Insurance Regulation: Observations on the Receivership of Monarch Life
Insurance Company (Letter Report, 03/22/95, GAO/GGD-95-95).

Pursuant to a congressional request, GAO examined the placing of Monarch
Life Insurance Company in receivership, focusing on: (1) whether the
actions of the parent holding company or affiliated companies endangered
the solvency of Monarch Life; and (2) the adequacy of regulatory
oversight leading up to the insurance receivership.

GAO found that: (1) the holding company pledged Monarch Life stock as
collateral on a loan which endangered its solvency and led to the
regulatory takeover by the holding company's creditors; (2) the holding
company diverted about $165 million from Monarch Life to fund its real
estate activities, but it was unable to repay the loan; (3) Monarch Life
also lost $54 million in real estate investments and faced additional
risk by acting as a loan guarantor for the holding company's real estate
operations; (4) the Massachusetts Division of Insurance was unaware of
Monarch Life's solvency problems until November 1990, when the holding
company disclosed its inability to repay its loans; (5) previous
regulatory examinations of Monarch Life's financial statements did not
reveal its solvency problems due to inadequate information on
interaffiliate transactions; (6) once the holding company publicly
announced that its financial condition endangered Monarch Life's
solvency, state regulators acted quickly to protect the insurance
policyholders; and (7) although the state expanded its regulatory
authority to prevent abusive interaffiliate transactions between
insurance companies, it continues to rely on insurer disclosure to
enforce insurance holding company laws.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  GGD-95-95
     TITLE:  Insurance Regulation: Observations on the Receivership of 
             Monarch Life Insurance Company
      DATE:  03/22/95
   SUBJECT:  Life insurance
             Insurance companies
             Insurance regulation
             Loans
             Financial statement audits
             Loan repayments
             Real estate purchases
             Investments
             Financial disclosure reporting
             Regulatory agencies

             
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Cover
================================================================ COVER


Report to the Ranking Minority Member, Committee on Commerce, House
of Representatives

March 1995

INSURANCE REGULATION -
OBSERVATIONS ON THE RECEIVERSHIP
OF MONARCH LIFE INSURANCE COMPANY

GAO/GGD-95-95

Observations on Monarch Life


Abbreviations
=============================================================== ABBREV

  ACIR - Advisory Commission on Intergovernmental Relations
  NAIC - National Association of Insurance Commissioners
  SEC - Securities and Exchange Commission

Letter
=============================================================== LETTER


B-259883

March 22, 1995

The Honorable John D.  Dingell
Ranking Minority Member
Committee on Commerce
House of Representatives

Dear Mr.  Dingell: 

On May 30, 1991, Monarch Life Insurance Company of Springfield, MA,
was placed in receivership by the Massachusetts Division of
Insurance.  State insurance regulators initiated this action to
protect the policyholders and safeguard Monarch Life from the
financial difficulties of its parent company, Monarch Capital
Corporation ("the holding company").  You asked that we examine
whether the actions of the parent holding company or affiliated
companies endangered the solvency of Monarch Life and evaluate the
adequacy of regulatory oversight leading up to the insurance
receivership. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

Real estate investment losses of the parent holding company
endangered Monarch Life's solvency and led to the regulatory
takeover.  The holding company pledged its Monarch Life stock as
collateral on a loan, exposing the insurer to possible takeover by
the holding company's creditors.  As of September 1990, the holding
company had diverted nearly $165 million from Monarch Life to fund
its real estate activities but could not fully repay the cash, which
represented over 110 percent of the insurer's reported capital and
surplus.  Monarch Life also lost $54 million on investments in
affiliated real estate ventures and faced additional risk by acting
as a loan guarantor for the holding company's real estate operations. 

The Massachusetts Division of Insurance was unaware of Monarch Life's
solvency problems until November 1990, when the holding company
disclosed its inability to repay loans from Monarch Life.  Until
then, Massachusetts regulators lacked crucial information about the
risks of Monarch Life's transactions with affiliated companies
because the insurer's statutory financial statements neither revealed
the magnitude of its loans to the holding company nor disclosed other
interaffiliate transactions.  The regulatory examination completed in
January 1990 did not detect the risks facing Monarch Life because
examiners did not assess whether the holding company could repay
money borrowed from the insurer.  Once the holding company publicly
announced that its financial condition endangered Monarch Life's
solvency, Massachusetts regulators moved swiftly to protect the
insurance policyholders. 

In November 1993, Massachusetts expanded its regulatory authority to
prevent potentially abusive interaffiliate transactions involving
insurance companies.  However, the regulatory approach in
Massachusetts continues to rely on insurer disclosure to enforce
insurance holding company laws.  Timely verification of
insurer-reported data about interaffiliate transactions would allow
regulators to monitor more effectively and help prevent future
interaffiliate dealings that could undermine insurer solvency. 


   BACKGROUND
------------------------------------------------------------ Letter :2

At the time of the regulatory takeover, Monarch Life was domiciled in
Massachusetts and licensed in all 50 states and the District of
Columbia.  Monarch Life was subject to solvency monitoring in each
state in which it was licensed.  As the state of domicile,
Massachusetts had primary responsibility for taking action to resolve
the insurer's financial troubles.  As of December 1990, about 5
months before it entered receivership, Monarch Life reported assets
of $4.5 billion.  The insurer's business included variable life
insurance, annuities, and disability insurance.  As a wholly-owned
subsidiary of the holding company, Monarch Life, in turn, owned two
life insurance company subsidiaries:  Springfield Life Insurance
Company, Incorporated, domiciled in Vermont, and First Variable Life
Insurance Company, domiciled in Arkansas.  Springfield Life was
placed in receivership by Vermont regulators in May 1991.  First
Variable, however, was not taken over by Arkansas regulators. 
Finally, the holding company also owned various real estate and
investment management companies. 

A holding company structure provides opportunities for an insurance
company to diversify its business and increase efficiency by sharing
administrative operations with affiliated companies.  Also, a holding
company can draw on its resources to provide capital infusions and
financial support for a troubled insurance subsidiary.  However,
interaffiliate transactions may pose risks to an insurer's solvency. 
An insurer faces the risk that affiliates may not repay money
borrowed from the insurer.  Selling or transferring assets from
affiliated companies to an insurer also places the insurer at risk of
receiving poor quality assets.  Moreover, financial problems within a
holding company structure may adversely affect an insurer.  An
overleveraged holding company cannot provide financial support for
its insurer and may attempt to divert funds from the insurer to
assist ailing noninsurance affiliates. 

Abusive interaffiliate transactions have contributed to several major
life insurance failures.  The Baldwin-United failure in 1983 was
caused in large part by abusive interaffiliate transactions in which
the holding company siphoned cash from its insurance subsidiaries. 
In an investigation of the 1991 failure of Guarantee Security Life,
the Permanent Subcommittee on Investigations of the Senate Committee
on Governmental Affairs learned that Guarantee Security allegedly
used phony investments in unreported affiliates to mask its
insolvency.\1 We previously testified that interaffiliate
transactions drained the capital or masked the financial condition in
four other failures:  Executive Life of California, Executive Life of
New York, First Capital, and Fidelity Bankers.\2

Every state has statutory guidelines requiring insurers to disclose
transactions with affiliated companies, and many states require prior
regulatory approval to prevent abusive transactions.  State
regulators rely on off-site analyses of insurer-reported statutory
financial statements and periodic on-site examinations to monitor
insurer solvency.  The National Association of Insurance
Commissioners (NAIC) has a program for accrediting state insurance
departments that meet its financial regulation standards.  These
standards define the laws and regulations, as well as various
regulatory practices and procedures, that NAIC believes, at a
minimum, are needed for effective insurance solvency regulation.  The
Massachusetts Division of Insurance was accredited by NAIC in
December 1993. 


--------------------
\1 Third Interim Report on United States Government Efforts to Combat
Fraud and Abuse in the Insurance Industry:  Enhancing Solvency,
Regulation and Disclosure Requirements--A Case Study of Guarantee
Security Life Insurance Company (Senate Report 103-29, Mar.  23,
1993).  The report was based on the Subcommittee's hearings of April
29 and 30, 1992. 

\2 Insurance Failures:  Regulators Failed to Respond in Timely and
Forceful Manner in Four Large Life Insurance Failures
(GAO\T-GGD-92-43, Sept.  9, 1992). 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :3

To determine whether interaffiliate transactions had a role in
Monarch Life's financial problems, we reviewed the insurer's annual
statutory financial statements filed with state regulators, financial
statements filed with the Securities and Exchange Commission (SEC) by
the insurer as well as its parent holding company, public reports of
regulatory examinations of Monarch Life as of 1985 and 1988, and
court proceedings pertaining to the receivership.  We also met with
Monarch Life officials and reviewed legal documents pertaining to the
insurer's lawsuit against its former law firm and independent
auditors. 

To evaluate the adequacy of regulatory oversight by the Massachusetts
Division of Insurance, we attempted to establish when Massachusetts
regulators became aware that transactions with affiliated companies
could endanger Monarch Life's solvency and what actions regulators
took to protect policyholders.  We reviewed financial analysis files
of the Massachusetts Division of Insurance and interviewed regulatory
officials responsible for managing the Monarch Life receivership.\3
We also reviewed the workpapers from the examination conducted in
1989 for the 3-year period ending December 31, 1988 (hereafter "the
1988 examination").  The public report of the 1988 examination was
issued in January 1990--10 months before the holding company's public
disclosure of Monarch Life's financial problems.  We sought to
identify how examiners assessed Monarch Life's transactions with
affiliated companies and whether the examination detected any
problems.  In particular, we attempted to determine whether the
examiners followed guidance on investigating interaffiliate
transactions recommended in NAIC's Financial Condition Examiners
Handbook.  Compliance with NAIC's examiners handbook is required for
a state to be accredited. 

We also examined Massachusetts insurance holding company laws in
place at the time of the Monarch Life takeover, as well as amendments
to those laws adopted in November 1993.  We used NAIC data to
determine to what extent Massachusetts had adopted NAIC's model
Insurance Holding Company System Regulatory Act.  This model--one of
the minimum standards for accreditation--details regulatory
authorities recommended by NAIC for monitoring an insurance company
within a holding company structure.  In particular, we considered
whether Massachusetts had (1) requirements for prior approval of
material transactions, (2) examination access to affiliated
companies, and (3) sanctions for violating insurance holding company
laws.  NAIC had added such provisions to the model Insurance Holding
Company System Regulatory Act following the Baldwin-United failure. 

We obtained written comments on a draft of this report from the
Massachusetts Division of Insurance and incorporated its comments
where appropriate.  (See app.  I for the text of Massachusetts
regulators' comments.) We did our work in Boston and Springfield, MA,
between January 1993 and July 1994 in accordance with generally
accepted government auditing standards. 


--------------------
\3 In August and October 1991, we also had discussions concerning
Monarch Life with the then Massachusetts Insurance Commissioner. 


   THE HOLDING COMPANY'S FINANCIAL
   TROUBLES LED TO MONARCH LIFE'S
   TAKEOVER
------------------------------------------------------------ Letter :4

Financial troubles of the holding company endangered the solvency of
Monarch Life and led to the regulatory takeover.  In December 1989,
the holding company reported $72 million in losses on its real estate
investments, including estimated costs for disposing of those assets. 
In May 1990, the holding company borrowed $235 million from a
consortium of banks and pledged its stock in Monarch Life as
collateral for the debt.\4 In addition to the stock pledge, the loan
agreement included a net worth covenant requiring the holding company
to maintain a minimum capital level. 

As a result of the depressed real estate market, the holding company
reported additional losses in 1990 on its real estate operations.  In
the third quarter report it filed with SEC in November 1990, the
holding company disclosed that real estate losses of $103 million
caused a default on the net worth covenant in the loan agreement.  At
that time, the holding company informed the Massachusetts Division of
Insurance that its real estate losses and resulting inability to
repay money borrowed from Monarch Life had adversely affected the
insurer's liquidity and capital resources.  In the fourth quarter,
the holding company reported additional losses of $20 million and
defaulted on the interest payment due on its loan.  Further, the
holding company disclosed that, because it had pledged its Monarch
Life stock, it could lose control of the insurer to its bank
creditors. 


--------------------
\4 The holding company also pledged the stock of six other
subsidiaries. 


      THE HOLDING COMPANY DIVERTED
      FUNDS FROM MONARCH LIFE
---------------------------------------------------------- Letter :4.1

In 1985, the holding company had begun operating a cash pool account
to control and maximize use of available cash from its subsidiaries
within the holding company group.  According to the "Short-Term
Investment Pool" agreement dated September 1986, Monarch Life was to
transfer its available cash to the holding company's pool account at
the end of each day.\5 In return, Monarch Life was to receive a
short-term interest rate on its cash funds, which previously had been
placed in noninterest- bearing accounts.  In 1986, the holding
company reportedly had bank lines of credit totaling $125 million,
which were to guarantee the availability of Monarch Life's cash on a
demand basis.  Any subsidiary in the holding company system could
borrow cash from the pool account at the holding company's short-term
interest rate. 

In effect, the pool account represented loans from Monarch Life to
the holding company and other subsidiaries.  These loans were not
secured by collateral, and Monarch Life had no controls to ensure
that affiliates borrowing from the pool account could repay their
loans.  Table 1 shows how much the holding company owed to Monarch
Life at year-end from 1985 to 1989.  In 1985, before the pool was
formally established, the insurer lent nearly $7 million to the
holding company.  By the end of 1986, Monarch Life had a balance of
$70 million--approximately 59 percent of its reported capital and
surplus--in the holding company's pool account.  By year-end 1989,
the insurer's balance in the pool account had grown by 57 percent to
nearly $111 million--about 80 percent of its reported capital and
surplus.  Given the size of its "investment" in the holding company's
pool account compared with its surplus, Monarch Life's financial
health depended on the holding company's ability to repay the cash. 



                           Table 1
           
             Percentage Growth in Monarch Life's
            Year-End Pool Account Balance and Its
            Balance as a Percentage of Capital and
                      Surplus (1985-89)

                    (Dollars in millions)

                                      Percent     Percent of
                  Pool account    growth from    capital and
Year                 balance\a      past year        surplus
---------------  -------------  -------------  -------------
1985                      $6.8            Not             6%
                                   applicable
1986                      70.3           934%             59
1987                      80.2             14             61
1988                     101.6             27             72
1989                     110.6              9             80
------------------------------------------------------------
\a Springfield Life also reported balances in the holding company's
pool account of $20 million in 1985, $12.2 million in 1986, $12.6
million in 1987, $14 million in 1988, and $15.1 million in 1989. 

Source:  Annual statutory financial statements and financial
information provided by Monarch Life. 

The pool account provided a means for the holding company to divert
cash from Monarch Life.  Instead of servicing short-term cash needs,
the holding company used the insurer's cash to finance long-term real
estate investments.  However, the holding company did not have the
financial resources to repay the insurer's cash.  By September 1990,
the holding company owed nearly $165 million to Monarch Life and its
subsidiary--equivalent to over 110 percent of Monarch Life's reported
capital and surplus.  In the third quarter 1990 report it filed with
SEC, the holding company disclosed that it had discontinued the pool
account and was trying to repay Monarch Life.  Of $157 million owed
to Monarch Life and its subsidiary as of November 1990, the holding
company partially repaid the balance by transferring three
subsidiaries to Monarch Life.\6 The holding company estimated the
subsidiaries were worth $60 million.  In its 1990 annual statutory
financial statement, Monarch Life wrote off $63 million of its
balance in the pool account and nearly $4 million on its holdings of
common stock of the holding company. 


--------------------
\5 Regarding Monarch Life's insurance subsidiaries, Springfield Life
participated in the cash pool, but First Variable did not participate
at the direction of Arkansas regulators. 

\6 The holding company also offset Monarch Life's $34 million
deferred commission liability owed to another holding company
subsidiary. 


      MONARCH LIFE FACED
      ADDITIONAL LOSSES ON
      AFFILIATED REAL ESTATE
      INVESTMENTS AND GUARANTEES
---------------------------------------------------------- Letter :4.2

At the holding company's direction, Monarch Life also invested
directly in several affiliated real estate entities.  In December
1989, Monarch Life and its two insurance subsidiaries invested $53
million--equivalent to 38 percent of Monarch Life's reported capital
and surplus in 1989--in an affiliated real estate limited
partnership.\7 According to Monarch Life officials and Massachusetts
regulators, the holding company created the partnership because it
did not have the liquidity to repay cash borrowed through the pool
account.  The partnership's assets had been transferred to the newly
created partnership from the holding company's real estate
affiliates, and the holding company, as the general partner,
continued to control the underlying properties.  The partnership
served as a way for the holding company to transfer assets, including
mortgage loans exceeding 75 percent of the properties' values, that
would not qualify as legally permitted investments if held directly
by Monarch Life.  According to Monarch Life, the insurer and its
subsidiaries lost $34 million on the limited partnership. 

In June 1990, Monarch Life paid $33 million to purchase three bank
loans on the marina joint venture of an affiliated real estate
company.  At that time, the real estate market in Massachusetts was
depressed, and the marina units were not selling.  The three loans
had been overdue since March 1990, and the venture was on the verge
of bankruptcy.  The failure of the joint venture would have
bankrupted the real estate affiliate and could have precipitated a
chain of defaults under the holding company's various loans and lines
of credit.  Monarch Life's purchase of the three bank loans disguised
the possible insolvency of the affiliate and potential credit crisis
for the holding company itself.  We question whether the investment--
representing 33 percent of Monarch Life's reported 1990 capital and
surplus--in a troubled real estate venture was in the best interest
of the insurance policyholders.  According to Monarch Life officials,
the insurer lost nearly $20 million as a result of its investment. 

Monarch Life faced additional risk by acting as a loan guarantor for
some of the holding company's real estate operations.  As of December
1990, Monarch Life was committed to lend $6 million to the holding
company's limited partnerships and had guaranteed mortgage loans for
the holding company's real estate ventures totaling about $69
million--$14 million more than the estimated value of the underlying
properties.  According to the Massachusetts receivership petition in
1991, Monarch Life received little, if any, compensation for the loan
guarantees, which were highly risky given the inadequate underlying
collateral. 


--------------------
\7 The investment was funded by reductions in the pool account
balances of Monarch Life and Springfield Life, as well as by cash
from First Variable Life. 


   THE MASSACHUSETTS DIVISION OF
   INSURANCE WAS UNAWARE OF THE
   PROBLEMS ENDANGERING MONARCH
   LIFE
------------------------------------------------------------ Letter :5

Until the holding company's disclosures in November 1990, the
Massachusetts Division of Insurance was unaware of the interaffiliate
transactions that depleted Monarch Life's assets and undermined its
solvency.  The statutory financial statements that Monarch Life filed
with state regulators did not disclose information crucial for
regulators to fully assess the risks of the insurer's transactions
with affiliated companies.  Further, the last triennial examination
of Monarch Life did not detect the riskiness of the pool account
transactions because examiners did not assess whether the holding
company could repay the loans.  Once the holding company disclosed
that its inability to repay Monarch Life endangered the insurer's
solvency, Massachusetts regulators responded swiftly to protect the
insurer's policyholders. 


      REGULATORS LACKED CRUCIAL
      INFORMATION ABOUT MONARCH
      LIFE'S INTERAFFILIATE
      TRANSACTIONS
---------------------------------------------------------- Letter :5.1

Timely, accurate, and complete information about an insurer's assets
is crucial for effective solvency regulation.  If financial reporting
does not fairly and promptly present an insurer's true condition,
regulators cannot act quickly to resolve problems.  Monarch
Life--like all insurers domiciled in Massachusetts--was required to
submit quarterly and annual statutory financial statements as well as
annual audited statutory financial statements. 

However, Monarch Life's statutory financial statements indicated
neither the magnitude of its investments in affiliates nor the
economic substance of the pool account.  In its 1989 statutory
financial statements, Monarch Life disclosed its purchase of the
limited partnership from the holding company as an interaffiliate
transaction but did not reveal that the partnership itself was a
related party.  In its 1990 statutory financial statement, Monarch
Life did not indicate that its purchase of the marina bank loans
resulted in its investment in an affiliated joint venture.  Monarch
Life reported its participation in the pool account as "Other
Long-Term Invested Assets"\8 and did not identify these amounts as
unsecured long-term loans to affiliated companies. 

Moreover, statutory financial statements filed with Massachusetts
regulators did not fully disclose the magnitude of Monarch Life's
loans to the holding company.  Monarch Life officials and
Massachusetts regulators alleged that the holding company manipulated
the pool account to lower the balances reported in Monarch Life's
quarterly and annual statutory financial statements.  Figure 1 shows
the insurer's pool account balance at the end of each month from
December 1988 to January 1990.\9 During this time period, the pool
account balance in each of Monarch Life's quarterly reports--March,
June, September, and December--was lower than the monthly balances
both preceding and following the quarter's end.  The December balance
of nearly $111 million reported in Monarch Life's 1989 annual
financial statement was sizably less than its November balance of
nearly $190 million.  The $111 million balance (80 percent of Monarch
Life's capital and surplus at year-end 1989) did not trigger closer
scrutiny by Massachusetts regulators, in part because the reported
balance was less than $125 million--the amount of the holding
company's lines of credit which were to guarantee the availability of
the insurer's cash on a demand basis.  Monarch Life has alleged that
the holding company drew down its lines of credit to manipulate the
pool balances and did not disclose the pool's illiquidity. 

   Figure 1:  Monarch Life's
   Monthly Balances in the Holding
   Company's Pool Account
   (December 1988 - January 1990)

   (See figure in printed
   edition.)

Source:  Financial information provided by Monarch Life. 

Monarch Life's statutory financial statements also did not portray
its full exposure to the pool account because Monarch Life was not
required to consolidate the financial accounts of its wholly-owned
subsidiaries.  In accordance with Massachusetts statutory accounting
practices, Monarch Life reported the statutory capital and surplus of
its insurance subsidiaries as assets on its own statutory financial
statements.  Monarch Life reported its pool account balance of nearly
$111 million in its 1989 statutory statement, but its subsidiary,
Springfield Life, also had a pool account balance of $15 million at
year-end.  Whereas Monarch Life's pool account balance alone
represented 80 percent of its capital and surplus, the combined
exposure of the insurer and its subsidiary totaled 91 percent.\10
Financial information consolidating details about the assets and
liabilities of wholly-owned subsidiaries would have been useful to
regulators monitoring Monarch Life's solvency. 


--------------------
\8 Other long-term invested assets are reported on Schedule BA of the
life insurance statutory financial statement and include real estate
partnerships and joint ventures. 

\9 We chose this time period because 1989 represented a crucial point
for the holding company:  it reported $72 million in real estate
losses and discontinued several real estate operations at the end of
that year. 

\10 From December 1988 to November 1990, Monarch Life's combined
monthly balance exceeded $125 million, the amount supposedly
guaranteed by the holding company's credit lines, in all but 4
months.  These 4 months coincided with the filing of Monarch Life's
1988 annual statement and the first three quarterly reports for 1989. 


      THE LAST TRIENNIAL
      EXAMINATION DID NOT DETECT
      THE RISKINESS OF THE POOL
      ACCOUNT
---------------------------------------------------------- Letter :5.2

We reported in 1989 that most states required on-site examinations
only once every 3 to 5 years, although regulators could examine a
troubled insurer more frequently.\11 Regulatory examinations took
months or even years to complete.  According to NAIC's examiners
handbook, the state of domicile is to lead the examination of a
multistate insurer, and examiners from other states in which the
insurer is licensed can participate.  The final examination report is
to be distributed to all states where an insurer is licensed and
filed as a public document.  We previously found that time lags
between triennial examinations, as well as reporting delays, had
impaired regulators' ability to evaluate financial deterioration and
take corrective action in the case of other life insurance
failures.\12

By law, the Massachusetts Division of Insurance was required to
examine the financial activities of domestic insurance companies at
least once every 5 years, but the state's practice was to examine
life insurers on a triennial basis.  Massachusetts regulators
examined Monarch Life as of 1985 and again as of 1988.  The insurer
was not due to be examined again until 1993 by law, or until 1991 on
a triennial basis. 

The public examination reports we reviewed did not reveal the
problems with interaffiliate transactions that led to the regulatory
takeover of Monarch Life.  The public report of Massachusetts' 1985
examination of Monarch Life did not mention the pool account.\13 The
public report of Massachusetts' 1988 examination--issued in January
1990--listed Monarch Life's $102 million balance in the pool account
but did not discuss whether the balance was recoverable.  The
reported examination scope included "a general examination of the
accounts and records of the subsidiaries" within the insurer's
control. 

According to the Special Counsel to the Receiver of Monarch Life,
however, the 1988 examination did not detect the riskiness of the
pool account transactions because the examiners did not follow
examination policies and procedures.  NAIC's examiners handbook
identifies unsecured loans to affiliates as a potentially abusive
transaction and suggests examiners verify that an insurer's cash
accounts are not used for the benefit of affiliates.  NAIC's
examiners handbook also recommends confirming collateral for loans
and obtaining information as to the financial capability of
affiliated companies to repay material balances.  Even though Monarch
Life's pool account balance represented 72 percent of its capital and
surplus in 1988, we saw no evidence in the 1988 examination
workpapers that Massachusetts examiners assessed the holding
company's ability to repay the pool account loans.  The Massachusetts
examiners verified that Monarch Life transferred cash in the amounts
reported as of 1988, but the workpapers contained no evaluation of
whether Monarch Life could recover its money. 

In an October 1993 report on the Massachusetts Division of Insurance,
the Massachusetts State Auditor found that the state's field
examinations of insurance companies were ineffective.  In a sample of
6 of 14 examinations completed in fiscal year 1990, state auditors
found that 5 of the 6 sets of examination workpapers contained no
evidence of an internal control assessment.  The sixth set--those for
Monarch Life--included limited control testing but no conclusions
about control adequacy.  Moreover, the regulatory examinations
focused on account-by-account balances reported in the insurers'
annual statutory financial statements and did not provide an overall
assessment of solvency.  In particular, the State Auditor cited the
1988 examination of Monarch Life as an example of the examination
report describing each account balance but providing no conclusions
about the insurer's solvency. 

In its response to the State Auditor's report, Massachusetts
indicated that its examination process has changed significantly
since the receivership of Monarch Life in May 1991.  In late 1991,
Massachusetts hired a new deputy commissioner to oversee the
examination and financial surveillance units and replaced the former
examination managers with technically qualified professionals with
insurance experience.  Starting in 1993, Massachusetts was to
implement a new examination handbook and increase supervisory review
of examiners' work.  NAIC's accreditation of Massachusetts in
December 1993 signified that a review team determined, among other
things, that Massachusetts was in compliance with NAIC's examiner's
handbook.  In its comments on this report, the Massachusetts Division
of Insurance said that it had upgraded its examination capability by
hiring more examiners and using independent auditors and actuarial
firms to assist in examinations of large insurance companies. 


--------------------
\11 Insurance Regulation:  Problems in the State Monitoring of
Property/Casualty Insurer Solvency (GAO/GGD-89-129, Sept.  29, 1989). 

\12 Insurer Failures:  Regulators Failed to Respond in Timely and
Forceful Manner in Four Large Life Insurance Failures
(GAO/T-GGD-92-43, Sept.  9, 1992). 

\13 According to Monarch Life officials, Vermont regulators
questioned the lack of a debt instrument underlying the pool account
in 1986 during an examination of Springfield Life.  Subsequently, in
September 1986, the holding company drew up a demand note and agreed
to use its lines of credit to guarantee liquidity of the pool
account. 


      ONCE AWARE, REGULATORS
      RESPONDED SWIFTLY TO PROTECT
      MONARCH LIFE POLICYHOLDERS
---------------------------------------------------------- Letter :5.3

Once the holding company disclosed that its financial condition
endangered Monarch Life's solvency, Massachusetts regulators moved
swiftly to protect the insurer's policyholders.  In November 1990,
the Division of Insurance ordered Monarch Life to cease payments to
the holding company and began a special examination to assess Monarch
Life's financial condition.  Massachusetts regulators disapproved
Monarch Life's request to pay a dividend of $25 million to the
holding company at year-end 1990.  In December 1990, Monarch Life
reduced its operations by selling $3 billion in variable life
insurance policies to another insurer.  In a letter to the
Massachusetts governor dated November 29, 1990, the Massachusetts
insurance commissioner projected that the Division's "forceful
actions will prevent any threat of insolvency for Monarch Life, but
the situation will require continued vigorous regulatory action on
our part over the next few months." At that time, Massachusetts
regulators believed that the financial woes of the holding company
would not have a direct effect on Monarch Life. 

However, on the basis of the special examination results,
Massachusetts regulators initiated the receivership on May 30, 1991,
in order to safeguard Monarch Life's assets for policyholders. 
Acting on behalf of Monarch Life, the Massachusetts Insurance
Commissioner, as Receiver, filed an involuntary bankruptcy petition
against the holding company in the United States Bankruptcy Court on
May 31, 1991.  Under the bankruptcy reorganization, the former
holding company's bank creditors became the majority shareholders of
the reorganized holding company.  As part of the reorganization,
Monarch Life was released from court-supervised receivership in
September 1992 but remained under the close supervision of the
Massachusetts Division of Insurance. 

Monarch Life ceased selling new life insurance and annuities during
1992.  Monarch Life also ceased selling disability insurance in June
1993 because of higher than expected losses.  On the basis of a
special actuarial examination conducted as of September 1993,
Massachusetts regulators directed Monarch Life to increase its
insurance loss reserves and sell its subsidiary, First Variable, to
increase liquidity and capitalization.  Because the bank shareholders
objected to the sale, which was crucial to the insurer's
recapitalization, Monarch Life's financial condition was deemed
unsound, and Massachusetts regulators put the insurer back in
receivership in June 1994. 


   INTERAFFILIATE TRANSACTIONS
   WERE A REGULATORY BLIND SPOT
------------------------------------------------------------ Letter :6

In our 1992 testimony about four large life insurance failures, we
reported that interaffiliate transactions of insurance companies were
a regulatory blind spot.\14 State regulators did not regulate either
the parent holding companies or the noninsurance affiliates and
subsidiaries of the failed insurers.  Instead, state regulators were
to evaluate and control the insurers' transactions with affiliated
companies.  In the case of Executive Life, California regulators
could not effectively assess interaffiliate transactions and protect
policyholder interests because Executive Life repeatedly failed to
report and secure approval for transactions with affiliated
companies. 

Massachusetts regulators relied on insurer-reported data to assess
whether Monarch Life's transactions with affiliates were fair and
reasonable.  Under Massachusetts laws, Monarch Life was required to
file registration statements describing the financial condition of
the holding company and the identities of all companies within the
holding company system, as well as reports of material transactions. 
According to Monarch Life officials and Massachusetts regulators,
however, the insurer and its parent holding company repeatedly failed
to comply with Massachusetts holding company reporting requirements. 
As a result, Massachusetts regulators were unaware of risky
interaffiliate transactions that depleted Monarch Life's assets and
undermined its solvency. 

Financial information about the overall condition of a holding
company can be useful in anticipating whether the holding company's
leverage or asset quality problems might lead to financial trouble
for its insurance subsidiary.  However, the consolidated financial
statements received by Massachusetts regulators were of limited use
in assessing Monarch Life's transactions with affiliated companies. 
First, transactions within the holding company system were netted to
zero on a consolidated basis.  Monarch Life has alleged that, as a
result, the pool account was not revealed in the holding company's
consolidated financial statements before 1990.  Also, the holding
company financial statements were prepared in accordance with
generally accepted accounting principles, which were not comparable
to the statutory accounting practices used by Monarch Life.  In its
1992 report on state insurance solvency regulation, the Advisory
Commission on Intergovernmental Relations (ACIR)\15 concluded that

     "Intercompany transactions and intermingling of assets make it
     nearly impossible to estimate the solvency of an insurer without
     looking at the various entities that are a part of the holding
     company, including the parent.  Effective regulation of
     insurance holding company systems requires state regulators to
     review consolidated financial statements with uniform accounting
     standards and to examine the financial transactions among the
     parent holding company and its affiliates as a unitary economic
     enterprise."\16

At the time of the Monarch Life takeover in 1991, Massachusetts
lacked the authority, recommended under NAIC's model Insurance
Holding Company System Regulatory Act, to prevent abusive
interaffiliate transactions.  In Massachusetts, only large
dividends--those exceeding the greater of 10 percent of policyholder
surplus or net gain from operations for a life insurer--required
prior regulatory approval.  NAIC's model recommends prior approval
not only for large dividends but also for any transaction exceeding 3
percent of a life insurer's admitted assets.  Massachusetts could
request that Monarch Life produce records and accounts pertaining to
interaffiliate transactions but lacked the authority recommended by
NAIC to examine the affiliates.  Massachusetts also lacked the
authority to impose sanctions for violating insurance holding company
laws. 

In November 1993, Massachusetts expanded its insurance holding
company legislation to provide greater regulatory authority over an
insurer's transactions with affiliated companies.  Massachusetts
regulators now have greater authority to prevent potentially abusive
transactions beforehand, rather than trying to recover money after a
transaction has occurred.\17 Massachusetts regulators gained
authority to examine affiliates' records if an insurer fails to
produce data about interaffiliate transactions.  Massachusetts also
added civil and criminal penalties for violating holding company
reporting and approval requirements.  NAIC's accreditation of
Massachusetts in December 1993 signified that a review team
determined, among other things, that Massachusetts holding company
regulations were "substantially similar" to NAIC's model Insurance
Holding Company System Regulatory Act.\18

We support state adoption of the minimum authorities recommended
under NAIC's model Insurance Holding Company System Regulatory Act as
an important step towards improving regulatory oversight of an
insurer within a holding company.  However, even the best holding
company reporting requirements cannot prevent dishonesty. 
Regulators' ability to enforce Massachusetts insurance holding
company laws still relies on prompt and complete disclosure of an
insurer's transactions with affiliated companies.  Untimely or
incomplete disclosure can hinder regulators' ability to protect an
insurer from potentially abusive interaffiliate transactions.\19
Since a holding company's operations may be the cause of a subsidiary
insurer's solvency problems, total reliance upon the insurer and its
holding company to disclose the nature and extent of potentially
abusive transactions is not prudent. 

On-site examinations are regulators' primary way to verify
insurer-reported information and detect violations of holding company
reporting and approval requirements.  To adequately assess the
consequences of an insurer's transactions with affiliated companies,
examiners must recognize the economic substance of transactions and
use procedures for investigating interaffiliate transactions
recommended in NAIC's examiners handbook.  The longer the interval
between examinations, the greater the opportunity a holding company
has to engage in potentially abusive transactions without prompt
regulatory detection. 


--------------------
\14 GAO/T-GGD-92-43. 

\15 ACIR is an independent, bipartisan commission created by Congress
to monitor the American federal system and recommend improvements. 

\16 Advisory Commission on Intergovernmental Relations, State
Solvency Regulation of Property-Casualty and Life Insurance
Companies, Dec.  1992, p.  29. 

\17 Massachusetts laws also now specify that amounts owed by an
insurer's stockholders are inadmissible as an asset unless secured by
sufficient approved collateral. 

\18 In Insurance Regulation:  The National Association of Insurance
Commissioners' Accreditation Program Continues to Exhibit Fundamental
Problems (GAO/T-GGD-93-26, June 9, 1993), we reported that NAIC has
not specified criteria defining "substantially similar."

\19 Under new fraud provisions enacted by Congress in 1994, to
knowingly file a false financial statement or report with insurance
regulators is a federal crime (18 U.S.C.  sections 1033- 1034). 


   CONCLUSIONS
------------------------------------------------------------ Letter :7

Before November 1990, Massachusetts regulators were unaware that
Monarch Life would be unable to recover cash diverted by the holding
company into risky real estate investments.  In part, Massachusetts
regulators were unaware because Monarch Life did not disclose the
extent and riskiness of its transactions with affiliated companies. 
Deficiencies in the last triennial examination of Monarch Life also
contributed to regulators overlooking the riskiness of Monarch Life's
dealings with affiliated companies. 

Since the Monarch Life receivership in 1991, Massachusetts has
increased regulatory safeguards against potentially abusive
transactions between an insurer and affiliated companies.  However,
the regulatory approach continues to rely on a holding company system
to reveal potentially abusive transactions involving an insurance
subsidiary.  The case of Monarch Life illustrates how an insurer's
failure to comply with holding company reporting requirements can
create a regulatory blindspot.  Without independent evaluation of
insurer-reported data, insurance regulators may not detect problems
within a holding company system until losses endanger insurer
solvency. 


   AGENCY COMMENTS
------------------------------------------------------------ Letter :8

In commenting on a draft of this report, the Massachusetts Division
of Insurance said the report was fair and accurately addressed an
area deserving of regulatory focus.  The Division also provided
information about improvements in its examination process implemented
since 1991 when Monarch Life was placed in receivership.  We revised
the text to reflect this information and to incorporate where
appropriate other technical corrections provided by the Massachusetts
Division of Insurance. 


---------------------------------------------------------- Letter :8.1

We are sending copies of this report to interested congressional
members and committees, the Massachusetts insurance commissioner, and
NAIC's Executive Vice President.  We also will provide copies to
others upon request. 

This report was prepared under the direction of Lawrence D.  Cluff,
Assistant Director for the Insurance Group, who may be reached on
(202) 512-8023 if you have questions concerning the report.  Other
major contributors were MaryLynn Sergent, Evaluator-in-Charge, and
John McDonough, Senior Evaluator. 

Sincerely yours,

Thomas J.  McCool
Associate Director, Financial
 Institutions and Markets Issues



(See figure in printed edition.)Appendix
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