Report 2005-115.1 Summary - October 2006

Department of Insurance

:

Its Conservation and Liquidation Office Continues to Collect and Distribute Proceeds From the Liquidation of the Executive Life Insurance Company

HIGHLIGHTS

Our review of the Department of Insurance's (department) management of the Executive Life Insurance Company (ELIC) estate and related litigation indicates the following:

RESULTS IN BRIEF

The Department of Insurance (department) is responsible for protecting California policyholders by regulating insurance companies (insurers), brokers, and agents operating in the State. The department's Conservation and Liquidation Office (CLO) assists the insurance commissioner (commissioner) in conserving, rehabilitating, or liquidating financially distressed or insolvent insurers. An insurer subject to a conservation or liquidation order is called an estate.

Executive Life Insurance Company (ELIC) was a multibillion-dollar life insurance company that had its principal legal residence in California and operated in the State from 1962 to 1991. According to a report issued by the chief deputy insurance commissioner in 1994, ELIC invested 55 percent to 60 percent of its portfolio in high-yield, noninvestment-grade corporate bonds, also known as junk bonds, during the 1980s. The industry average for this type of investment typically ranged from 7 percent to 11 percent. In late 1989 the junk bond market experienced a significant decline in value, and by early 1991 the commissioner determined that ELIC's financial statements were grossly overstated and that the company was insolvent. On April 11, 1991, acting on a court conservation order, he took over the operation of ELIC.

The commissioner has received more than $1.1 billion in litigation proceeds from two significant legal matters on behalf of the estate since 1991. The first concerned alleged civil and criminal fraud in the purchase of ELIC's junk bond portfolio and insurance business. The second concerned the failure of ELIC and the bankruptcy of its corporate parent, the First Executive Corporation. The ELIC estate has expended more than $165 million on litigation costs to recover these proceeds. The CLO has designated and distributed part of almost $988 million in proceeds to policyholders and guaranty associations. The commissioner also anticipates receiving more litigation proceeds, which the CLO will distribute in the future.

Once the CLO closes the estate, it will initially transfer any remaining funds that could not be paid to policyholders, because of a lack of information or legal reasons, to the State Controller's Office as unclaimed property. Ultimately the funds are transferred again to the department for safekeeping until the rightful owners claim them. As of May 2006 the CLO was holding $18.4 million from the ELIC estate that eventually may be transferred.

The commissioner used outside counsel to represent him in the ELIC estate conservation and liquidation as well as the recent civil fraud litigation. Generally, the Office of the Attorney General (attorney general) acts as legal counsel for California state agencies. Before 1996 the law gave the commissioner discretion to use the attorney general or outside counsel in delinquency proceedings. In 1996 the law changed, requiring the commissioner to use the attorney general's legal services or to obtain that office's approval to hire outside counsel. He hired outside counsel with the knowledge of the attorney general to handle the conservation and liquidation of ELIC as well as the recent civil fraud litigation. Based on our review of a sample of the CLO's contracts with both outside counsel and others, the terms of the agreements were reasonable and the fees generally were comparable to fees paid by other public entities or were reasonable for the types of services rendered.

We have not determined how much money policyholders have received and are yet to receive, the percentage of policyholders who have recovered their entire investment, or the percentage of the loss to ELIC policyholders that ultimately will be recovered. The data we need to complete these and other tasks reside with Aurora National Life Assurance Company (Aurora), ELIC's successor. With the assistance of the department, we are in the process of obtaining the needed data from Aurora. We will analyze this data and issue an additional report addressing these and other topics when Aurora makes the data available to us.

The ELIC estate is still open. The closing has been delayed because the commissioner is involved in two disputes surrounding proceeds from the civil litigation. In September 2006 the CLO estimated that it would close the ELIC estate in late 2008.

AGENCY COMMENTS

The CLO generally agreed with our audit conclusions but has a different interpretation of our conclusions regarding the reliability of certain of its data.

1 Noninvestment-grade bonds are a grade assigned by bond rating agencies such as Standard & Poor's.

2 Guaranty associations are entities established to cover the obligations of insolvent insurers by paying policyholders' covered claims where appropriate.