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SUPERIOR
COURT OF NEW JERSEY, CHANCERY DIVISION, GENERAL
EQUITY, MERCER COUNTY 1993 N.J.
Super. LEXIS 940 August 12,
1993, Decided August 12,
1993, Filed SUBSEQUENT
HISTORY: [*1] Approved
for Publication. COUNSEL:
Jack M. Sabatino, Assistant Attorney General, Director of the Division of
Law, (Robert J. DelTufo, Attorney General of New Jersey, attorney; Sharon M.
Hallanan, Patricia A. Kern, and Lisa R. Levine Deputy Attorneys General, on the
briefs) appeared for Samuel F. Fortunato, Commissioner of Insurance of New
Jersey and Rehabilitator of Mutual Benefit Insurance Company. Michael S.
Meisel, and Mark C. Ellenberg of New York (Cole, Schotz, Bernstein, Meisel &
Forman, P.A., and Cadwlader, Wickersham & Taft, attorneys; Mitchell I.
Sonkin, of counsel; Steven R. Kline Gregory M. Petrick and Peter M. Dodson on
the briefs) appeared as Special Counsel to Samuel F. Fortunato, Rehabilitator. Shawn L.
Kelly, Joseph A. Hoffman and Lawrence Reich (Riker, Danzig, Scherer, Hyland
& Perretti; Mudge, Rose, Guthrie, Alexander & Ferdon; and Carpenter,
Bennett & Morrissey, attorneys) appeared for Claimant Association of Mutual
Benefit Life Insurance Contractholders. Paul A. Rowe
and David Welchel of New York (Greenbaum, Rowe, Smith, Ravin & Davie, and
Simpson, Thacher & Patlett, attorneys; Carlton T. Spiller, of counsel and on
the briefs, Marcia D. Alazraki and Jay S. Handlin [*2]
on the briefs) appeared for Claimants Bank of America, et als. Frederick B.
Lacey (LeBoeuf, Lamb, Leiby & McRae, attorneys, Theodore D. Aden, of
counsel, James B. Manning and Robert E. Plunkett, on the briefs) appeared for
Claimants Citibank, N.A., Bankers Trust Company and Morgan Guaranty Trust
Company of New York. Frederick B.
Lacey (LeBoeuf, Lamb, Leiby & McRae, attorneys, Charles M. Lizza, on the
brief) and Philip C. Neal of Illinois (Neal, Gerber & Eisenberg, attorneys,
H. Nicholas Berberian and Mark T. Carberry on the briefs) appeared for Claimant
Shearson Lehman Brothers Inc. David M.
Satz (Saiber, Schlesinger, Satz & Goldstein, attorneys) and Jeffrey W.
Kelley of Georgia (Powell, Goldstein, Frazer & Murphy, attorneys) appeared
for Claimants Bank South, N.A. and NationsBank of Georgia, et als. Marc S.
Friedman (Freidman Siegelbaum, attorneys) appeared for Claimant Maryland
National Bank. Joseph
Lubertazzi, Jr. (McCarter & English, attorneys; Eugene M. Haring, of
counsel; Penelope M. Taylor on the briefs) appeared for Claimants Bankers Trust
Co of California, N.A., et als. Herbert J.
Stern (Stern & Greenberg, attorneys) and Stephen D. Libowsky of Illinois (Katten,
[*3] Muchin & Zavis,
attorneys) appeared for Claimants Henry F. McCamish, Jr. and IAS Development
Corp. Joseph J.
Fleischman (Hannoch Weisman, attorneys) and Joseph P. Busch, III of California
(Gibson, Dunn & Crutcher, attorneys) appeared for Claimant California
Institute of Technology. Shawn L.
Kelly (Riker, Danzig, Scherer, Hyland & Perritti, attorneys) and Roger J.
Bagley of New York (Hawkins, Delafield & Wood, attorneys) appeared for
Claimant Marine Midland Bank, N.A. Stuart Gold
(Lowenstein, Sandler, Kohl, Fisher & Boylan, attorneys) and Michael S.
Oberman of New York (Kramer, Levin, Naftalis, Nessen, Kamin & Frankel,
attorneys) appeared for Claimant Equitable Life Assurance Society. Daniel S.
Versfelt of New York (Donovan, Leisure, Newton & Irvine, attorneys) appeared
for Claimant Advertising Educational Foundation, Inc. JUDGES: LEVY OPINIONBY:
LEVY OPINION: LEVY, P.J.Ch. Background
Facts and Procedures n1
n1 This portion of the
opinion was previewed by lead counsel before the final version was written.
Nothing should be concluded from the inclusion, exclusion or modification of
their comments. However, the court is most appreciative of their extra help in
this complex matter. [*4] As
previously reported in In re Rehabilitation of Mutual Benefit Life Ins.
Co., 258 N.J.Super. 356 (App. Div. 1992), Mutual Benefit Life Insurance
company (MBL) was placed in rehabilitation, by order of this court, on July 16,
1991. Pursuant to N.J.S.A.
17B:32-43(e), the Rehabilitator applied for court approval of his proposed plan
of rehabilitation. The court is to determine whether the proposed plan is
"fair and equitable to all parties concerned," and either approve,
disapprove or modify and approve the proposed plan. The factual statements and
conclusions which follow are based on the preponderance of the believable
evidence presented to the court. The
series of events which led MBL to these statutory rehabilitation proceedings is
not disputed. It was described by several witnesses and is detailed in a report
from the Commissioner of Insurance, dated February 21, 1992. Samuel F. Fortunato
and Victor H. Palmieri, Interim Report Regarding the Rehabilitation of The
Mutual Benefit Life Insurance Company (1992). MBL
was founded in 1845 as a mutual insurance company domiciled in the State of New
Jersey. MBL is licensed and authorized, among [*5]
other things, to write life and health insurance and annuity contracts,
including Guaranteed Investment Contracts (GICs) and Guaranteed Annuity
contracts (GACs). It has always provided a varied and diverse number of
insurance and annuity products. By 1991, it was the eighteenth largest life
insurance company in the country, with assets approaching $ 14 billion. It had
approximately 430,000 individual policyholders, several hundred thousand pension
plan participants owning insurance product: from MBL, and employed approximately
2,700 people. n2 At the time it had four primary lines of business: A. Life
insurance, including traditional whole life and universal life, valued at
approximately $ 3 billion, which had to be kept in force if there was to be a
rehabilitation; B.
Individual and group annuity contracts issued in connection with an employee
benefit plan for retirement pursuant to @@ 401, 403(b), 408 or 457 of the
Internal Revenue code, valued at approximately $ 5 billion, which also had to be
continued if rehabilitation was to succeed; C. Corporate
owned life insurance (COLI), basically insurance on the lives of selected
corporate employees, but owned by the corporate
[*6] employer, and which
would soon lapse if not sold; and D. Group
health, life and disability insurance, managed by a separate division in Kansas
City, Missouri, also would lapse if not sold to preserve its value to the
estate.
n2 Owners and beneficiaries
of life insurance policies and trustees, contributors and beneficiaries of
pension plans and referred to in this opinion as policyholders or
contractholders. Individually
owned life insurance policies are complex, and they service many consumer needs
beyond a simple death benefit, but the underlying and primary benefit for which
the contract was purchased is the death benefit. That is, life insurance is not
purchased as an investment but is a protection against the buyer's untimely
demise. MBL sold various types of life insurance products, including universal
life insurance and combination life and endowment policies. The policies
credited minimal, guaranteed, interest but MBL historically paid annual
dividends, thus producing a return to policyholders competitive [*7] with that
offered by banks and investment firms. Retirement
plans typically provide insurance benefits and tax-deferred savings, while
allowing access to the funds by the beneficiaries or the insured, as the
contract permits. These are based on an annuity contract in which the primary
benefit is retirement income. they are usually funded from salary and a
contribution from the employer, the sum of which is the principal balance of the
account. They include life insurance protection, paying benefits in case of
death, disability, employment termination or retirement, usually offering an
option for a full payment of the account's value or payment, over time, in the
form of an annuity. GICs do not provide life insurance protection. On the
savings side, all MBL policies guaranteed repayment of the principal account
balance, plus a guaranteed fixed or variable interest crediting rate. Typical
annual crediting rates for short-term GICs ran from 8 1/2% to 17 1/2%, thus
providing a guaranteed tax deferred investment. Retirement policies could be
transferred to other forms of investment or other insurance companies without
any adverse tax consequence. If either a life insurance or retirement [*8] plan
policyholder needed access to the investment before maturity, it could be
invaded by a loan. Policy
holders, therefore, were concerned about three essential contract rights (1)
insurance protection in case of death or cessation of employment, with benefits
payable in an agreed-upon manner, (2) growth of the account balance at
contracted, guaranteed and applied rates of interest, and (3) liquidity, by
being able to cash out, borrow against account balances, or transfer to another
investment. The
bulk of MBL's annuity business concerned "full-service defined contribution
products," mainly in tax deferred annuities. Known by this Internal Revenue
Code section numbers, most were either @ 401(k) plans, usually for commercial
organizations, or @ 403(b) plans, for non-profit organizations. The New Jersey
Hospital Association has about 28,000 participants domiciled in this state with
more than $ 1 billion invested in MBL, and it represents the largest number of @
403(b) policyholders affected by this reorganization. MBL, and most other
insurers, sold GICs directly to plan sponsors, in July 1991, 30% of its annuity
reserves were GICs. To
offset these insurance liabilities, MBL invested [*9]
in various assets, but it relied primarily on commercial mortgage loans.
MBL also invested in real estate projects, thereby directly and indirectly
incurring liabilities, from guarantees on mortgage related bonds, for projects
in which it has equity interest. When real estate values fell at the end of the
decade, returns on the mortgage portfolio decreased as delinquencies and
foreclosures grew. Its subsidiaries became involved in businesses, with MBL
providing a significant portion of the financing, but the businesses were not
particularly successful. Further, while the assets were losing value, MBL
incurred more liabilities by writing more group pension business. In
order to enter the sophisticated investment markets, MBL needed a national
credit rating, and its initial ratings were as high as could be. However, in
1990 and 1991, the insurance company rating services (Standard & Poor's,
Moody's and Bests) each twice downgraded MBL's rating because an ill-advised
investment mix had reduced its capital surplus. The drastic contraction in the
national real estate market at that time created a lack of liquidity and loss of
value for MBL's real estate related investments. In the spring [*10]
of 1991, MBL officers realized that these reduced credit ratings would
adversely affect the company's ability to do business in its most profitable
markets. They began to meet with representatives of the New Jersey Department of
Insurance to discuss the company's liquidity problem. The Department was advised
that MBL would try to negotiate a merger with Metropolitan Life Insurance
Company (MetLife) or with The Prudential Insurance Company of America
(Prudential). Unfortunately, these meetings were reported in the financial
press, which aggravated the situation. National publicity about MBL's plight,
including stories in the Wall Street Journal and New York Times, led to a
withdrawal of approximately $ 500 million by MBL policyholders during the first
half of 1991 and projections of another $ 500 million being withdrawn by the end
of the year, a situation characterized as a "run on the bank." A
takeover by the Department of Insurance became inevitable, and on July 15, 1991,
MBL's Board of Directors unanimously consented to the filing of a petition for
rehabilitation. On the following day, Attorney General DelTufo appeared for the
commissioner of Insurance, seeking an order from this [*11]
court to place the company in rehabilitation and direct the Commissioner
to take over the company and rehabilitate it. The power to do this, for both the
court and the Commissioner, came from N.J.S.A.
17B:32-1 et seq., the Uniform Insurers Liquidation Act (UILA). On
July 16, 1991, the court signed an order to show cause, with temporary
restraints, placing MBL in rehabilitation with a moratorium on withdrawals,
pursuant to N.J.S.A. 17B:32-7(a).
MBL ceased all operations, no further distributions were made to any
policyholders and the Commissioner, as Rahabilitator, assumed control of the
company, which became known as Mutual Benefit Life Insurance Company in
Rehabilitation. The significant restraints prohibited MBL from "lending
funds ... on policy loans, payment of cash surrender values, surrenders,
withdrawal of pension deposits, funds transfers, lapses, cash cuts, conversions,
options or redemptions, and the payment of any benefits or periodic payments of
any kind." MBL was permitted to pay benefits only with respect to death and
disability claims, and to continue existing annuity benefits. The
matter was next presented to the court on August 7, 1991, when certain [*12]
restraints were modified and the procedure for withdrawing funds in
hardship cases was better defined. The courtroom was full, with more than 60
lawyers present, so the Court asked the several counsel representing pension
plans, tax shelter annuities and group individual retirement accounts to appoint
lead counsel. They, in turn, organized the Association of Mutual Benefit Life
Insurance Contractholders (AMBLIC), a New Jersey non-profit corporation,
including more than 100 plan sponsors and representing more than 700,000
individuals, nationwide, who had invested more than $ 4.2 billion in pension
plans, tax-shelter annuities and group individual retirement accounts. One of
the largest groups was the New Jersey Hospital Association, previously
mentioned. AMBLIC's members hold group annuity contracts and guaranteed
investment contracts comprising approximately 50% of the value of MBL's
insurance assets. Initial
Efforts in Rehabilitation The
Rehabilitator ascertained that Mutual Benefit Life Insurance Company was the
apex of a very complicated network of subsidiaries. It had a holding company, an
intermediate holding company, various subsidiaries and a diverse set of
commercial [*13] organizations that
owned different properties and syndications in which Mutual Benefit became
involved. He initiated negotiations for the sale of the group life and health
insurance business, retained a consultant to review the real estate portfolio,
contracted with MetLife and Prudential for reinsurance of new or continued
individual life insurance business of MBL, dealt with Commissioners of Insurance
in other states to avoid ancillary proceedings elsewhere, redomesticated and
licensed, in most states, a subsidiary called MBL Life Assurance Corporation (MBLLAC),
and created a mechanism to deal with all the questions and demands from the
policyholders and the public. In
mid-August 1991, the Commissioner appointed Victor Palmieri, Chairman of The
Palmieri Company, as Deputy Rehabilitator and Chief Executive Officer of MBL in
Rehabilitation. he and his company had experience regarding reorganization of
large, distressed companies and management of large, troubled real estate
portfolios. As CEO, he reorganized top management, directed an internal
investigation and evaluation of all facets of MBL's business relationships,
changed several business systems, restructured departments, analyzed [*14] MBL's
own retirement commitments to its employees, continued communication with MBL's
customers, and directed negotiations with many of the creditors in order to
initiate the rehabilitation of the company. The
first major step accomplished during rehabilitation was the sale of the group
health, life and disability business, with headquarters in Kansas City. This was
described as a "wasting asset," whose value would disappear without
immediate action. On September 27, 1991, this court approved a sale of that book
of business to AMEV Holding, Inc. An initial cash payment of $ 200 million was
made to the rehabilitation estate as a result of this agreement, and MBL could
potentially realize as much as $ 375 million. AMBLIC had been monitoring the
proceedings and discovered that the purchase agreement did not value the assets
to be transferred at the closing date, causing MBL to lose the appreciation on
certain of its assets. When rectified, this led to a savings of $ 6 million to
the rehabilitation estate. Negotiations
were undertaken to preserve value from the COLI business, and involved a $ 3.7
billion book of business with very sophisticated insurance products designed to
protect corporations [*15] and
their executives. This business was in peril because MBL was in rehabilitation,
but an agreement was eventually reached with The Hartford Life Insurance
Company, thereby enabling MBL to retain an interest in future profits. Under
Palmieri's direction, a major problem was solved at The Carter Company (a
subsidiary of MBL), various standstill agreements were negotiated with several
creditors, interest rate swap contracts were continued and then terminated
(without prejudice to the Rehabilitator's right to treat the contracts as
rejected), management was improved at the two largest real estate projects to
reduce annual overhead at one by $ 5 million and increase annual cash flow at
the other by $ 3 million, n3 investment policies to maximize continued revenue
were developed, arrangements were made to continue servicing tax deferred
annuities and retain this significant business, and various other transactions
important to the estate were concluded. Most importantly, Palmieri directed
discussions with representatives of the various state life insurance guaranty
associations and representatives of the life insurance industry to establish a
basis for their involvement in the rehabilitation [*16]
of MBL. The Rehabilitator contacted more than 100 parties to discuss the
possibility of a third-party transaction to assist the rehabilitation.
Substantive discussions were conducted with five or six of those parties, but to
help was forthcoming because the risk associated with the real estate portfolio
was too great.
n3 MBL had invested $ 550
million in loans and joint venture investments at Fisher Island and Williams
Island in Florida. The
Rehabilitator's staff completed a thorough financial analysis by the end of
1991, and it was learned that as of June 30, 1991, MBL had insurance liabilities
of approximately $ 9.9 billion, but had assets with a going concern value of
approximately $ 8.8 billion, Valuation on a going concern basis assumes the
assets will be held for five to ten years. Comparing the value to the
liabilities demonstrated that MBL had only 88 cents of assets for each dollar of
its policyholder liabilities. The evaluation of the real estate portfolio led
the Rehabilitator to conclude that the company [*17]
lacked sufficient liquidity to permit policyholder withdrawals, except
under certain extreme circumstances. In addition to the $ 1.1 billion
policyholder shortage, MBL had incurred substantial unsecured debt in the face
amount of $ 1.5 billion, which the Rehabilitator has estimated to have an actual
value of approximately $ 705 million. A major part of the unsecured debt was
owed to certain industrial revenue bond (IRB) trustees, based on deficiency
claims relating to numerous real estate projects involving MBL subsidiaries. n4
Special counsel and Palmieri have spent and are still spending a great deal of
time negotiating with these trustees. The negotiations were made more complex
because the basic debt was secured by the underlying real estate, and this court
enjoined any foreclosure actions on these properties. See, In re Rehabilitation
of Mutual Benefit Life Ins. Co.,
supra, 258 N.J.Super. at 362.
n4 As of the completion of
the hearings concerning the proposed plan of rehabilitation, negotiations
continue with many of the IRB's, and only the unsecured portion of that debt,
relating to guarantees by MBL, is the subject of this decision. [*18] The
Bank of America and four other banks have a general unsecured claim for $ 150
million. In 1989, these banks loaned that sum of money to TG Limited and E.H.C.
Companies, Inc., and MBL, having a substantial ownership and creditor interest
in the borrowers, guaranteed repayment of the debt. The debt to the Bank of
America was also secured by assets of the borrowers, so it remains to be seen
how much debt, if any, remains unpaid after the collateral is exhausted. Bankers
Trust, Citibank and Morgan Guaranty Trust, (SWAP banks) negotiated interest rate
exchange agreements with MBL. These are hedging devices, known as a swap, used
to balance a mismatch between assets and liabilities. In MBL's case, the
agreements also included a loan feature which MBL used to enhance its earnings.
Based on an agreed-upon, but unexchanged, sum of money, the banks paid MBL a
floating rate of interest and MBL paid the banks a fixed rate of interest (only
the interest streams are exchanged, not the principal on which the interest is
calculated). If interest rates rose, MBL's bond portfolio shrank but payments
from the SWAP banks insured against loss; if interest rates fell, MBL had to pay
the banks the [*19] difference
between their fixed rate and the reduced rate of the banks. By July 16, 1991,
MBL owed these banks approximately $ 55 million. MBL
did not immediately act to terminate or reject the agreements, which it could
have done, as they were executory contracts, and it did not reduce its bond
portfolio. Nor did the SWAP banks unilaterally terminate the agreements or take
legal steps to terminate them or compel the Rehabilitator to decide whether to
affirm or reject them. Instead, the parties negotiated for a settlement or
restructuring of this debt, and while they negotiated, interest rates fell.
While MBL's debt grew, the Rehabilitator continued to believe interest rates
would rise, and he consciously kept the SWAP agreements in place. On September
30, 1991, MBL paid $ 369,235 to Morgan Guaranty Trust to avoid a payment
default; its obligation to the other banks would default in March 1992. Unable
to negotiate a restructuring or a standstill, the parties agreed in November
1991 that the agreements should be terminated, and a termination agreement was
executed December 23, 1991. The termination documents included a letter which
reserved the Rehabilitator's right to consider the SWAP [*20]
agreements rejected. The total of the stated termination payments is $
113.5 million, of which approximately $ 60 million was incurred since the order
for rehabilitation was entered. Henry
F. McCamish, and his company IAS Development Corporation (IDC), helped develop
and build MBL's COLI business. They made several executory contracts for
services with MBL and had a shareholders agreement concerning an MBL subsidiary
called MBL holding Corp. MBL and McCamish settled their differences, as set
forth in a consent order of August 14, 1992, in which they agreed that McCamish
and IDC have a liquidated and allowable claim of $ 148.8 million, for
terminating certain of the agreements. McCamish challenges the treatment that
claim will receive, by assigning it the priority of a general creditor, as
unconstitutional. The
Stand-Alone Plan After
concluding the financial evaluation, the staff began to work on a model for
rehabilitation that became known as the stand-alone plan. The fundamental
principle of the stand-alone plan was that it would be supported solely by MBL,
but since MBL's assets covered only 88% of its policyholder liabilities, the
stand-alone plan provided for an immediate [*21]
12% reduction of principal account values on all policies. Any interest
crediting rate to be applied to the reduced policy account value, from that time
on, would entirely depend upon the return on investment of MBL's existing
assets. The policyholders would probably recover 88% of their account values,
and be left with a hope that wise investments by the Rehabilitator and his staff
would replace all or part of the missing 12% of the principal and some
additional earnings. Of
course, since the assets were insufficient to cover the insurance liabilities,
it was obvious to the Rehabilitator that the same assets were insufficient to
cover additional liabilities to the general unsecured creditors, regardless of
the total of their claims. Accordingly, from its earliest formulation in October
1991, the stand-alone plan did not provide for any payment to the general
unsecured creditors. If provision had been made to pay the policyholder and the
general creditors on a pari passu basis, whatever amount was determined to be
payable to the general creditors would be taken from the account values of the
policyholders. Under
this stand-alone plan, almost all policyholder liquidity disappeared [*22]
Withdrawals were permitted but only after payment of a significant
moratorium charge. Policy loans were not permitted, except according to strict
hardship standards, and policyholders could not transfer any of their account
balance to another insurance company. Normally, such a transfer is an ordinary
feature of a retirement plan, accomplished without any income tax liability.
26 U.S.C.A. @ 1035. The idea was to have an "earn-out," which
would eliminate the deficit through the growth of MBL's assets over a period of
time. It was expected that a target surplus would be accumulated and that the
company would recover and continue in business after 7 years. During the period
of rehabilitation, full death benefits and disability benefits would be paid
when due. Payments to retirees would begin at age 65 and be limited to a 10%
annual distribution of the account value over a 10 year pay-out. The debts to
MBL's unsecured general creditors would be completely eliminated. Regardless
of these limitations on liquidity, the stand-alone plan was much more beneficial
to the policyholders than a liquidation. It was determined that if the company
was liquidated [*23] on a six month basis, its assets would be worth 55 cents for
each dollar of liabilities, so when the policyholders were paid, they would lose
45% of their account values, and their insurance contracts would be void. On a
liquidation basis, less than half of the face value of the mortgage loan
portfolio, and only 30% to 50% of the value of real estate owned, would be
recovered. There is no evidence that the liquidation value of the real estate
assets has improved since July 1991, and the court believes it is unlikely to
improve in the immediate future. Many policyholders could not replace their life
insurance policies at an equivalent premium cost, because their physical
condition (and age, of course) had changed since they initially contracted with
MBL. On the other hand, although liquidity was lost and principal account values
were reduced by 12%, there was till coverage for death or disability. More
concisely put, as of July 16, 1991, under the stand-alone plan MBL's liability
for a $ 100,000 account would be reduced to $ 88,000 and interest would be
credited at the market rate until December 31, 1999. Thus the policyholder would
immediately suffer a 12% loss in value and be credited [*24] with earnings on
the reduced principal, never to reach what could have been earned on the
original account value by the end of 1999. Even then, the only solace for
policyholders lay in the future success of MBL, which no one predicted was very
likely. If MBL failed to meet its financial projections, the stand-alone plan
would collapse and the rehabilitation process would start anew, with liquidation
a strong possibility. State
Guaranty Associations Policyholders
had an additional source of relief in their local state guaranty association or
fund, but these associations did not provide uniform coverage to all
policyholders. Every state has a guaranty association to protect policyholders
in case a life insurance company becomes insolvent. In this state,
N.J.S.A. 17B:32A-1 et seq., enacted July 15, 1991, created a guaranty
association. Relief varies from state to state, often with uncertain benefits
provided to some policyholders and sometimes with no benefits provided to
others. Most state guaranty associations categorize policies as either
"allocated" or "unallocated," and significantly greater
protection is provided for allocated policies. Generally, allocated contracts
[*25] provide benefits directly on
an individual level, and the policyholder is the individual. Unallocated
contracts usually are held by corporate employers or retirement plan trustees,
and the policyholder is considered to be the group. For the individual insured
under an allocated contract, statutory limits of coverage from the guaranty fund
range, from $ 100,000 to $ 500,000. Limits are between $ 1 million and $ 5
million fro the group policyholder with an unallocated contract. In several
states, unallocated contracts are completely ineligible for relief, and even the
determination of which contracts are allocated or unallocated varies from state
to state. No court has determined how these concepts apply, and AMBLIC
vigorously disputes the limitations which various guaranty associations assert
under the various statutes. As
of June 30, 1991, MBL's total insurance liabilities were approximately the $ 9.9
billion. The Rehabilitator has estimated that about $ 3.2 billion would be
clearly protected by state guaranty associations (still subject to statutory
limits), about $ 3.5 billion would have coverage challenged by various guaranty
associations, making success for the policyholders questionable,
[*26] and the remaining $ 2
billion in policyholder liabilities would not seem to be eligible for any relief
from state guaranty associations. The
Reinsurers The
insurance industry is often involved in rehabilitation proceedings, mainly
because it supplies the financial support for the state guaranty associations.
See, e.g., Texas Commerce Bank v. Garamendi, 14 Cal.Rptr. 2d 854 ( Cal. Ct. App.
1992); Foster v. Mutual Fire, 614 A. 2d 1086 (Pa. 1992); N. Carolina &c
Guaranty Assn. v. Underwriters National Assurance Co., 269 S.E. 2d
688 (N.C. Ct. App. 1980). Here, the insurance industry's involvement with
MBL was delayed, because it was heavily involved with Executive Life Insurance
company, a very large company in rehabilitation in California. By late 1991, a
consortium of prominent life insurance companies, led by Prudential and MetLife,
became involved in the MBL rehabilitation. These insurance companies decided to
participate in MBL's rehabilitation in large part to protect the reputation of
GICs and to protect their ability to sell GICs and other products. That group,
known [*27]
as the Industry Advisory Group (IAG), knew that it needed a financial
analysis of MBL in order to discuss adequately any participation in any plan of
rehabilitation. Rather than rely on the Rehabilitator's evaluation of the
financial circumstances of MBL, the IAG decided to act for itself, and MBL
agreed to defer filing the stand-alone plan pending further input from the IAG.
By May 1991, the IAG had completed its study and made a calculation of the
extent of the insolvency, similar to the analysis done by the Rehabilitator.
There was a difference of approximately $ 300 million, but that was reconciled,
and both the IAG and the Rehabilitator agreed that the MBL deficit was
approximately $ 1.1 billion. The
IAG study revealed the problems that caused the MBL failure. The Chairman of the
IAG, an executive from Prudential, persuasively testified that the assets
supporting the liabilities were of very poor quality. Normally, when writing
such large business for large pension customers, an insurance company would use
AAA and AA rated bonds, which would be scheduled to mature when a GIC matured.
The problem with MBL was that 60% of its investments were in real estate and
mortgages, rather [*28] than high quality bonds. The Prudential executive testified,
convincingly, that it was "unthinkable" to voluntarily underwrite
large insurance risks with such a weak asset base. After
agreeing that there was indeed a $ 1.1 billion deficit, the IAG began conferring
with the Rehabilitator' staff in order to form another plan of rehabilitation
that the industry could support. It must be recognized that if the stand-alone
plan were adopted, the industry would be heavily involved across the country,
because most of the policyholders would be making claims against their local
state guaranty funds. Other than indirectly through the guaranty associations,
the insurance industry had no legal obligation to assist in this rehabilitation,
but the stand-alone plan would require the guaranty associations to dispute or
support the policyholders' claims in each state which would cost significant
sums of money. For several months there were serious negotiations involving MBL,
AMBLIC an IAG, as well as direct involvement from the National Organization of
Life & Health Guaranty Associations (NOLHGA). NOLHGA and the IAG wanted the
plan to be governed by the state guaranty system, but AMBLIC opposed this [*29] because the potential benefit to individual policy holders
was so uncertain from state to state. Eventually, due in great part to AMBLIC's
urging, a plan was made which provided better assurance for the policyholders,
and, although it did not solve the loss of liquidity problem, it would relieve
their anxiety over having to deal solely with a crippled MBL. The Proposed
Plan of Rehabilitation After
MBL was placed in rehabilitation by the order of this court on July 16, 1991,
and before the rehabilitation plan was filed, the Life and health Insurers
Rehabilitation and Liquidation Act (RLA) was enacted.
N.J.S.A. 17B:32-31 et seq. The plan of rehabilitation is based on the
statutory direction to reform and revitalize an insolvent life insurance
company, rather than liquidate it, through prompt application of appropriate
corrective measures. N.J.S.A.
17B:32-31(b)(1) and 43(c). It seeks to keep the company alive for the
benefit of the life insurance policyholders and the retirement plan
contractholders. It anticipates that the surviving company, MBLLAC, will operate
under strict guidelines for seven years in order to achieve a net surplus
sufficient to make it self-supporting. [*30]
It is also anticipated that the life insurance book of business may
attract a third-party purchaser if the financial statement is positive. The
National Association of Insurance Commissioners (NAIC) has proposed standards,
known as risk-based capital requirements, prescribing the amount of capital
required of an insurance company. It is currently estimated that for a portfolio
such as MBL's, the risk-based capital requirement is approximately 8% of total
assets. Under the plan, MBLLAC is to set crediting rates at a level designed to
yield such a surplus, calculated to be $ 212 million at the end of 1999, plus a
mandated valuation reserve of an additional $ 272 million. Theoretically this $
485 million would pay the insurance liabilities to the policyholders at the end
of the period of rehabilitation. However, policyholders wishing life insurance
coverage and continued annuity payments would not want to cash in their
policies. The
plan calls for payment of claims in the particular order and manner prescribed
by the RLA. Special deposit claims, secured claims and separate account claims
receive first priority on the assets collateralizing such claims. N.J.S.A.
17B:32-87(b) and (c). [*31]
Secured creditors may surrender their collateral and then have a class 4
claim priority as a general creditor, or they may receive the fair market value
of the collateral and the deficiency becomes a class 4 claim. All other claims
are divided into eight classes, pursuant to N.J.S.A. 17B:32-71(a). Of particular
interest here are the first four classes: (1) administrative claims, (2 priority
wage claims, (3) policyholder claims and guaranty association claims not in
class one, and (4) general creditor claims. The
plan centers upon the transfer of substantially all the assets and liabilities
of MBL to MBLLAC, a stock life insurance company. MBLLAC was a direct,
wholly-owned subsidiary of MBL, is currently licensed in all states (except New
York) and D.C., and has been redomesticated to New Jersey. To accomplish the
transfer from MBL in Rehabilitation to MBLLAC, the following five separate
agreements are to be executed by MBL: 1. the
Rehabilitation Agreement with MBLLAC; 2. the
Liquidating Trust Agreement; 3. the Stock
Trust Agreement; 4. the
Participation Agreement with MBLLAC, NOLHGA and each participating guaranty
association; and 5. the
Reinsurance Agreement with [*32] MBLLAC and the participating reinsurers. Under
the Rehabilitation Agreement, MBLLAC agrees to assume and reinsure all MBL
insurance contract obligations, as reaffirmed or restructured, after receiving
MBL's assets. Excluded from the asset transfer are contract obligations for
policyholders who opted out of the plan, and certain "retained assets"
from MBL affiliates involved in real estate transactions. MBL will reaffirm all
term life, disability income, separate account and new money accumulation
contracts, as well as contracts that were in pay status which were issued by
July 16, 1991, or issued later and resulting in death benefits. MBL will
restructure its other contracts. For example and generally speaking, permanent
traditional life, universal life and group adjustable life contracts will be
restructured into non-participating universal life contracts, with
interest-sensitive crediting rates, to mature on the same date as the original
contract. Death benefits are to be paid without a moratorium charge and may be
annuitized. The crediting rate is the contract rate for the remainder of 1991, 5
3/4% for 1992 and not less than 3 1/2% for 1993; thereafter the crediting rate
will [*33]
be determined by a formula tied to MBLLAC's investment performance. Cost
of insurance charges and expense charges shall be assessed against each contract
that was not paid up by July 16, 1991 and shall be deducted from the account
value. Surrenders are permitted, either net of any loan value and subject to the
moratorium charge, or in exchange for an annuity of at least ten years or a
periodic payout during ten years. A similar scheme applies to covered
accumulation contracts, certain contracts in pay status, deferred maturity
contracts and group flexible paid-up contracts, and a slightly different scheme
applies to wrapped accumulation contracts. Withdrawals under restructured
contracts are permitted without moratorium charges if a hardship can be proven.
Parameters of hardship petitions are set forth, providing for an initial
determination by MBLLAC and possible appeal to this court. Participants may
reject a restructured contract, opt-out of the plan and be paid 55% of the value
of the original account. These
restructured and reaffirmed contracts shall be transferred to MBLLAC, and MBLLAC
will assume and reinsure them and pay all related liabilities. Persons making
withdrawals from [*34] covered
contracts generally will pay moratorium charges of 40% until the end of 1993,
32.6% for 1994, 27.1% for 1995, 21.1% for 1996, 16.3% for 1997, 10.9% for 1998
and 5.4% for 1999. Different schedules are specified for certain other types of
contracts. The
Liquidating Trust Agreement creates a liquidating trust, which is to receive
certain retained assets of MBL, including the stock of MBL Holding Corporation.
These are potentially troublesome assets that might discourage an entity
interested in purchasing MBLLAC when it is in better condition. The Commissioner
is named trustee, to hold, invest or sell the assets for the benefit of the
holders of restructured insurance contracts who retain their contracts until the
rehabilitation period ends. This trust can sell its assets, with prior court
approval. The trust, unless terminated sooner, ends on December 31, 1999, the
end of the rehabilitation period. The
Stock Trust Agreement, like the Liquidating Trust Agreement, makes the
Commissioner the trustee, for the benefit of the holders of restructured
contracts at the end of the rehabilitation, when the trust terminates. It is to
receive and hold all the issued and outstanding capital [*35]
stock of MBLLAC. All stock in the Stock Trust will be held for the
benefit of certain restructured contract holders who maintain their interest in
MBLLAC through the end of the rehabilitation period. The participating guaranty
associations and reinsurers are granted warrants to purchase up to an aggregate
of 20% of the common stock, at a fair market price; the warrants are valid for
one year following the end of the rehabilitation period. In
the Participation Agreement, the various guaranty associations guarantee that
"covered" insurance contracts will have an account value at least
equal to that of a "restructured" contract with an average annual
interest of 3 1/2%. These contracts represent about $ 6 billion of insurance
liabilities. Assets will be transferred from MBL to the MBLLAC general account
to reserve for these liabilities, and they will be supplemented by each state
guaranty association making benefit support payments to MBLLAC. Each
participating guaranty association will be financially responsible for the value
of individual contracts, having waived the benefit of any local statutory limit.
It is expected that the guaranty associations will be required to pay
approximately [*36] $ 200 million
to MBLLAC, during the period of rehabilitation, with greater potential
liability, depending on MBLLAC'S performance. They have a right to subrogation
for the repayment of any monies that are paid to policy holders, but repayment
will be delayed until policyholders are paid in accordance with the plan and
until MBLLAC accumulates surplus exceeding the risk-based capital criterion. All
guaranty association except those from Colorado, Louisiana and the District of
Columbia are parties to this agreement. Upon
withdrawals, surrenders or annuity payments of covered contracts subject to the
moratorium charge, the policyholders would be credited at rates determined
pursuant to the Rehabilitation Agreement, but not less than 3 1/2% per year,
applied to the restructured account value. At the end of the rehabilitation
period, for contracts that have not received payouts subject to the moratorium
charge, the rates are the same, with an additional choice of 5% per year of the
restructured account value, capped by statutory limits unless the limits were
waived. The New York Guaranty Association (NYGA) has agreed to waive all
statutory limits except for group annuity contracts where [*37] benefits are not
provided on a per-participant basis. Further, for withdrawals subject to the
moratorium charge, the NYGA guarantees minimum crediting at the contract rates,
and for those not subject to the charge, it guarantees either the contract rates
or a floating rate based on three-year treasury bills plus 50 basis points (1/2
of 1%), subject to a 4 1/2% floor. New Jersey contractholders are guaranteed a
5% crediting rate at the end of the rehabilitation period, or earlier as to
withdrawals or benefit payments not subject to moratorium charges. The statutory
limits have been waived by the New Jersey Life and Health Guaranty Association,
at the Commissioner's direction. If a guaranty association waives its statutory
limits with respect to the 5% crediting rate, or if the New York crediting rate
exceeds 5%, MBLLAC is not required to repay to that association the amount of
such enhancement, regardless of the size of its adjusted surplus at the end of
the rehabilitation period. The
life insurance industry is supporting the plan through the Reinsurance
Agreement, which assures performance, by reinsurance, for each uncovered group
accumulation contract (they will also be responsible [*38] for
the value of each covered group accumulation contract in excess of the statutory
limit supported by the local guaranty association). This is known as the
"Wrapped Accumulation Contract" or the "Wrapper." A separate
account was created to receive approximately $ 2 billion of MBL's insurance
liabilities and assets, representative of the entire mix. The assets to be
transferred to the separate account will represent 88% of the liabilities
assigned under the Wrapper. A small group of life insurance companies (sixty
companies were asked to participate, but only fourteen agreed) will reinsure
100% of the liabilities assumed, plus interest. For 1991 interest will be
credited at the contract rate, and for 1992, 1993 and 1994, interest will be
credited at 4%, 3 1/2% and 3 1/2%, respectively. Thereafter, the crediting rate
depends on a formula based on the earnings of the assets in the account, but
there is no guaranteed rate. If all MBL's policyholders and contractholders were
credited with rates guaranteed in their policies and contracts, the total
expense would exceed that to be paid under the participation and reinsurance
agreements. Group accumulation contracts from Colorado, Louisiana [*39] and the District of Columbia are reinsured under this
agreement, and life contracts from these jurisdictions will be restructured but
without a guaranteed account value. The
reinsurers will manage the investment of the assets of the special account. They
will pay a management fee to MBLLAC for administrative work with the
policyholders, and be eligible to earn a reasonable incentive fee for themselves
based on the earnings. The fee is calculated as a percentage of the earnings
pursuant to a complicated formula which, in general, is 25% of the excess return
above 3 1/2%. It is to their interest to maximize the earnings, because the
higher the earnings, the less the reinsurers will have to contribute and the
higher will be the incentive fee. The
proposed plan, therefore, creates a seamless web of coverage for all
policyholders, regardless of the type of policy or contract held, guaranteed by
the combination of the participating state guaranty associations and reinsurers.
Any policyholder may opt-out of the plan and withdraw the account value and
credited interest, but this will require payment of a penalty equal to 45% of
the existing account value. After paying that charge, policyholders [*40]
deciding to opt-out and withdraw their account balances will receive at least as
much as they would receive in a liquidation of MBL. The entire account balances
of those remaining will be maintained, and interest will be credited to provide
some growth. Benefits will be paid when they become due, according to the terms
of the restructured policy or contract. MBLLAC expenses will be paid on a
current basis, and at the end of the period of rehabilitation on December 31,
1999, the corporation is projected to have a surplus that will satisfy the
risk-based capital rules. At that time, covered policyholders may withdraw their
accounts without payment of a moratorium charge, but those that are uncovered
(under the Wrapper) will be paid over time. The payout is scheduled to last five
years, but it may last up to twelve years, depending on the performance of the
special account. The
combination of the MBLLAC assets and the guaranty associations and reinsurers
contributions probably will not yield as much money as the policyholders
reasonably expected to earn. Furthermore, since all policyholders will be unable
to use their investments in MBL for voluntarily paying premiums, making loans,
[*41] withdrawing savings,
utilizing various sophisticated methods of receiving benefits, or transferring
to other competing investment vehicles on a tax-free basis, they have lost the
liquidity of their investments. This loss of liquidity has value, but the court
was not persuaded that this value should be assigned a dollar amount. A
reasonable policyholder owning a restructured guaranteed annuity contract with
MBLLAC would be expected to transfer to another insurance company offering the
same kind of contract with a higher rate of return. To the extent that another
well rated insurance company pays a market rate exceeding the crediting rate
under the plan in any one year, the increment would measure the value of the
loss of liquidity. Ordinarily this value would be included in a determination of
whether or not the policyholders' class 3 claims had been fully paid, thus
enabling the court to find what was available for satisfaction of class 4
claims. Since no specific amount was proved for this liability, it cannot be
awarded, and if anything is left after satisfying the policyholders' interests
under the plan, it will pass to class 4 claimants. The
concise effect of the proposed plan on [*42]
an account valued at $ 100,000 on July 16, 1991 is to maintain the value
at $ 100,000 but credit interest at specific levels, below the market rates,
until December 31, 1999. The projected average crediting rate is 4.84% through
the completion of rehabilitation. The account values and the crediting rates are
guaranteed by the state guaranty associations and the insurance industry, so
there is only a remote chance that the policyholders will be faced with
liquidation. Standard of
Review The
parties differ as to the court's standard of review of the proposed plan of
rehabilitation. The Rehabilitator urges the court to treat his activities in
formulating a plan of rehabilitation as a regulatory or administrative agency
action. If viewed in that manner, the court would review the proposed the plan
under the substantial evidence rule, defer to the expertise of the agency
concerning insurance matters and look only for arbitrary, unreasonable or
capricious action by the Rehabilitator. See, Williams v. Dept. Human Services,
116 N.J. 102, 107 (1989). On the other hand, the statutory direction
requires the Rehabilitator to apply to the court for approval [*43]
of the plan, and the court is directed to preside over hearings and then
approve, disapprove or modify the plan depending on what is "in the
judgment of the court, fair and equitable to all parties concerned."
N.J.S.A. 17B:32-43(e). Treating
the activities of the Rehabilitator and his staff as those of an administrative
agency leaves little room for review, because there is no proper record for the
court to review. They were concerned with operating an insurance company, not
with regulating its activities in the classic sense of administrative agency
regulation; their main purpose was rehabilitation in order to avoid liquidation.
Most importantly, the Rehabilitator is required to prepare a plan, not to
approve a plan submitted by another party. Approval is to come from the court,
upon application by the Rehabilitator. The court is to direct what notice shall
be given and what hearing shall be held. Pursuant
to an order to show cause filed August 7, 1992, the hearings to consider the
proposed plan were scheduled to begin January 28, 1993. Extensive notice was
given to all policyholders, creditors, agents, and employees of MBL, as well as
the commissioners of insurance and the [*44]
guaranty associations wherever MBL did business. Publication was ordered
in the major New Jersey newspapers as well as The Financial Times and The Wall
Street Journal. The
statute directs the court away from the review of an administrative agency
decision. Ordinarily a court affirms a decision or reverses and remands it back
to the agency, but N.J.S.A. 17B:32-43(e) permits the court to approve the plan
or to disapprove it or to modify the plan and approve it as modified. Rather
than presuming the plan to be reasonable, reversible only by sustaining a heavy
burden of proof, the court is directed to decide what is "fair and
equitable to all parties concerned." Those parties are the claimants, not
the regulators. Discovery
was limited, at first, because the court was convinced that formal discovery
would interfere with the myriad tasks of formulating a plan. Shortly before the
hearings, and again during the hearings, it became apparent that it was not easy
to gather and deliver all the supporting documentation related to the many
decisions made by the Rehabilitator. There was a clear need for formal discovery
of experts and other witnesses who exercised their discretion, so the hearings
[*45] were spaced out over four
months to accommodate the discovery process. Searching
the actions of the Rehabilitator for abuse of discretion is unfair to everyone,
except perhaps the Rehabilitator and his staff, because everyone had some
objection to the plan as first published and then as amended. Besides 31 formal
objections filed with the court, the court received hundreds of letters from
policyholders on life and annuity issues, none of which agreed with everything
the Rehabilitator proposed. Accordingly, the court has considered all the
proposals in the plan de novo. The burden of proof is on the Rehabilitator as
the proponent of the plan, to establish its validity by the preponderance of the
believable evidence. The statute imposes an affirmative duty of review on the
court, to be guided by whether the plan is fair and equitable to all parties
concerned. Priorities
of Policyholders and Creditors The
plan of rehabilitation presented to the court for approval rests on a statutory
preference for claims by policyholders over claims of general unsecured
creditors. N.J.S.A. 17B:32-71(a) n5
allocates various types of claims against the rehabilitation estate to several
classes, [*46]
and requires satisfaction of all claims in a class before any members of
the next lower class receive any payment. Policyholders are placed in class 3,
while general unsecured creditors are in class r.
N.J.S.A. 17B:32-37(a) makes the RLA applicable to the within proceeding.
It says: Every
proceeding heretofore commenced under the laws in effect before the enactment of
this act shall be deemed to have been commenced under this act henceforth for
all purposes and shall be governed by the provisions of this act including, but
not limited to, Section 41 of this act, except that, in the discretion of the
commissioner, the proceeding may be continued, in whole or in part, as it would
have been continued had his act not been enacted. The
Commissioner did not seek to apply the exception, and the application of the
1992 scheme of priorities is the source of the major challenge to the plan of
rehabilitation. Various objectors have claimed this scheme to be
unconstitutional. In addition, retroactive application of the priority scheme is
challenged as inequitable because it causes manifest injustice to the general
unsecured creditors.
n5 This section defines the
priority of distribution of claims, and it is often referred to by its section
number in the Model Act -- @ 41. [*47] Priorities
under the UILA When
the order for rehabilitation was entered in 1991, the Commissioner's powers were
based on the New Jersey version of the Uniform Insurers Liquidation Act (UILA)
for persons engaged in the business of life insurance, health insurance or
annuity. N.J.S.A. 17B:32-1 et seq.
N.J.S.A. 17B:32-2 placed original jurisdiction in the Superior Court, and
all substantive actions of the Commissioner as Rehabilitator were dependent upon
authority from the court or approval of the court, with certain administrative
and ministerial functions delegated to the Commissioner.
N.J.S.A. 17B:32-15. When issuing orders concerning the rehabilitation of
a life insurance company, the court is to be guided by the statute, and the
Commissioner is granted certain limited authority to seek relief from the court,
without which the Commissioner would have been unable to take over MBL. Since
the source is the UILA, the court is directed to interpret and construe it in
order to "effectuate its general purpose to make uniform the law of those
States which enact it." N.J.S.A.
17B:32-23. The
UILA was approved by the National Conference of Commissioners on Uniform State
[*48] Laws and the American Bar
Association in 1939. By 1954, the UILA had been adopted in 14 states, and by
1986, in 30 states, but now the RLA, as a Model Act of the NAIC, has become
popular and only 28 states follow the UILA. The
UILA was enacted to harmonize the various state statutes governing multi- state
insurance insolvencies and provide reciprocal provisions. The drafters were in
favor of having the Insurance Commissioner, usually from the state of the
insurer's home office, serve as receiver, with authority to act in other states,
including the authority to take possession of the insurer's property in
non-domiciliary jurisdictions, having creditors file proof of claims in their
own states, controlling the ability of foreign creditors to seize the insurer's
property in foreign states, and eliminating any distinction between local and
foreign creditors. They had only limited concerns about preferences, referring
only to "wage claims, compensation claims, tax claims and the like."
See, 13 Uniform Laws Ann. 322-23 (1986). In
a different context, it was noted that the purpose of the UILA is "to
provide for a uniform, orderly and equitable method of making and processing
claims [*49] against financially
troubled insurers." See, In re Rehabilitation of Mutual Benefit Life Ins.
Co., supra, 258 N.J. Super. at 368. But that court was not examining the UILA to
ascertain the existence of a priority scheme for making claims. Rather, it was
concerned with the interstate aspects of rehabilitation. Thus, when it listed
the six "central remedies" of the UILA, none related to priorities
between policyholders and general creditors. In
a recent review article, it was suggested that the UILA represents a "universalist"
approach in seeking to have one receiver with primary control, regardless of the
location of the assets or creditors. But it is also noted that the UILA contains
several "territorialist" provisions which do not recognize the
extra-territorial effects of other states' laws. Stephen W. Schwab et al.,
Cross-Border Insurance Insolvencies: The Search For A Forum Concursus, 12 U. Pa.
J. Int'l Bus. L. 303 (1991). The authors say that the priorities found in @ 6 of
the UILA ( N.J.S.A. 17B:32-21) providing that priorities are governed by the
laws of the domiciliary state, "achieves [the UILA's] universalist goal by
accommodating [*50] states'
territorialist concerns." Id. at 321-22. This section simply recognizes
that states may have different priority schemes, but the domiciliary state's
priority rules govern. Thus there is a universalist rule protecting territorial
concerns, but there is no hint of any intent to differentiate between
policyholders and other general creditors. In
New Jersey, when dealing with property and casualty insurance companies, a
specific priority plan was added to the UILA in 1975, giving a preference to
policyholders over general unsecured creditors. See, N.J.S.A. 17:30C-26(c).
However, the Legislature did not amend the UILA for life and health insurance
companies until it adopted the RLA in July 1992. The RLA was a Model Act drafted
by the National Association of Insurance Commissioners (NAIC). At the present
time, all states, the District of Columbia and Puerto Rico have this act or a
specific statutory scheme for prioritization of loss claims among creditors.
Each of these statutes grants a priority to policyholders ahead of general
unsecured creditors. Therefore, from 1971 to 1992, rehabilitation of an
insolvent life insurance company was governed by the UILA. In
the [*51] matter at bar, the
Rehabilitator argues that under the UILA, claims of policyholders had priority
over claims of general unsecured creditors, based on his interpretation of
N.J.S.A. 17B:32-1 to 30. His analysis is as follows: N.J.S.A. 17B:32-1(h) shows the UILA recognized priorities
because it defines a "preferred claim" as a claim for which the law of
a state, presumably New Jersey, "accords priority of payment from the
general assets of the insurer." Then N.J.S.A.
17B:32-4(d) directs the court, when determining whether to grant an application
to place an insurance company in rehabilitation, to consider the need for
"other relief as the nature of the case and the interests of the
policyholders, creditors, stockholders, members, subscribers or the public may
require." Later, at N.J.S.A.
17B:32-20(c), the Rehabilitator is directed to serve notices of the proceeding
for confirmation of the plan of rehabilitation, and those notices "shall
concisely state the amount and nature of the claim, the priorities asserted if
any, and the recommendation of the [Rehabilitator] with reference thereto."
Finally, N.J.S.A. 17B:32-21
provides reciprocity and "equal priority"
[*52] between residents and
non-residents of New Jersey, but does not mention equality of priority among
policyholders, creditors and stockholders. To
the same end, AMBLIC looks at the UILA and points to the definition of
"preferred claims" in N.J.S.A. 17B:32-1(h), arguing that the Legislature would not
have included this definition if it had intended all claims to be treated
equally. Then AMBLIC examines the sequential listing of claimants in
N.J.S.A. 17B:32-4(d) and
6(f) and finds significance in the location of policyholders at the beginning of
each list. The
Rehabilitator and AMBLIC postulate that these references mean that "nothing
in the UILA required deviation from the usual priority of policyholders over
creditors." It seems that the "usual priority" resides in the
statutory law of the other states and in N.J.S.A.
17:30C-26(c), but none of those statutes is the source of authority to the New
Jersey Commissioner when serving as the Rehabilitator for a life insurance
company. They
also argue that the act does not require equal prioritization of claims of
policyholders and general unsecured creditors, so the lack of a legislatively
specified plan of priorities leaves [*53] the
Rehabilitator and the courts "to the determination of those priorities in a
manner not inconsistent with state and federal law." This position lacks
merit because it ignores the nature of the UILA as an enabling act, to wit:
authority comes from the statute's contents, not from its lack of direction. A
list of powers the Commissioner lacked could go on forever, but to effect any
prioritization of claims, the court must search for what authority he was
granted. There
is no "federal law" cited by the Rehabilitator, nor should there be,
since insurance regulation is a state, not federal, governmental function. In
1991, there was no specific "state law" in New Jersey determining
priorities between policyholders and general unsecured creditors of a life
insurance company in rehabilitation. Absent an express statutory provision
establishing priorities, all creditors asserting loss claims stand on an equal
basis. See, Appleman, Insurance Law and Practice @ 10726 (1982); 2A Couch on
Insurance 2d @ 22:84 (1984). Clifford
v. Concord Ins. Co., 114 N.J.Super. 168, 172 (Ch.Div.
1971), aff'd, 114 N.J.Super. 495 (App.Div. 1971), [*54]
certif. denied, 58 N.J. 395 (1971), held that the Commissioner of
Insurance (and the court) lacked statutory authority to approve a rehabilitation
plan which provided for payment of claims of some policyholders and excluded
others. n6 Clifford specifically held that the Commissioner lacked statutory
authority: ... to scale
down claims, fail to provide for any claim or group of claims or do anything,
short of full liquidation, except to approve a liquidation plan which will
provide for payment of all claims in full or in a percentage to which all
claimants have agreed. [Id.] In other
contexts, other courts have observed that New Jersey does not prefer
policyholders over other creditors of an insolvent insurance company.
Skandia America Reinsurance
Corp. v. Schenck, 441 F.Supp. 715, 727-8 (S.D.N.Y. 1977); Central-Penn v. N.J.,
117 N.J.Eq. 548, 552-53 (Ch. 1935).
n6 This lack of authority to
set priorities among claimants was cured by the amendment of the UILA for
property and casualty insurance companies in 1975. See, N.J.S.A. 17:30C-26(c)(4
and 5). [*55] Nor
is there persuasive authority elsewhere under the UILA.
White v. State of Alaska,
597 P.2d 172, 176 (Alaska 1979) held that "any decision to accord priority
to claims must come from the legislature and not this court," and that
"absent inequitable conduct of a claimant, a court is without power to
consider the general requirements of equity in setting priorities among
creditors." In re Dome Ins. Co., 592 F.Supp. 1219, 1121 (D. V.I. 1984) held
that "no general creditor, such as a policyholder claiming an unearned
premium, will gain any advantage over any other general creditor. The economic
hurt and damage will be shared by all in proportion to his or her loss."
Courts in Oklahoma, New York, North Carolina and Illinois have observed that the
UILA treated policyholders and general creditors alike. See, State ex rel. Hunt
v. Community Nat'l Ins. Co., 560
P.2d 560 (Okla. 1977); In re Rehabilitation of All City Ins. Co., 413
N.Y.S.2d 929, 933 (App. Div. 1979); Long v. Beacon Ins. Co., 359 S.E.2d
508, 509 (N.C. Ct. App. 1987); [*56] In
re Liquidation of Reserve Ins. Co., 524 N.E.2d
538, 543 (Ill. 1988). Finally,
there is direct evidence from the Legislature that it was filling a void when it
created a specific list of priorities in 1992. The Senate Commerce Committee
Statement, printed following N.J.S.A.
17B:32-31, lists 21 "major differences between this bill and the current
regulatory scheme," and the nineteenth difference says that the new
legislation: Provides a
detailed scheme with respect to the priority of distribution of claims from an
insurer's estate. Under current law, a priority of distribution of claims,
except for secured claims and certain other claims, does not exist. For example,
a claim of a policyholder is currently on the same priority level as a claim of
a general creditor of an insurer. The Senate
Budget and Appropriations Committee also issued the same statement when it
released the bill. Thus,
without any priorities established by common law or statute, the court concludes
that policyholders and general unsecured creditors would share the general
assets of an insolvent life insurance company, pari passu, under the UILA. The
UILA does not permit [*57] either insurance companies or courts to create ad hoc
priority schemes. Priorities
Under the RLA In
1968, the NAIC adopted the Insurers Rehabilitation and Liquidation Model Act (RLA),
based on the Wisconsin code of 1967, which in turn was based on the UILA, to
address all aspects of rehabilitation, liquidation and conservation in
governmental regulation of insurance companies. The RLA was revised in 1977 to
deal with insolvenices of insurers and to coordinate with model acts concerning
insurance guaranty funds. See, Kimball, History and Development of the Law of
State Insurer Insolvency Proceedings: another Look After 20 Years, 5 J. Ins.
Reg. 6, 32 (1986). Concerns about priorities centered about administrative
expenses, wage claims, deductibles and payment of insured losses, because
"if there is enough money to pay losses and unearned premium reserves, even
with a deductible, the essential function of the insurer will have been carried
out. The next priority is residual claims -- all other claims, such as ordinary
commercial debts, that there is no specific reason to subordinate." Id. at
23. Protection for policyholders was not a major consideration, because [*58]
the advent of guaranty funds was thought to cover that class of claims.
Id. at 27-28. These funds were not meant to directly guarantee the solency of
life insurance companies, but they were expected to reimburse policyholders for
"justifiable losses." See, Washburn, State Regulators and the NAIC:
Innovators in Improving Consumer Protection, 6 J. Ins. Reg. 194 (1987). The
stated goals of the RLA in New Jersey are all sought in order to protect
"the interests of insureds, claimants, creditors and the public
generally." N.J.S.A. 17B:32-31(b). To do so, among other things, the
priority provisions of the UILA at N.J.S.A.
17B:32-26 were expanded and became N.J.S.A. 17B:32-71, which initially states: a.
The priority of distribution of claims from the insurer's estate shall be in
accordance with the order in which each class of claims is set forth in this
section. Every claim in each class shall be paid in full or adequate funds or
other assets retained for such payment before the members of the next class
receive any payment. No subclasses shall be established within any class. Class 3 (
N.J.S.A. 17B:32-71(a)(1)(3)) includes "all claims under policies,"
[*59] and provides further that: All claims
under life insurance and annuity policies, whether for death procees, annuity
proceeds, or investment values, shall be treated as loss claims. For the purpose
of this section, life insurance and annuity policies shall include, but not be
limited to, any and all individual and group annuity and investment contracts
issued by an insurer under or in connection with an employee benefit plan or
program to which section 401, 403(b) ... of the federal Internal Revenue Code of
1986 ... relates, to whomever and whatever persons or entities such contracts
are issued, together with all individual annuities issued pursuant to any such
contracts. N.J.S.A. 17B:32-71(a)(4) places claims of general creditors in
class 4. It has been noted elsewhere that it is rare for any payment to be made
to class 4 claimants under the RLA, and class 3 claims customarily receive a pro
rata payment calculated by comparing available assets to the amount to approved
claims. See, Traylor, Insurance Company Liquidations: A Liquidator's
Perspective, 6 J. Ins. Reg. 160 (1987). Retroactivity
of the RLA The
court has been asked to approve a plan of [*60]
rehabilitation, based on the prioritization scheme of the statutory law
in effect at this time. Because the objecting general unsecured creditors made
certain contractual arrangements with MBL when the UILA was in effect, or
because the UILA was in effect when the company was placed under the control of
the Rehabilitator, they challenge the application of the current statute as
being retroactively applied to transactions made or relationships created under
the earlier statutory law. Legislative
Intent In
Brown v. State and Atlantic City, 257 N.J.Super. 84, 88 (App Div. 1992), Judge
Carchman reiterated the general rule that "statutes relating to substantive
rights should be construed prospectively unless the legislature indicates
otherwise." The circumstances under which courts will support retroactive
applications of statutes are set out in Twiss v. State, 124 N.J.
461, 467 (1991): 1. when the
Legislature has expressed its intent, either explicitly or implicitly, that the
statute be so applied; or 2. when the
statute is curative; or 3. when the
reasonable expectations of those affected by the statute [*61] warrant such
application. "The
rule favoring prospective application, however, is one only of statutory
interpretation. Its purpose is to aid the court in its search for legislative
intent .... Once a court determines that a statute applies retroactively, it
should apply the statute in effect at the time of its decision." Ibid. N.J.S.A.
17B:32-37(a) clearly indicates the Legislature's intent that RLA @ 41 (the
priority scheme) should apply to the current MBL rehabilitation. Every
proceeding heretofore commenced under the laws in effect before the enactment of
this act shall be deemed to have commenced under this act henceforth for all
purposes and shall be governed by the provisions of this act, including, but not
limited to, section 41 of this act, except that, in the discretion of the
commissioner, the proceeding may be continued, in whole or in part, as it would
have been continued had this act not been enacted. Further,
Commissioner Fortunato testified, before the Legislature, in support of the
enactment of the RLA, and he stated that if the bill were enacted, he intended
to apply the priority provisions to the MBL rehabilitation. He also communicated
this [*62] viewpoint, in letters,
to specific members of the Legislature. Additionally, several objectors to the
MBL, rehabilitation plan lobbied against the enactment of the Model Act's
priority scheme. In the General Assembly, the Insurance Committee submitted a
substitute for the bill pending in that house (identical to that in the Senate,
which eventually was enacted) which would have expressly applied the new
priority scheme on a prospective basis. The Chair of that committee submitted a
written statement to the bill which said "our intention is to release a
committee substitute of this bill without a retroactive clause." It was her
position that there were sufficient protections for policyholders to be found in
the Guaranty Fund. Nevertheless, the Legislature adopted the priority provisions
set forth in the Model Act as well as the above retroactivity provision. This
evidence indicates the Legislature's intent that the priority scheme in N.J.S.A. 17B:32-71(a) be applied to the matter at bar. The
Commissioner did not seek to utilize the statutory exception to the general rule
that the RLA was to apply to ongoing rehabilitation proceedings, because he
believed the purposes supporting [*63] policyholder
priority were valid and important. He had no strong basis for acting otherwise,
although he believed, erroneously, that policyholder priority over general
creditors was permissible under UILA. He first sought to create a
"Stand-Alone Plan," but the appearance and cooperation of the
organizations representing the guaranty funds (NOLHGA) and the insurance
industry (IAG) presented a more likely chance of a firm and credible recovery
for policyholders, because they were not assured of recovery under the various
state guaranty plans. The
drafters of the NAIC Model Act took special note of the exception permitting the
insurance commissioner to continue an ongoing rehabilitation under the prior
statutes, and they thought that changes from the UILA were not likely to affect
substantive constitutional rights. They said: This section
permits immediate application of the new law when the commissioner seems it
desirable and practicable. There might be circumstances under which application
to old transactions of one or another of the new rules would be
unconstitutional. It can be assumed that the commissioner will then not apply
the new law, or at least that portion of it, and [*64]
that if he did, the court would simply treat the application of the new
law as inappropriate and would correct the error, without invalidating the
entire proceeding. For the most part, however, changes are merely remedial and
will not affect substantive rights in any way that would open the door to
constitutional challenge. Discretion seems more appropriately lodged in the
commissioner than in the court, since the decision should ordinarily turn on
considerations of practicability and administrative convenience. (emphasis
supplied) In 1975, the
Legislature prohibited retroactive application of new priority rules when it
repealed the UILA for property and casualty insurance companies and replaced it
with a version of the UILA which granted a priority to policyholders over
general creditors in a rehabilitation proceeding. In so doing, L. 1975, c. 113
specifically provided that "such repeal shall not affect pending
proceedings under such sections." But that was not their purpose here: they
enacted the RLA knowing it would be applied to the ongoing MBL rehabilitation
proceedings. Clarification
of the UILA The
Rehabilitator contends that under the UILA, a priority scheme [*65] favoring
policyholders over general unsecured creditors was already in place, and the RLA
merely clarifies the existing priority scheme under the UILA by classifying
specific types of claims. Indeed, N.J.S.A.
17B:32-31(b)(3) states that one of the Legislature's purposes in enacting the
RLA was to achieve "enhanced efficiency and economy of liquidation, through
clarification of the law, to minimize legal uncertainty and litigation." It
is clear from the history of the UILA that its basic purpose was to provide
uniform treatment for multi-state companies faced with insolvency. Little
thought was given to prioritization of claims between policyholders and general
unsecured creditors of life insurance companies, probably because life insurance
companies had few insolvencies. The RLA sought to integrate relief from guaranty
associations in the legislative system in order to satisfy policyholder claims
from a source beyond the assets of the troubled insurance company. However,
as already discussed, there was no priority scheme in place under the UILA, so
there were no statutory terms needing clarification. The
RLA as Curative and Remedial Legislation The
Rehabilitator next argues [*66] that
the RLA priority provisions should be applied to MBL's rehabilitation as
curative or ameliorative legislation. Through use of curative legislation, the
government may validate actions which it might have originally authorized.
Goddard v. Frazier, 16 F.2d 938, 941 (10th Cir. 1946), cert denied, 329
U.S. 765 (1946). The curative legislation exception has been applied to
amendments which are designed to carry out the effect of prior legislation or to
explain the intent of the original act. See, e.g., Non-Profit Affordable Housing
Network v. COAH,
N.J.Super.
,
(App Div. 1993) (slip op. at 7). Although this argument is
valid, it is not as straightforward as that based on express legislative intent. Doctrine
of Manifest Injustice
A final consideration, aside from constitutional challenges, is whether
the application of the new law, to a relationship created under the old law,
will result in "manifest injustice" to the general unsecured
creditors, because the plan of rehabilitation places them in a class unlikely to
share in the company's assets. This inquiry looks to whether there was reliance
on [*67] the prior scheme, and
"whether the consequences of this reliance are so deleterious and
irrevocable that it would be unfair to apply the statute retroactively."
See, Gibbons v. Gibbons, 86 N.J. 515, 523-4 (1981) (divorce statute was amended
to exclude assets acquired by gift or devise from the definition of equitable
distribution). The
Bank of America, the IRBs and McCamish assert that they relied on pari passu
treatment at the time each made their particular contract with MBL, but this
position must be rejected. Under their theory, if the contracts creating the
obligations were made prior to the order for rehabilitation, any action brought
under either N.J.S.A. 17B 32-31 et seq (the RLA) or N.J.S.A. 17.30C-1 et seq.
(the UILA for property and casualty insurers) would have to treat unsecured
obligations equally with policyholder and beneficiary claims. |
