The Long Island Jewish Medical Center recently performed a procedure that`s the envy of employers across the country: It extracted about $75 million of its workers` tax-sheltered retirement savings from a life insurer that has since frozen withdrawals.
The New Hyde Park, N.Y., institution tipped off employees about the problems of Mutual Benefit Life Insurance Co. in time for a lot of them to shift their accounts out of the insurer`s investment contracts.
Other non-profit organizations also were sounding alarms, sometimes on the advice of outside consultants and generally after ratings on Mutual Benefit`s financial strength dropped precipitously in May. Their warnings apparently resounded at the New Jersey offices of Mutual Benefit and of that state`s insurance regulators.
Redemptions of these retirement accounts-and mounting demands for additional withdrawals-played a surprisingly big role in the Mutual Benefit crisis, in which the insurer was forced to seek state aid because of a drain on its cash reserves by worried policyholders.
That Mutual Benefit, though essentially solvent, was vulnerable to this kind of ”run” is forcing policyholders, regulators and some ratings agencies to re-evaluate the standards used to examine even America`s largest insurance companies.
But contrary to conventional wisdom, the bulk of withdrawals didn`t come from sophisticated corporate pension managers, but from participants in tax-sheltered retirement plans sponsored by non-profit institutions. They are known as 403(b) programs, after the section of the Internal Revenue Code that authorizes them.
These retirement savings plans, similar to corporate-sponsored 401(k)
plans, allow workers to put earnings before taxes into investments structured as tax-sheltered annuities. Some institutions make matching contributions.
”A number of large 403(b)s got very concerned about Mutual Benefit and talked to their participants,” said James Hiner, a principal at the benefits consulting firm of William M. Mercer Inc. in Chicago.
”Thousands of participants with individual rights were all asking to have their money taken out,” agreed Steven Benson, a vice president of Prudential Insurance Co. of America`s asset-management arm in Moosic, Pa.
At Mutual Benefit, more than $400 million was withdrawn in the first half of the year, and a spokeswoman acknowledged that the outflow was ”skewed a little bit” toward such accounts and away from guaranteed investment contracts, or GICs, a fixed-interest investment popular for 401(k) plans. The 403(b) funds also would have accounted for much of the $1.2 billion in anticipated redemptions for the rest of the year, she said, though she declined to supply specific figures or to identify the institutions involved. That this kind of money would be so fleet-footed surprises even some insurance experts.
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”It`s impossible for it (the Mutual Benefit withdrawals) to be 403(b)
money,” said a skeptical William Stephenson, president of Donald F. Smith and Associates, an insurance brokerage in Lawrenceville, N.J. ”Those are individual participants.”
GICs usually are considered more volatile because they are contracts between retirement plan sponsors and insurance companies. On the other hand, individual employees must deal directly with insurers in shifting the tax-sheltered annuities and other investments in 403(b) plans. In the case of both kind of contracts, surrender or transfer charges were low, though apparently not out of line with industry standards.
To be sure, some of Mutual Benefit`s largest non-profit clients didn`t send out warnings about the insurer. Among them were five state hospital associations-in New Jersey, Connecticut, New Hampshire, Maine and Vermont-that offered Mutual Benefit`s tax-sheltered annuities for their member hospitals through an arrangement with Stephenson`s firm.
Hospital workers in these states invested about $1.58 billion with Mutual Benefit. That includes approximately $800 million by Mutual Benefit`s biggest pension client, the New Jersey Hospital Association, whose hospitals have about 35,000 workers with Mutual Benefit investments.
Other institutions with large amounts of employee retirement money at Mutual Benefit include the Michigan Education Association, that state`s biggest school employees union with about $500 million, and the University of Illinois, with approximately $160 million.
Despite these big numbers, Mutual Benefit isn`t a major player in the vast 403(b) market, in which total assets are pegged at hundreds of billions of dollars. Pension plans account for about $5.3 billion, or 38 percent, of Mutual Benefit`s $13.8 billion in total assets; of that, $2.4 billion is in 403(b) plans.
The hospitals and universities that cautioned their workers typically grew concerned after Standard & Poor`s Corp. lowered Mutual Benefit`s claims- paying ability rating four notches in May, an action followed a few days later by a three-level downgrading by Moody`s Investors Service Inc. Both ratings agencies cited low capital and real estate problems at the insurer;
the reductions came after Mutual Benefit failed to interest Metropolitan Life Insurance Co. in a merger.
The ratings moves left Mutual Benefit in the ”good” categories of both ratings services, though S&P`s move meant that Mutual Benefit was among only three of the top 20 life insurers that wasn`t awarded at least ”excellent”
grades by that firm. In the wake of the collapse earlier this year of Los Angeles-based Executive Life Insurance Co., the rating apparently wasn`t good enough for some of Mutual Benefit`s clients.
The seizure by California regulators in April of junk bond-laden Executive Life led to a ban on policy loans and redemptions, and annuity payments were slashed by 30 percent. (Last week the California Insurance Department announced that French investors may take over most of Executive Life`s policies and investment contracts in a deal that eventually may pay policyholders at least 81 cents on the dollar.)
At the Long Island hospital, the retirement program covers about 4,500 workers and retirees and includes contributions by the institution. Workers could choose between ”a guaranteed interest account,” a stock mutual fund and a money market fund, but about 95 perecent of the money went to the first option, which paid a specified interest rate. The whole plan was administered by Mutual Benefit, but only money in the guaranteed interest account was at risk if the insurer folded, because those funds represent a claim on the company`s general assets.
Hospital officials first became concerned in January, shortly after a downgrading by Moody`s, and sent a letter to employees describing the rater`s move and laying out workers` options. After the May ratings reductions, ”we got deeply concerned and sent out an extensive communique” to workers a week later, said I. Sanford Forman, vice president for human resources.
”There were rumors abounding, about a run, about the (insurance)
commissioner taking over, that created tremors. There was further deterioration of other insurance companies,” said Forman.
The institution subsequently closed the door on new contributions to Mutual Benefit, putting new money in escrow. Members of the board of trustees, which includes attorneys and officials of prominent financial services firms, played an active role, Forman said.
As a result of the hospital`s warnings, some 1,000 workers shifted about $75 million out of the exposed account into the other funds, which already held about $8 million. As of July 1, another $112 million was still in the account that has been frozen by state regulators. There were no charges for switching, Forman said.
”We didn`t advise them (employees) what to do or what not to do. We`re not financial advisers; we struggle to run a hospital,” said Forman. But ”we believe we had a legal obligation to notify them. We didn`t think it was appropriate to run a risk with their money.”
The Long Island institution wasn`t alone. On the West Coast, the University of Southern California on June 28 told its 1,600 workers and retirees with Mutual Benefit investments that it wouldn`t send more money to the insurer and was negotiating to transfer assets of about $41 million elsewhere.
Mutual Benefit was seized before the funds could be moved, but about 100 employees shifted their money to other investments beforehand, said Brian Dougherty, senior vice president for administration in Los Angeles. The university acted on the advice of Brian Ternoey, a principal at the Princeton, N.J.-based consulting firm of A. Foster Higgins & Co. Ternoey declined to comment.
Similarly, the California Institute of Technology in Pasadena clipped a newspaper story about the big ratings reductions and sent it to employees in mid-June. A spokesman said some employees transferred funds out of Mutual Benefit, but he said the university doesn`t know how much was involved and he declined to supply total asset figures.
At the University of Louisville, where employees had invested about $11 million with Mutual Benefit, officials met with Mutual Benefit representatives in Newark soon after the ratings downgradings. Larry Owsley, vice president for administration, told employees in a June 24 letter that he planned to recommend to trustees that no more money be sent to the insurer; it`s not clear how many shifted their funds.
Meanwhile, many GIC managers and advisers say they saw no reason to cancel clients` contracts. ”People didn`t know there was a run going on; you had to know there was a run to act,” said Kim McCarrell, a consultant with Wyatt Asset Services Inc. in Portland, Ore. ”In my opinion, a company with a `Single A` (rating) is perfectly viable,” said Murray Becker, a leading GIC consultant in Teaneck, N.J.
A group of 25 big companies, led by American Telephone & Telegraph Co., recently asked the New Jersey Court overseeing Mutual Benefit to resume payment on GICs covering 425,600 of their employees. The group wants treatment similar to annuity holders, whose payments are continuing.
Bankers Trust Co. in New York, which manages GIC portfolios of about $6 billion, said it canceled two clients` contracts before the seizure at no penalty because interest rates are lower than when the contracts were issued. Jeremiah Chafkin, senior vice president, declined to comment on the value of the contracts, which sources put at about $20 million.
But Chafkin said Bankers Trust`s decision was based on Mutual Benefit`s inability to sell itself to Metropolitan, rather than the ratings changes.
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”What`s happening is that historically the insurance industry has been overrated by the agencies. When the agencies now seek to correct this, it scares the market and can cause a liquidity crunch that can put a company into rehabilitation,” he said.
Most experts expect Mutual Benefit`s policy and contract holders eventually to be paid in full. But the episode also is likely to bring lasting changes to the 403(b) market, where some institutions still offer few investment choices for employees.
”The flight to quality is enormous,” said Benson at Prudential, which still has the highest ratings from three major services. ”We`ve got unsolicited plan sponsors and agents we`ve never heard of calling us every day.”