In a Business section article yesterday, an insurance company holding 35 to 40 percent of its assets in junk bonds was misidentified. The company is Presidential Life of Nyack, N.Y. (Published 7/31/87)
A junk-bond crisis affecting life insurance companies could be far worse than the liability crisis was for the property-casualty insurance industry, New York's superintendent of insurance warned yesterday.
James P. Corcoran told a House subcommittee that "if even one of the major life insurance companies ... were to find itself unable to meet its obligations, it would raise the prospect of hundreds of millions or billions of dollars' worth of policyholder obligations being thrown into the maelstrom of insolvency." Last month, his office put into force a regulation limiting investments by insurance companies in risky, high-yield bonds to 20 percent of assets.
Faced with the problem of aggressive but often troubled savings and loans investing in junk bonds, federal regulators recently put a cap of 11 percent on S&L assets that can be invested in junk bonds. However, insurance is regulated by the individual states. Thus far, Arizona is the only other state to have curbed junk bond investments; California's legislature rejected a measure to curb such investments.
Junk bonds are commonly issued by firms that cannot obtain investment-grade ratings and are often used to raise money in connection with corporate takeovers. In an economic slump, the issuers may find themselves unable to pay the high interest rates, which average 4 or 5 percentage points above higher grade bonds because of higher risks.
Although there are no accurate figures on the amount of junk bonds held in insurance portfolios, Rep. James J. Florio (D-N.J.), chairman of the commerce, consumer protection and competitiveness subcommittee, cited industry estimates of between $30 billion and $40 billion.
More important, it is known that several dozen companies have put up to 60 percent of their assets in these bonds. Fred Carr, chairman of First Executive Corp., a Los Angeles insurance holding company, has said that more than 40 percent of his company's assets are in junk bonds. Insurance regulators have said that the portfolios of his Executive Life of New York contained 57 percent junk bonds before the regulation went into effect, and his Executive Life of California, 47 percent.
First Executive's assets grew from $1.88 billion in 1981 to $14.38 billion last year, according to The Wall Street Journal, and its sales keep soaring. Carr's controversial investment policy had enabled First Executive to offer higher rates on annuity contracts than its competitors. First Executive is today one of the 20 largest life insurance companies in the nation.
Although Standard & Poor's Corp. gave First Executive a triple A rating, regulators are worried that excessive concentration could land the company in trouble if the economy turns down.
The junk bond surge has occurred in the past few years, so there is no long-term track record of their repayment. Experts estimate the default rate was 3 percent to 3.4 percent in 1986. If the issuers defaulted on the bonds, or refinanced them at lower rates, insurance companies depending on the high interest rates would be unable to pay annuity holders what they promised.
This could affect many retirees whose former employers have terminated their pension plans and bought them annuities.
Thus far, no insurance company insolvencies have been attributed to junk bonds. Therefore, companies like Prudential Life of Nyack, N.Y., which has 35 to 40 percent of its assets in junk bonds, argue vehemently against the need for restrictions. Chairman Herbert Kurz stated that the mandatory system of reserves took care of any potential problem with junk bonds.