State senator wants to junk bids for Executive Life.

Letter to Garamendi claims new bill outlaws acquisition

A number of the bids to buy failed insurer Executive Life Insurance Co. may violate a new state law designed to limit the amount of junk bonds a life insurance company can have in its investment portfolio.

An angry letter from the author of the law, State Sen. Patrick Johnston, D-Sacramento, to California Department of Insurance Commissioner John Garamendi urged Garamendi to prevent bidders who wish to retain Executive Life's junk bond portfolio from trying to work around the law.

"It would indeed be a cruel hoax to policyholders if this 'first step' of SB 1135 (the junk bond law) was undercut by attempts to amend this law before it has had a chance to work," said Johnston's Oct. 15 letter to Garamendi. "In this vein, I wish to bring to your attention rumors that my staff has heard concerning such possible efforts to substantively amend SB 1135. If true, I find this disheartening since the ink has not even dried on this important piece of legislation."

In a response to Johnston's letter released to the media, Garamendi denied he had encouraged or supported attempts to amend the bill.

The new law, signed by Gov. Pete Wilson on Oct. 5, limits to 20 percent the percentage of invested assets that a life insurance company can maintain in junk bonds.

Executive Life has 64 percent of its invested assets in junk bonds.

Of the seven bidders for Executive Life, five are "bonds-in" bids, which would keep the junk bonds with the company.

For many of the bidders, hopes to recoup their investment from gains in the junk bond portfolio are considered the main reason for their interest in the deal.

Several of them last week said they intended to set up reserves against the junk bonds in case their value declines.

"We'll create various mechanisms to limit the risk of junk," said Julio Herrera, president of the Municipal Bondholders Protective Group, which is representing a group of Executive Life investment contract holders. "We intend to sell the junk over the next 48 months," said Martin Oliner, representative of another group of bidders, the First Executive Corporate Creditors Committee. "There are $3 billion in guarantees against any downside in the portfolio."

Asked about the anti-junk bond legislation, Oliner replied: "I don't understand the law, maybe you do. It seems absolutely absurd for them to wreck all companies that have over 20 percent in junk bonds. . . . We don't think the junk bonds should just be sold into the market in a fire sale, particularly when the downside is guaranteed. That (slow sale) is the only way policyholders can get 100 cents on the dollar."

In his reply letter to Johnston, Garamendi said he hopes that financial guarantees could result in an increasing rating for the bonds that would meet the law's requirements.

Reserves against junk bonds and other mechanisms, however, were not what Johnston had in mind when he wrote the law, a source close to the state senator said.

"The law doesn't say you can have over 20 percent if you have credit reserves," said the source, who requested anonymity.

The limit on junk bonds, said the source, was meant to be absolute.

Meanwhile, the two bidders whose bids would sell off the company's junk bonds issued statements calling attention to that fact.

"Under several of the proposals, policyholders would remain at risk with regard to Executive Life's entire junk bond portfolio, including its lowest-rated bonds," said a statement from Eli Broad, head of Los Angeles-based Broad Inc. The company has proposed that it buy Executive Life policies and that someone else, yet to be found, buy the junk.

Broad warned that a sharp downturn in the junk bond market could sink a revitalized company backed by junk.

"While the bonds have recently benefitted from a big junk bond rally, policyholders have not been told that if those bonds in the future dropped in value to the same levels they were just 10 months ago, the restructured company would incur at least a $1 billion unrealized loss, far exceeding the new capital put in by bidders."

A statement issued by bidder Mutuelle Assurance Artisanale de France, said it would sell off most of the company's junk bonds to Altus Finance, also of France, thus putting the acquisition in compliance with the new state law.