well over a century, through Lincoln, Nebraska; Raleigh, North Carolina; Bismarck, North Dakota; Albany, New York, and the rest of the State capitals of this great Nation.

Thank you, Mr. Chairman.

Mr. DINGELL. Thank you.
Mr. Pomeroy, proceed.

TESTIMONY OF EARL R. POMEROY

Mr. POMEROY. Mr. Chairman, committee members, over the last few years, State insurance regulators have moved to strengthen solvency regulation of the insurance industry on a State-by-State basis throughout the country. Utilizing unique attributes of the existing insurance regulatory format, systemic improvements have been implemented through four key strategies.

First, additional sources of verification have been included in the annual statement blank required of insurance companies. Through this vehicle, CPA audits and actuarial verification of loss reserves are now required throughout the system.

Second, the NAIC budget was expanded, and significant new resources were completed in the NAIC's computer technological support to States and its solvency analysis function, which was increase by more than $2 million last year alone.

Third, regulators strengthened the internal peer review process, whereby domiciliary States are required to account to other States for their regulatory actions with respect to financially-troubled companies.

Finally, minimum standards for the regulation of solvency were unanimously adopted by the States, an independent audit mechanism has been established, and complying jurisdictions are publicly certified. Companies in noncomplying States will be subject to additional regulatory requirements when they seek to do business in certified jurisdictions beginning in 1994.

Because the GAO testimony has dwelled at some length with the solvency regulatory standards, the remainder of my brief remarks shall address this initiative.

The NAIC's minimum standards established bottom-line requirements for State solvency regulation in three key areas: first, laws and regulations; second, regulatory practices and procedures; and third, the organizational and personnel practices within a State.

We do not view these standards as voluntary, and the impetus for States to comply with the NAIC standards does not rest merely on the policy notion that every State ought to comply with standards. Rather, the State insurance departments have devised sanctions, which are based on their legal power to impose regulations on insurers doing business in their respective States. Accredited States will imposed additional regulatory requirements on companies based in noncomplying States. For example, beginning in January 1984, accredited States will not accept reports of financial examination from non-accredited States.

Additional restrictions on companies based in non-accredited States are being developed. The NAIC is considering a model act which would sanction companies domiciled in non-accredited States by requiring them to meet the solvency regulations of every accred

ited State in which they do business. As a result of these and other contemplated sanctions, being domiciled in a non-accredited State will increasingly become a liability, inducing States to either meet the standards or witness the re-domestication of their companies. Furthermore, the heightened scrutiny of such companies inures to the benefit of insurance consumers throughout the country.

So far, two States, Florida and New York, have been accredited under this recently-established program. Other States are being reviewed for accreditation in 1991. It should be noted that the initial audits were conducted in two States recognized as having wellequipped solvency regulatory capabilities. In addition to verifying the capabilities of these departments, we learned a great deal about the audit procedures required to obtain a thorough credible assessment of solvency regulatory resources. Improvements to these procedures will be incorporated into upcoming audits.

Commissioner Long has reported to you the widespread legislative and administrative activity in 44 States as a direct result of seeking to come into compliance with NAIC standards. Those with lingering doubts about whether State legislatures will respond to the NAIC standards should ask Commissioner McCartney, whose legislature recently passed his 155-page solvency bill, or Commissioner Long, whose 80-page bill addressing 12 individual NAIC model laws, has cleared one house and is moving rapidly through the second in North Carolina. Such skeptics could call me, and I would tell them about my 135-page solvency bill that was approved in North Dakota this spring. The fact of the matter is that State legislatures across this Nation are taking the NAIC's solvency program very seriously and are responding with legislative enactment of this program.

In a broad, unsupported assertion, the GAO report states that structural limitations of State regulation thwart the efforts of State regulators and the NAIC to establish nationally-recognized minimum standards for solvency regulation. The GAO would scrap a system that has provided solid protection for consumers to replace it with what? A blend of Federal and State regulation of the sort that brought us problems in banking and thrifts? Complete transfer to Federal regulators, whose own record of regulation is spotty, at best, and who face unimaginable budget deficits year in and year out?

Do they contemplate letting this vital industry police itself, notwithstanding the antitrust concerns, including price fixing, which would flow from such an arrangement, or do they contemplate leaving premium rate regulation with State governments, while giving solvency oversight to the Federal Government, notwithstanding the inextricable relationship between rates and solvency? Mr. Chairman, we do not maintain that the existing regulatory structure is perfect. We have worked diligently to strengthen the system, and there is, admittedly, more to be done. However, common sense would indicate that the quickest, least expensive, and most effective way of addressing public concerns about solvency regulation is to implement the improvements necessary within the existing insurance regulatory structure.

The State insurance commissioners of this country are dedicated to that goal.

Mr. DINGELL. Mr. Curiale?

TESTIMONY OF SALVATORE R. CURIALE

Mr. CURIALE. Mr. Chairman and members of the subcommittee, my name is Salvatore Curiale. I have been requested to comment today on the New York Insurance Department's actions with respect to Executive Life Insurance Company of New York, ELNY, and to also provide our views with respect to the inclusion of highyield investments in the portfolio of a life insurance company.

My oral testimony today will consist of a brief review of two prior appearances by the New York Insurance Department before Congress to testify on matters related to ELNY.

On June 18, 1990, then Acting Superintendent Wendy Cooper testified before this subcom.nittee on the subject of its report "Failed Promises" and on matters related to our actions with respect to ELNY. In addition, we are attaching to today's testimony a copy of my testimony given on May 7, 1991, at a hearing before the U.S. Senate Committee on Commerce, Science, and Transportation, chaired by Senator Richard Bryan, which not only provides greater detail on our action with respect to ELNY, but also provides some insight into the condition of the life insurance industry in general. I ask that that testimony be included in the record, Mr. Chairman. Mr. DINGELL. Without objection, so ordered.

Mr. CURIALE. For reference purposes, ELNY is a company organized under the laws of the State of New York. The company has about $3.2 billion in assets, and approximately 94,000 policies and contracts in force. The insurer was licensed to do business in 23 States and the District of Columbia.

The Department's actions with regard to ELNY go back to the early part of the last decade. ELNY's investment strategy was one of the primary factors in prompting the Department to promulgate its junk bond regulation in 1987. In addition, the Department has, through a series of actions, caused ELNY to remove from its balance sheet all "financial reinsurance," a form of reinsurance that artificially inflates surplus. Finally, both in the Report on Examination filed on May 2, 1990 and in our recent actions, we have indicated that the company's reserves requires strengthening because of a mismatching of the cash flows from assets and liabilities.

Despite the Department's actions, which resulted in a number of heavy fines and a capital infusion of over $200 million, the company's concentration of investments in junk bonds left it with a high degree of risk. The Department's junk bond regulation did not require the divestiture of bonds held, because the return on those investments was assumed, pricing the company's annuity contracts, that is, its liabilities.

As a practical matter, the regulation prohibited the acquisition of new junk bonds until the company was below the limit. This caused the proportion of junk bonds in the portfolio to decrease from approximately 75 percent prior to the regulation in 1987 to approximately 50 percent by 1989. However, the heavy surrenders which began in early 1990 took, for the most part, non-junk assets out of the company, which caused the proportion of junk bonds in

the portfolio to, increase again to over 60 percent, although the amount of junk bonds contained therein remained relatively level. Early in 1991, the publicity attendant to Executive Life Insurance Company's (ELIC's) and ELNY's problems with their portfolios was at an extremely high level. Speculation regarding regulatory action was printed daily, and surrenders again began to mount. After meeting with the company to discuss its asset/liability cash flow matching, the Department instructed ELNY on April 3 to refile its financial statement in all jurisdictions in which it was licensed, showing an additional reserve of $125 million and indicating that discussion with the New York Department with respect to possible additional reserves were continuing.

We also instructed ELNY to discontinue writing all new business until it had demonstrated to the Department that such new business was self-supporting and not eroding the position of current policyholders. The Department announced these actions to the press and to all State insurance departments, so that the public and the regulators would be aware of these actions as soon as possible.

On Thursday, April 11, the California Commissioner went to court to begin the process of placing ELIC, the California company, into conservatorship. The press coverage of this event precipitated an avalanche of surrender requests at ELNY. By Monday, April 15, crowds of policyholders were gathering at ELNY's offices.

The hemorrhaging was having a destabilizing effect on the company, and had the potential of disadvantaging those contract holders without surrender rights. These surrender requests would result in non-junk assets being liquidated, thus increasing the percentage of junk bonds supporting the remaining policies. Therefore, on the afternoon of April 15, the New York Department went into Court, seeking to place ELNY in rehabilitation. The Department had not declared the company impaired or insolvent, but sought the order because the company's condition was considered hazardous to the policyholders and the public.

The Department continues to feel that the company should be able to meet all of its obligation and therefore has expressed its intention to continue to pay death claims and payments to annuitants at full value. However, there are risks beyond the Department's control that could alter our view of the company and consequently our treatment of the benefit payments. One such risk is the actual performance of ELNY's junk bond portfolio. If that performance is much worse than the already-harsh default assumptions that have been used in testing, then a reassessment would be required. Another considerable risk is unforeseen claims against the company, such as the one recently filed by the Internal Revenue Service. Such claims, if sustained, could invade policyholder funds.

The Department would like to stabilize the company as quickly and as efficiently as possible. To this end, it has requested the expert advice of the member companies of the New York Life Guaranty Corporation. The Department will keep in place many of the company's employees in New York and will be acquiring such other resources as the company requires to maintain full and efficient service to its policyholders.

During the last decade, the life insurance industry has undergone dramatic changes due to the explosive rise in interest rates in the late 1970's and early 1980's.

The life industry scrambled to satisfy a consumer whose transformation from saver to investor was being propelled by a pyrotechnic interest-rare environment. New products were developed as the marketing emphasis shifted from "security" to selling, at least partially, a rate of return. The public became less interested in solidity and service, seeking instead, a maximum return on its dollar. IŇ this environment, product margins began to shrink precipitously as companies struggled to compete.

Some companies have sought to improve their margins by achieving higher returns from their assets, generally by assuming greater risks. Although mixing moderate amounts of well-diversified higher-risk assets in an insurer's portfolio can be an acceptable investment strategy, concentrations in high-risk assets put the policyholders in jeopardy

For this reason, the New York Insurance Law places aggregate caps on most, types of investments that a life insurer may invest in. These include stocks, subsidiaries, and investment real estate. Even within these limits, insurers have generally mixed higher risks judiciously. However, in the mid-1980's, the Department saw several insurers begin to build substantial concentrations of junk bonds. Because original issue junk bonds were relatively new, the New York Insurance Law does not directly refer too them. However, because the Department viewed concentrations in junk bonds as a substantial risk to policyholders, a regulation was promulgated in 1987 limiting future investments in these assets. This regulation was amended in February, 1991 to further tighten restrictions on these types of investments.

The Department is also chairing an NAIC Working Group that is studying junk bonds. The first proposal of this group, dealing with more appropriate disclosure of and accelerated reserving for these types of bonds, was adopted in June 1990 by the NAIC. The Working Group has now developed a model law that would set aggregate and individual issuer investment limits for medium and lower-quality bonds. It will be proposed for adoption at the NAIC meeting in June.

The New York Department believes it had acted aggressively and with foresight in addressing the problems of the industry and the particular problems of ELNY. We also note that despite those efforts, ELNY's management, basically due to its extraordinary appetite for a new and untested investment vehicle, has brought the company to the precipice of disaster. We nevertheless believe that the Department's actions over the last decade have, in fact, prevented the company from being in significantly worse condition than it is today.

Our system encourages entrepreneurial innovation in the pursuit of value to the consumer. The regulator must be deft at balancing the value to the consumer with appropriate safety, realizing that the two are, at times, on a collision course.

Given the dramatic upheaval and traumatic changes in the life insurance industry over the past decade, we at the New York Insurance Department are proud of the rapid and effective attention