover losses if an insurer is declared insolvent, but some fear Executive Life's huge losses could swamp those funds.

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None of the fixes will undo the anguish Executive Life's victims have already suffered. "I'm telling my friends and neighbors: `Find out what your bank and your insurance company are doing,' " says Pegelow, who invested her nest egg in an Executive Life annuity six years ago. "In 1985, I thought insurance companies were solid. I had no idea about junk bonds."

The catch, of course, is that Executive Life got top grades from most rating agencies until early 1990, when junk-bond losses began taking their toll. Thousands of Executive Life customers then cashed out their policies. But some annuity beneficiaries discovered they were trapped by the terms of their contracts. Eli Schefer, 71, a retired Revlon Inc. engineer, spent months demanding that Revlon and Executive Life cash out his pension, part of a group annuity that Revlon bought in 1986. "They told me I was locked in," says Schefer, who watched helplessly as the insurer collapsed.

Terrible Blow

Others heard of Executive Life's troubles but trusted that government monitoring of insurers would keep their money safe. "We were all supposed to be protected by the regulators," says a New York businessman who in 1987 bought municipal bonds backed by Executive Life GICs. He's incensed to learn now that the GICs are guaranteed only by the insurance company. In divvying up the money available, municipal bondholders must wait to be paid after Executive Life's insurance customers. The investor fears he may wind up with just a fraction of the money he put into the bonds. "It's a terrible blow to me."

Many of the victims are also calling for insurance reforms to prevent future debacles. "I think it's about time the federal government stepped in and put some very stringent controls on the insurance industry," says Mellvine Fuchs, 71, an Executive Life policyholder in Balboa, Calif.

Most simply want to put the insurance fiasco behind them. "Katie has suffered enough," says Susan Watson. The judge overseeing Executive Life assured the Watsons that their daughter's financial needs would be met. But just in case things don't work out, their house is still for sale. Considering the roller coaster they've been riding, their caution may be well advised.

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