Proceed With Caution.

Regulators weigh the liquidity risks in guaranteed investment contracts and similar instruments after General American's ordeal.

State insurance regulators are trying to gauge the suitability of insurers issuing instruments such as guaranteed investment contracts, a concern that took on new urgency last year when General American Life Insurance Co. put itself into receivership amid a liquidity shortfall.

A guaranteed investment contract--also known as a funding agreement or a deposit-funds contract--is a contract issued by an insurance company with a promise to pay a fixed rate of interest and return the investor's principal after a specified term, usually one to five years. A GIC is guaranteed only by the issuing insurer, not the government, and therefore can create risks for the public as well as insurers in keeping the promises.

In August 1999, General American came face to face with those risks when it abruptly faced refund requests from most of its funding-agreement contract holders. The cash-flow problem followed rating downgrades prompted by General American's recapture of about $3.5 billion of funding-agreement assets and liabilities from Integrity Life Insurance Co., a subsidiary of ARM Financial Group Inc.

Integrity Life had a marketing and reinsurance agreement with General American, ARM's largest partner. As part of the agreement, General American passed on the assets and liabilities that were part of funding agreements and guaranteed investment contracts. ARM, which had put itself up for sale in June 1999, needed to get rid of the General American business. General American was fully capitalized to meet those obligations, but the unexpected volume of redemptions on some funding agreements created severe pressure on the company's liquidity and its ability to convert the funds within the tight time frame.

The crisis led to the sale of the insurer's parent, GenAmerica Corp., and its subsidiaries to Metropolitan Life Insurance Co. for $1.2 billion. By the start of 2000, New York-based MetLife had paid more than $5.1 billion of the nearly $5.8 billion in liabilities that were transferred from General American.

New York Tackles GIGs

The New York Insurance Department launched an effort to solicit information on the liquidity risks of the 140 licensed insurance companies and 65 accredited reinsurers in the state, in light of General American's experience. State regulators from around the nation are watching the effort closely, and they, too, are increasing their focus on GIGs and other insurance investment vehicles.

New York state officials plan to issue a circular letter this fall that focuses on the liquidity and risk-management practices of insurers licensed in the state, said John Cashin, a deputy superintendent with the New York Insurance Department. The department will seek industry feedback on the circular letter and is working with insurers, trade associations and the National Association of Insurance Commissioners to develop a suitable questionnaire to address risk management and other issues involving the capabilities and resources of companies issuing GICs and related instruments. Cashin said state officials want to see what market conditions are and how companies are responding.

"We regard risk management to be critical to GICs" and want to prevent any company from facing the same situation as General American and its customers, Cashin said. The industry is cooperating in the state's effort to create a stable environment for GICs and other insurance instruments, he added.

Efforts under way in New York could serve as a liquidity model for all the states, said Bill Schreiner, an actuary with the American Council of Life Insurers. New York insurance officials will use the liquidity information insurers provide to identify companies with liquidity problems, Schreiner said.

As in New York, regulators in other states are keeping their eyes on GICs, said Neil Vance, chairman of the NAIC's Life Liquidity Risk Working Group and managing actuary for the New Jersey Department of Banking and Insurance. The NAIC wants to determine whether there are any additional liquidity risks in the making, Vance said. But he said he didn't consider what happened with General American to be a problem related to GICs specifically.

Before the General American situation came to light, the NAIC Life and Health Actuarial (Technical) Task Force sent all state insurance commissioners a fact sheet on surrender provisions and practices for different types of funding agreements. The informational document was intended for state regulators to review insurance contracts involving "employer/employee pension benefits, municipal obligations such as muni-GICs, and other programs." The task force expressed concern since some life insurers could defer or avoid cash payments though use of an "alternative course of action described in the contract."

Products available in the corporate-owned life insurance and bank-owned life insurance markets reflect some of the provisions linked to GICs. The concern extends to any arrangement or instrument that can cause liquidity problems. The states are only in a "research mode," so there is no immediate need for any rule or move against selling this type of product, Vance said.

Larry Gorski, an actuary who monitors GICs and other instruments for the Illinois insurance department, said regulators have been concerned with GICs and similar products since 1998, so they weren't caught entirely by surprise when the General American problem surfaced. Gorski said a regulator had learned of liquidity provisions in some GICs that allowed contract holders to extract money at book value if the insurance company experienced financial difficulties. As a result, Vance's working group has been evaluating various ideas to make such instruments safer for all policyholders, now and in the future. These include management and distribution practices, Gorski said.

Minnesota Takes Action

The Minnesota Department of Commerce last year became concerned with certain GIC bailout provisions that allowed holders of contracts to turn them in before the scheduled maturity date without the kind of penalty or adjustment that would normally occur. The bailouts could be activated by downgrades in the claims-paying ability or other financial-solvency factors faced by insurers.

As a result, the state decided that the bailout provisions weren't in the public interest and ruled last October that it would no longer approve filings of contracts containing rating downgrades or similar bailout provisions. The department said it would prohibit the sale of such contracts in Minnesota, regardless of whether they had previously been approved for sale in the state.

Blaine Shepherd, valuation actuary for Minnesota, said the regulation remains in effect as a screening tool with regard to companies that sell GICs.

While there is controversy and concern surrounding GICs and related investment vehicles, Michael Albanese, group vice president of the life/health division at A.M. Best Co., said the good news is that high-quality companies are engaged in selling GICs, while the less qualified companies have gone away. He said the market demands quality performance, allowing only the fittest to survive.