What is an annuity? That is a billion-dollar question and the main issue emerging Tuesday in a case challenging the California Insurance Department's rehabilitation plan for failed Executive Life Insurance Co.
The answer will determine whether or not holders of $1.85 billion in guaranteed investment contracts backing municipal bonds--so-called Muni-GICs--issued in Texas, Nebraska, Louisiana and Tennessee will recover all or part of their money.
These investors filed suit in Los Angeles Superior Court in August, when state regulators revealed a $3-billion rescue plan for Executive Life that did not cover these investors' losses. Executive Life was seized in April after losses mounted from junk bond defaults.
Regulators said Muni-GICs are not covered under the plan because they are not insurance policies but rather are "funding agreements." That means these bondholders would have to wait in line with all Executive Life's other creditors, hoping to be paid from a clearly insufficient pool of assets.
But the bond trustees and underwriters say their contracts were insurance policies, or, at the very least, annuities. So they should be able to get the same treatment as policyholders, who get paid before other creditors and who often get additional protection from state-operated guarantee funds.
All seven Muni-GICs were issued in 1986 to government agencies that sold municipal bonds to investors and used the proceeds to buy guaranteed investment contracts from Executive Life. Those contracts paid a bit more interest than what was promised to the bondholders, so the municipalities made a small "arbitrage" profit, until Executive Life defaulted on the bonds after it was seized by state regulators last April.
In opening arguments Tuesday, Philip S. Warden, attorney for some Muni-GIC issuers, argued that the insurance products were annuities. He quoted a Department of Insurance expert, who said in a deposition that Muni-GICs "meet my definition of an annuity."
But Karl Rubinstein, attorney for the California Department of Insurance, disagreed. "Every feline is not a tiger. Every canine is not a wolf--some are dogs. Every annuity is not an insurance policy," Rubinstein said.
To Executive Life policyholders, the issue is pivotal. The Insurance Department's $3-billion rehabilitation plan for Executive Life promises to pay them 81 cents on the dollar. If the Muni-GIC holders get policyholder status, policyholders may get only 60 cents to 72 cents.