by John Darer
Appellate Court documents in litigation over placement of an Executive Life Insurance Company terminal funding annuity provide a historical examination of what factors influenced sophisticated people , in this case executives of a massive consumer conglomerate (that in 1988, was subject of the largest leveraged buyout in American history at the time), to shun first impression and do an "all in one basket" placement of its retirees' pension buyout in the hands of Executive Life.
The 2000 ruling by the 5th U.S. Circuit Court of Appeals, New Orleans, in Robert A. Bussian et al. vs. RJR Nabisco Inc., overturned a lower court's summary judgment, and questioned the process by which the pension plan sponsor picked Executive Life as the terminal funding annuity provider. The company chose Executive Life because it was the cheapest provider, allowing RJR, based in Winston-Salem, N.C., to collect the most when it terminated its pension plan in August 1987 and pocketed the surplus assets.
According to the Labor Department brief supporting the appeal for Bussian, "The plan had tens of millions of dollars more than the price of even the most expensive annuity considered by RJR (emphasis ours). RJR could not choose the cheapest annuity in order to maximize the reversion of plan assets to itself, if another annuity better protected the participants' interest in the security of their retirement payments." [ The Court records shows that Prudential's cost was approximately $2MM more ]
An attack on structured settlements generally, rather than the ELNY company itself (and/or those who sold or recommended them, or a qualified assignment to First Executive) in a manner seens illogical to the thrust of the ELNY victims' class action law suit, wherein there is a claim that ELNY was solvent when it went into rehabilitation and that the financial shortfall is the result of failure of the New York Liquidation Bureau and other responsible parties to manage the estate.
On October 16, 1986, the Board of Directors of RJR Nabisco approved resolutions authorizing the termination of a Defined Benefit Pension Plan ("DB Plan") and several other plans of former RJR subsidiaries.
What is a Defined Benefit Plan
Briefly, a DB Plan is a traditional form of retirement plan where the employer promises to pay the retiring employee a benefit that is based on a fixed amount or formula (e.g.70% of the final 3 years average salary). DB plans differ from Defined Contribution Pension Plans ("DC Plan") which focus on the amount that is contributed rather than the benefit. DB plans are expensive to adminster. Moreover, as one can read in just about any newspaper today about unfunded pension plan liabilities, actuarial assumptions that have proved over the passage of time to have been overly optimistic, can wreak havioc on the balance sheet of a corporate or government entity.
According to Court documents, the RJR Board also approved the purchase of an annuity to cover all pension obligations to the participants and beneficiaries of all the plans. The Plan's documents provided that upon termination any excess funds would revert to RJR. At the time the decision to terminate was made, the Plan was over-funded, and the Board was informed that a reversion could be expected. By December 1986, RJR was assuming that an annuity would cost about $62.5 million, and allowing for a $10 million cushion, was anticipating a reversion of about $55 million.
Executive Life Not Invited to Initial Bidding
Executive Life WAS NOT initially invited to bid. This was "because it was involved in a nontraditional investment strategy: its portfolio had a higher percentage of low-quality bonds and a lower percentage of other investments than other insurance companies". Low-quality bonds, which are also referred to as "high-yield" or "junk" bonds, are rated below investment grade, i.e., ratings agencies have determined that the issuing entity is a greater than average credit risk. In order to compensate for the increased risk of default, such bonds must offer a higher interest rate. See, e.g., Levan v. Capital Cities/ABC, Inc., 190 F.3d 1230, 1235 (11th Cir. 1999). After Buck Consultants' William H. Overgard discussed Executive Life's strategy with one of his colleagues, the two decided that the company SHOULD NOT be included on the initial list.
50% Of Portfolio is Low Quality Junk, Compared to 6-7% average for Competitor Portfolios; Allegedly the Largest Original Issue Low Quality Bond Portfio EVER assembled!
According to the Court record, Overgard understood that by 1987, over 50% of Executive Life's portfolio was in low-quality junk bonds. The Court recognized that Executive Life was unusual compared to its competitors in the insurance industry. Information in the record suggests that the average percentage of low-quality bond holdings was on the order of 6% to 7%. Executive Life allegedly held the largest original issue low-quality bond portfolio ever assembled, with most of its acquisitions coming through Drexel Burnham Lambert ("Drexel"). Overgard understood Executive Life's low-quality bond holdings to be broadly diversified. (emphasis ours)
Executives Sought Reasons to Bring Executive Life to the Table| Relied on Reports of Rating Agencies| Dismissed Moodys A3 for ELIC When Prudential had AAA from Moodys
According to Court records, in his review of Executive Life's solvency and financial health, Overgard reviewed the reports and ratings of four rating agencies (Standard & Poor's Corp. ("S&P"), Moody's Investor's Services ("Moody's"), A.M. Best ("Best") and Conning & Company ("Conning"). He reviewed the pros and cons of including Executive Life on the list of carriers to be contacted with Henry Anderson, an actuarial expert with Buck who, as the account executive, had brought Overgard in on the RJR purchase. They discussed the high-quality ratings that Executive Life had received, the company's interest in doing business, its reputation for providing good service and for being knowledgeable in the business, and its nontraditional investment portfolio. Overgard believed that a broadly diversified portfolio of low-quality bonds was a viable investment strategy. Based on his investigation, Overgard determined that Executive Life should be included on the bid list because the ratings the company received from S&P, Best, and Conning were high [ Moodys had rated ELIC A3, which was not its top rating]; its low-quality bond portfolio was broadly diversified and its investment strategy sound; and its administrative capabilities and reputation in the annuity business were strong
Robert Shultz , RJR's Vice President of Pension Asset Management was aware of a number of facts regarding Executive Life, its chairman, Fred Carr, and the market for low-quality bonds, according to Court records. The Court cites as an exemplar, that Shultz was aware (1) of the percentage of Executive Life's portfolio that was devoted to low-quality bonds, (2) of allegations regarding a connection between Executive Life and Drexel's Michael Milken, (3) that Executive Life was one of Milken's largest customers, (4) that Drexel and Milken were the targets of SEC and Attorney General investigations of the 1986 insider trading scandal, (5) that Executive Life and Carr came within the scope of those investigations, and (6) that Executive Life of New York, a subsidiary of Executive Life, had been fined by New York insurance regulators due to the insurer's reinsurance practices, had $150 million of reinsurance disallowed, and had received from Executive Life $150 million to make up the difference. Shultz had not seen as much negative press regarding Aetna's or Prudential's holdings of low-quality bonds as he had seen with regard to the holdings of Executive Life, and he had not seen the diversity of reviews of the other companies that he had seen with respect to Executive Life. Shultz stated that he relied primarily on Tyner's input, and that his decision to concur in the purchase of Executive Life's annuity was made taking into account the fact that "Executive Life had the same S&P rating as did Prudential, had a reputation equal to or better than Prudential's for being able to service complex annuity contracts and was recommended by Buck."
RJR's Compliance with its Fiduciary Obligation
The court stated "Keeping in mind the standards set forth above, we must determine whether reasonable and fair-minded persons could conclude from the summary judgment evidence that RJR breached its fiduciary duties in selecting Executive Life's annuity. Based upon a careful review of the record in this case, we conclude that it was inappropriate for the district court to grant summary judgment in favor of RJR. Viewing the evidence in the light most favorable to Appellants, a reasonable factfinder could conclude that RJR failed to structure, let alone conduct, a thorough, impartial investigation of which provider or providers best served the interests of the participants and beneficiaries. Even if the factfinder were to conclude that RJR's investigation was appropriate, it could conclude, based on the evidence, that RJR could not reasonably determine that Executive Life best promoted the interests of plan participants and beneficiaries. Finally, moving on to the hypothetical prudent person standard, a reasonable factfinder could also conclude that Executive Life was not an objectively reasonable choice based upon the information RJR should have gathered" (emphasis ours)
While there are obviously differences and parallels between the sales processes of structure settlements and pension buyours/terminal funding the information provides a useful contemporaneous record.