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The CHAIRMAN. Senator Brooke.
Mr. Dillard, you state that perhaps some of your companies would agree with either or both concepts of optional Federal chartering and the Federal guaranty fund, but that most of them disagree with both concepts entirely.
I suspect from the comments I have heard that there are a number within your association who would support this legislation or some modified form of it.
When you state that most of your member companies disagree with the proposals entirely, I am not surprised, since I know that your membership includes many smaller companies, with regional biases, who are against any change, really, in the status quo.
And I am well aware that the opinion of the insurance commissioners who oppose this legislation carries considerable influence in your industry. I think that was made crystal clear to us in the testimony which we received more particularly yesterday.
But I would like to ask you these questions: How many States have adopted life and health guaranty plans? Twenty-two, did you say?
Mr. DILLARD. Twenty-two, yes.
Senator BROOKE. In most States, both property liability and life and health guaranty funds have been proposed in approximately the same time frame. To date, our information indicates that only 17 States have adopted life and health guaranty laws, whereas 48 States have property liability guaranty funds.
Why has adoption of life and health guaranty funds lagged so far behind adoption of property liability laws?
Mr. DILLARD. I think that there has been some resistance in the life business to the adoption of these guaranty bills. And simply on the proposition that there wasn't really a problem in this field, as there was in the property and casualty field.
We know that really the pressure has been in the property and casualty field, and not in the life field, because losses in the life field have been very, very small, and the commissioners themselves have been able, in most instances, to overcome the problem, where they have had problems in the life field.
So there has been some resistance. And I agree that the pressure has not been the same at all.
Senator BROOKE. Do you know whether life insurance companies opposed the adoption of life and health guaranty plans in some States?
Mr. DILLARD. I think they have in some States where there was no premium tax offset, that sort of thing. The ACLI's position has been they favored them if they had a tax offset.
Senator BROOKE. I referred yesterday to an article by Jack H. Blaine, appearing in the spring 1977 edition of Forum, which said, “State guaranty plans seem to be plagued by constitutional and other legal problems."
Do these serious and continuing legal difficulties comprise the effectiveness in your opinion of the State guarantee funds?
Mr. DILLARD. Not really. I kind of dreaded that question, Senator. I told Jack Blaine I wasn't going to defend him in any way. But I
don't think it has been a real inhibition against the adoption of these laws.
As you know, the first one that went to the Supreme Court of Washington, they sustained it, the constitutionality of it. Obviously when you take a new concept like this and lay it out before companies and lawyers, you have some resistance to the idea.
But basically I don't think there is but one State that has knocked it out, and that was on purely technical grounds, and they have repassed it to meet those technical objections, so I don't think that has been a real serious problem.
Senator BROOKE. Now Mr. Robert Hunter, of the Federal Insurance Administration, in his statement on Monday, testified:
We have yet to be convinced that form approval, which the bill clearly leaves to the States, is so divorced from financial or rating concerns that divided re sponsibility is either feasible or desirable.
Now we have heard many complaints from companies about the increasing number of different insurance policy forms prescribed by the States and the burden this places on companies doing business in many different States. You say in your judgment "Frustrations in State regulations continue to arise because of variations in State laws that bear no apparent relationship to local conditions or problems."
If the Federal Government were to offer alternative regulation for solvency purposes, do you think that such regulation would be more attractive to your members if it provided for Federal rather than State regulation of policy forms?
Mr. DILLARD. I think that is a step in the right direction, I would have to say that, yes, sir. What is said there in my statement, and by Mr. Hunter, is true. There are frustrations, there are difficulties involved in multi State approval of policy forms and that sort of thing.
Certainly that is a real problem for our business, I have to say that, you are right.
Senator BROOKE. Now in my opening remarks I mentioned the Washington Post article entitled “How an Insolvent Firm Keeps Selling Insurance.” I have asked the staff of your association to bring that article to your attention. I presume that they did ?
Mr. DILLARD. I have seen it before, yes, sir.
Senator BROOKE. I am submitting a copy of the article for inclusion in the record at this point.
Mr. Chairman, I would like to include a copy of that article in the record.
The CHAIRMAN. Without objection, that will be printed. [The article follows:]
(From the Washington Post, May 25, 1977)
How An INSOLVENT FIRM KEEPS SELLING INSURANCE
(By John F. Berry) COLUMBIA, S.C., May 24.–Eight years ago Mr. and Mrs. Odell A. Mize made the final payment on a $500 life insurance policy they had taken out 10 years earlier on their son.
The Mizes' policy provided in writing that the company, New South Life Insurance Co., based here in Columbia, would pay on demand the value of the policy in cash or make a loan against that value.
But recently, when the Mizes tried to get money from the company for a down payment on a mobile home for their son's wedding present, they learned that New South was not honoring its commitment.
"We tried two or three times to cash the policy in,” Mrs. Mize said. “I guess there's not much we can do."
The reason that the Mizes and about 175,000 other policyholders cannot get their money without dying is that New South has been insolvent since 1971 and the policyholders' money is being used-interest free—to bail out the company and its owners.
What is more, New South salesmen are still peddling policies to unsuspecting buyers who apparently are not aware of the company's financial difficulties.
The complex and questionable scheme to bail out New South has been directed by former South Carolina Gov. Robert McNair, the company's counsel. The policyholders' funds are being used to rescue a personal friend and political ally, Lester L. Bates, Sr., chairman and majority stockholder of New South and former mayor of this city.
Most of the New South policyholders do not seem to know what is happening. New South sells a form of coverage known as debit life insurance. The policies are higher-priced than comparable coverage, because salesmen come to the policyholders weekly or monthly to collect premiums. About 90 per cent of New South's policyholders are poor blacks living in rural areas of the state.
Few have contacted the state insurance department since it belatedly-in 1972—made public New South's collapse.
NO FEDERAL STANDARDS
There are no federal standards to protect policyholders, and there are no signs that Congress is willing to tackle the problem.
At present, for all practical purposes, small insurance companies that deal only in one state are regulated by that state's insurance department. And many of these departments (there are a few notable exceptions), instead of protecting buyers of insurance, have become extensions of business and political interests.
Federal Magistrate Charles W. Gambrell, one of the former South Carolina insurance commissioners interviewed for this story, blamed the system for the New South affair.
“This whole debacle is the accumulation of 50 years of indifference to insurance regulation," he said. “I'm humiliated that New South's troubles could have been overlooked so long."
In preparing this article, The Washington Post reviewed the sizable accumulation of court documents related to the case and interviewed many of the principals and sources familiar with it. Some refused to talk in detail because of legal implications; others requested anonymity because they feared retribution from powerful state figures involved.
What emerged, however, is the story of how prominent members of South Carolina's business and political establishment joined forces to stave off personal financial and legal liabilities of New South's principal owners.
The 71-year-old Bates founded Capital Life Insurance Co. in 1936. Capital, like his present firm, sold debit life insurance.
Capital seemed to be thriving in the 1930s. But by the late 1940s the company was found by the state insurance department to be short of necessary reserves to pay policyholder claims. (This same problem would crop up two decades later with New South.)
Whether the reserve deficiency was real or imagined, Bates was forced to sell his company to a Chicago outfit called United Life Insurance Co.
To this day, Bates claims he lost nearly $1 million in the forced sale.
In 1955, Bates got back into the debit life insurance business when he founded New South to sell policies within South Carolina.
Bates was active in business and politics and was elected mayor of Columbia in 1958. He ran unopposed two more times before retiring in 1970 on the eve of the New South debacle. He also ran unsuccessfully for governor in 1946 and 1950.
By then, New South had about 180,000 policyholders and an annual income from premiums of more than $6 million. On paper, the company looked prosperous,
and examiners from the insurance department, who went over the company's books every three years, never saw any problems.
But, in fact, there were serious problems at New South. It is a measure of the quality of the state insurance examination system that it failed to discover that, each year, New South was sinking deeper and deeper in red ink. The reason: New South's books and computer printouts were being deliberately altered to make the company look more profitable than it really was.
The man who would later be accused of rigging the records was Louis J. Glaser, a bookkeeper Bates had hired away from United Life. One of the unanswered question in the whole affair is why, after accusing United Life of cheating him out of nearly $1 million in the sale of Capital Life, Bates hired the man who had calculated the worth of his company for United.
In 1969 Glaser was accused of stealing money from the company by forging loans on insureds' policies. He got the checks, which were cashed by a friendly cashier.
CHARGES NOT PRESSED
But Bates did not press charges. Bates' son, Lester L. Bates Jr., who is president of New South, said in an interview that the reason was that Glaser had just had open-heart surgery.
Glaser retired to Clearwater, Fla., where he made a settlement, reportedly in five figures, on unpaid taxes with the Internal Revenue Service.
As it turned out, the revelation of Glaser's admitted caper was small change compared with what was to come.
In the spring of 1971, New South's consulting actuaries made a troubling discovery. They discovered that New South did not have enough financial reserves to meet future policyholder claims.
Reserves are the amounts actuaries calculate that a life insurance company will need to pay policyholders. The ratio of reserves to insurance outstanding is set by state law.
James L. Athearn, an insurance professor at the University of South Carolina College of Business Administration, describes reserves this way: "The reason for establishing reserves is to force a company to recognize it must accumulate assets to pay claims. The function of reserves is to keep a company from frittering away it assets."
It is clear that, when New South was warned by the outside actuaries of the reserve deficiency, the state insurance department should have been notified so it could conduct an audit. But Bates told neither the department nor the company's stockholders.
AN OPTIMISTIC REPORT Indeed, the younger Bates sent an optimistic quarterly letter to shareholders, dated Aug. 9, 1971, several months after the discovery. He told them that the company was following “an extremely good trend.”
During a recent interview with a reporter, Lester L. Bates Jr.'s attorney advised him not to discuss the August letter because of possible litigation.
It was not until the fall of 1971 that New South informed the insurance department that it had problems, some six months after they were turned up by the actuaries. And it was not until February, 1972, that the insurance department told the public of the New South situation.
By South Carolina law, an insurance company is required to report any “impairment” to the insurance commission immediately—a fact that Bates should have known, since he was a member of the insurance commission at the time.
Bates in his defense says that he was not aware of the extent of his company's difficulties immediately.
By then, moreover, the groundwork had been laid for the bailout of New South's board members, officers, and stockholders at the expense of its policyholders.
When the truth finally surfaced, it turned out that New South was awash in red ink with liabilities exceeding assets by more than $9 million. The company was legally insolvent, with assets of $14.1 million against liabilities of $23.1 million.
Glaser and the two Bates were indicted by a county court here on criminal charges of conspiracy and filing false financial statements. Glaser was never served with a warrant because of his poor health, and he died a short time later of a heart attack. In February, 1972, the Bates were found not guilty of the complicated charges growing out of the staggering $9 million deficit at New South.
A NEW PLAN
The Bates, who had been on leave from New South during the trial, returned to the company. That same month a rehabilitation plan was submitted to state Circuit Court Judge John Grimball, who, in June, accepted the unorthodox scheme.
Under the rehabilitation plan:
A lien was put on the company's reserves so that policyholders could not get the cash value provided for in their policy contracts. In short, an insured person had to die to get money that should be rightfully his alive.
Thirteen million dollars of the reserves were put on the asset side of the company's ledger. By the stroke of his pen, the judge erased the $9 million deficit and created a $4 million surplus, allowing the company to continue selling policies.
Stockholders and policyholders were enjoined from suing the management or the board of directors.
Describing the rehabilitation plan in the Business and Economic Review published by the University of South Carolina, Professor Athearn wrote, “In effect, policyholders have made an involuntary loan to the company at a zero rate of interest ... There is no guarantee when this loan will be paid back, or, in fact, it it will be paid."
Actually, the rehabilitation plan was created by New South's attorneys. former Gov. McNair, whom the company hired, when it learned of its problems, and C. Heyward Belser, another politically connected lawyer.
NO COURT CHALLENGE
South Carolina law stipulates that when a company is insolvent the insurance commission "shall" stop it from doing business. But Chief Insurance Commissioner John W. Lindsay never went to court to challenge the judge, who effectively usurped the commission's authority when he prohibited the commission from "holding any further hearings or revoking or suspending the license" of New South.
The same management that presided over the company's insolvency was left in place, immunized from suit by judicial decree. The elder Bates was quoted in September, 1972, as saying that he knew "not one thing in this world about insurance reserves. My education is limited to about a fifth-grade education."
The principal players in the New South bailout are members of the South Carolina establishment.
For example, McNair and Bates are old political allies, as is the chairman of the insurance department, Claude McCain, who was in the state senate with McNair and was the ex-governor's roomate in college.
Belser, the outside attorney for New South who presented Judge Grimball with the rehabilitation plan, is related by marriage to the judge.
Bates was a member of the five-member insurance commission until December, 1971, well after his company became insolvent.
ON THE BOARD
The New South, board—which had been shielded from suit by the judge's order-includes William F. Austin, a former insurance commissioner and a prominent attorney, Edward K. Pritchard, another well-known attorney here, Marshall A. Shearouse, an officer of a leading bank, C. Wallace Martin, a vice president of the University of South Carolina, and David McLeod, a brother of the state attorney general.
Soon after New South's insolvency was revealed, the legislature moved to create the South Carolina Life and Health Insurance Guarantee Association. Each company must join, and if one fails the others are assessed pro-rata to pay off policyholder claims.
The trouble is that although the failure of New South caused the association to be formed, its policyholders—even its new policyholders-are not covered. The reason: the state supreme court declared in 1976 that the $13 million lien asset created by Judge Grimball was not an asset at all.
Said the court : "The cash value of the life insurance policy is a debt owed to the policyholder and it cannot be transformed into an asset of the company by court decree.”
What this means is that New South is right back where it was in 1971, before Grimball's decree. But the high court's decision has not affected Grimball's refinancing decree nor has it stopped New South from busily writing new policies.
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