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R. Larry Johnson CPA was endorsed by the BUSH TEAM as an expert witness in the Florida Election Trials...
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SUPREME COURT OF THE STATE OF NEW YORK
COUNTY OF NEW YORK


Paul A. Goshen, on behalf of
himself and all others similarly situated, Index No.95-600466

Plaintiff,


-against-

THE MUTUAL LIFE INSURANCE COMPANY
OF NEW YORK and MONY LIFE INSURANCE
COMPANY OF AMERICA.

Defendants.



AFFIDAVIT OF R. LARRY JOHNSON

STATE OF FLORIDA )
)
COUNTY OF NASSAU) as:

R. LARRY JOHNSON, being duly sworn, deposes and says as follows:

1. I am a Certified Public Accountant who graduated from the University of Maryland with a Bachelor of Science Degree, magna cum laude. I completed my MBA work at George Washington University. I am a member of the American Institute of CPAs and am a Fellow of the Life Management Institute.

2. I am the managing partner of Johnson Lambert & Co., 7500 Old Georgetown Road, Bethesda, MD 20814. I am responsible for my firm's services to insurance companies and financial institutions and have substantial experience with private
placements, economic forecasting and securities offerings.

3.Before becoming managing partner of Johnson Lambert & Co. in 1986, I was associated with Ernst & Whinney (now Ernst & Young) for eighteen (18) years. I became a partner at Ernst & Whinney in 1978 and served as engagement partner for approximately (50) insurance company clients, both property/casualty and Life / health
I was Regional Director of services to the insurance industry for the Mid-Atlantic Region and Partner-in- Charge of the Accounting and Auditing Practice in Washington,D.C. I also directed a variety of accounting and consulting engagements for insurance companies, mutual funds and financial institutions and served as technical reviewer on both audit and consulting engagements.

4. I currently am a member of the Accounting Standards Executive Committee of the AICPA. Additionally, I serve or have served as a member of the AICPA Insurance Companies Committee and its task forces on auditing loss reserves, accounting for mutual life insurance companies and deposit accounting for reinsurance transactions and as a member of its Relations With Actuaries Committees.


I INTRODUCTION AND SUMMARY OF FINDINGS

5. At the request of counsel for the plaintiffs in the above captioned case, I have read the Annual Statements and the audited statutory financial statements of The Mutual life Insurance Company of New York (MONY) for the years ended December 31, 1982 through 1995, the examination reports issued by state insurance regulators during that period and certain other documents in order to evaluate the changes in and character of MONY's reported surplus during that period. A life insurer's surplus represents the difference between the insurer's admitted assets and its liabilities and is similar to shareholders' equity in an non-insurance entity. Based on the
information which I have read and the analysis I have performed, it is my opinion that during the period from January I, 1982 through December 31, 1995, MONY undertook a series of actions that were specifically designed to enhance its reported surplus. Those actions included, but may not be limited to, (a) delaying the recognition of losses incurred on investments, primarily mortgage loans and real estate investments, (b) changing many of its long-standing accounting practices that
provided favorable accounting results, (c) entering into sale and lease back transactions that resulted in additions to surplus for financial reporting purposes, (d)inappropriately recording reinsurance commissions that were never collected and
(f) issuing surplus notes. I have reviewed and analyzed specific examples of each of these actions (which are discussed in detail in the remainder of the affidavit) and have found that MONY followed a pattern of enhancing reported surplus to the detriment of its future surplus and dividend paying ability.

6. Exhibit 1 demonstrates that without these actions, reported surplus would have decreased from $481 million at December 31, 1982 to $291 million at December 31, 1995, a compound rate of decline of 3.8%. Exhibit 2 reflects the differences between the ratio of MONY's capital to its general account assets calculated using reported amounts and amounts adjusted for the effects of the above described actions. For purposes of this ratio, capital is defined as surplus plus the mandatory securities valuation reserve or the asset valuation reserve, as applicable.

II. BASIS FOR CONCLUSIONS

7. The following actions and transactions were specifically designed by MONY to enhance reported surplus. As discussed below, however, the real cost of these transactions was the mortgaging of the Company's future.

Actions That Delayed the Recognition of Losses

Real Estate Acquired by Foreclosure

8. Based on findings in the Report on Examination of MONY as of December 31, 1991 and the evolution of the accounting policies disclosed in the financial statements, it is apparent that MONY attempted to delay the recognition of losses on its troubled real estate and mortgage loan investments. Despite disclosures in the 1988 audited financial statements which stated in part,

"Property acquired through foreclosure is carried at the lower of cost or market" and in the 1990 financial statements, "Property acquired through foreclosure is carried at the lower of cost or net realizable value",

the New York State Insurance Department (the Department) found in its examination of 1991, that real estate acquired by foreclosure was overstated by $87,000,000. The Examination Report stated in part,

"It is the Department's position that pursuant to Section 1414(d) of the insurance Law, real estate acquired by foreclosure should be valued at the fair market value of the property at the time of foreclosure. In the 1990, 1991, and 1992 Annual Statements, the Company did not reduce real estate to market value when foreclosing. The Company has agreed to write down foreclosed real estate to reflect a fair market value of such properties and to do so on all foreclosures in the future. For the period under examination the amount of the write down is $87,000,000."

9. In recognition of this finding, MONY wrote down its foreclosed real estate investments by approximately $225,000,000 in 1993 and released investment reserves of $56,000,000 previously provided for estimated permanent impairment of these assets. The net effect of these actions resulted in a $169,000,000 reduction in surplus. The amount or the write down was determined using the estimated
discounted cash flows expected from the underlying real estate properties. Although MONY had previously provided an investment reserve for permanent impairment of certain investments, in real estate and mortgage loans, the amount was clearly not sufficient to provide for the extent of the impairment in MONY's portfolio. One reason for this shortfall is described in the 1993 audited financial statements which stated in part,
"Also, prior to 1993, the Company provided an investment reserve for permanent impairment of these assets which was estimated using undiscounted cash flows."

Using undiscounted cash flows ignores the time value of money which results in a larger carrying value for the properties and fails to reflect the realizable value of the investments.

10. The 1993 financial statements also included the following disclosure,
"In addition, the Company estimates that it will record an additional write
down totaling $75,000.000 in 1994, relating to 1993 and prior foreclosures.
The Company believes that this additional write down and release of the
related investment reserve will not have a material effect on surplus."

11. Based on the Examination findings, I have adjusted the 1991 surplus to reflect the $87,000,000 write down of real estate acquired by foreclosure. A portion of that adjustment is in all likelihood applicable to earlier years; however, sufficient information to make that determination was not available to me. Similarly, portions of the net remaining write down of $82,000,000 recorded in 1993 may be applicable to the 1992 accounting period but again, I was not able to make that determination based on available information.

Mortgage Loan Valuation

12. MONY should have reported its investments in mortgage loans that were permanently impaired at their realizable values. In an apparent attempt to minimize the adverse impact on surplus of impairment losses, MONY changed its definition of impaired loans from year to year. In addition, MONY used inconsistent methods of estimating the realizable values of the underlying real estate.

13. During the period from January 1, 1982 through December 31, 1995, MONY disclosed a variety of policies related to mortgage loan valuation. Certain of these policies may have by definition excluded permanently impaired loans from the determination of a valuation adjustment. From 1982 to 1985, MONY reported that mortgage loans were reported at their unpaid principal balances. In 1986 and 1987, MONY disclosed that mortgage loans were carried at their unpaid balances, with a provision for losses on delinquent loans. In 1988, MONY disclosed that they had recorded a provision for losses for uncollectible loans. By 1989, MONY again reported that mortgage loans were principally carried at their unpaid balances. There was no mention of adjustment for impairment in 1989. In 1990, MONY again disclosed that "Mortgage loans are carried at their unpaid balances...less a valuation reserve for expected uncollectible amounts relating to mortgages in default." In 1991, MONY disclosed that "The Company provides, through a direct charge to surplus, an investment reserve for permanent impairment of real estate investments and mortgage loans delinquent over 90 days and in process of foreclosure. This reserve reflects the excess of carrying value of such assets over the estimated undiscounted cash flows expected from the underlying real estate properties." In I992, the investment reserve was expanded to include mortgage loans delinquent for more than 60 days, loans in process of foreclosure and restructured loans but continued to use undiscounted cash flows as the basis for the determination of realizable value. As discussed above, the use of undiscounted cash flows resulted in a higher carrying value than would result from using discounted cash flows.

14. As previously discussed, for the year ended December 31, 1993,
MONY began carrying real estate acquired through foreclosure at the lower of cost or estimated fair value at the time or foreclosure, less subsequent depreciation, and mortgage loans in process of foreclosure at estimated fair value. Fair value was determined using the discounted cash flows expected from the underlying real estate properties. The 1993 financial statements disclose that for determining the carrying value of real estate investments, mortgage loans delinquent for more than 60 days and restructured loans MONY used the "estimated undiscounted cash flows from the underlying real estate properties." MONY did not explain the reason for this inconsistent and more liberal approach to valuing these troubled assets.

15. A substantial majority of MONY's mortgage loans were non-amortizing or partially amortizing (sometimes referred to as "cash flow mortgages') which may have masked potential collection problems. Borrowers who were able to meet interest only or partial principal payments (and thus prevent the loan from becoming delinquent under the terms of the loan) may not have been able to fund loan payments on a fully amortizing basis. To the extent that these loans were not delinquent more than 60 days or had not been restructured, they would have been excluded from MONY's determination of its investment allowance in 1992 through 1995.

16. MONY disclosed that in 1992, $3.8 billion or 87% of its consolidated mortgage loan portfolio (including loans issued by MONY's subsidiaries) were partially amortizing or non-amortizing. The applicable percentages for 1991 through 1995 are as follows:

Partially
or Non-Amortizing
Year Ended

1991 71%
1992 87%
1993 84%
1994 30%
1995 77%

17. In a disclosure document dated August 9, 1994, MONY disclosed the following:
"There is currently a very weak market for real estate and, accordingly, if MONY were required to dispose of equity real estate or commercial mortgage loans in the near term, it is likely that, for a significant portion of its portfolio, MONY would recover significantly less than the related carrying values. There can be no assurance whether or when markets for mortgage loan or real estate assets will recover, or that the recent investment performance of these assets will not persist or worsen."

Changes in Accounting Methods

18. Beginning in 1985 and increasing in 1986, MONY followed a practice of changing certain of its accounting practices in order to enhance its reported surplus. This pattern of changes, substantially all of which resulted in increases in reported surplus, indicates that MONY was attempting to enhance declining surplus by manipulating its reported results. The most significant of these changes which were quantified and disclosed in the financial statements related to accounting for goodwill, depreciation and life insurance and annuity reserves.

Goodwill
19. MONY has disclosed that the total costs of subsidiaries acquired in 1986 and 1985 were $113,312,000 and $18,974,000, respectively. These acquisitions were made through MONYCO, a wholly owned subsidiary that held MONY's investments in non-life insurance entities. Coincident with this increased acquisition activity, MONY changed its method of accounting for investments in subsidiaries. Prior to October 1, 1985, MONY had followed the accounting practice of recording purchased subsidiaries at the equity in the net assets acquired. In other words, to the extent that MONY paid more for the acquired company than its book value, the excess (or goodwill), was written-off (non-admitted) immediately. The theory behind this accounting practice is simple - goodwill cannot be used to pay policyholder claims and thus is non-admitted for statutory purposes. Effective October 1, 1985, however, MONY changed this accounting policy and capitalized goodwill of more than $87 million dollars related to 1986 acquisitions.

20. In 1987, MONY changed its policy with respect to goodwill again and reported that, "These subsidiaries are carried at their original cost adjusted for operating results with no amortization of intangible assets." [emphasis added] Pursuant to the 1986 change, MONY was prepared to write-off the goodwill over a 40 year period; however, in 1987, MONY changed its plan again and decided to permanently carry the "goodwill" without future amortization.

21. The effect of these accounting changes was to increase reported surplus by approximately $92 million over the two year period ended December 31, 1987. The illusory aspect of this "goodwill" became apparent in the 1989 financial statements which included the following disclosure:

"During 1989, the Company disposed of or decided to discontinue certain of its MONYCO operations. Losses from discontinued operations were $77,997,000 and $166,782,000 for 1989 and 1988, respectively. Assets relating to discontinued operations are recorded as estimated net realizable value. Liabilities have been established for the estimated loss on disposal including an estimate for operating losses through the date of disposal."

Depreciation

22. The 1988 financial statements included the following disclosure related to the change in the method of calculating depreciation:

"In 1988, the Company changed its method of depreciation from straight-line to the constant yield method. This change applied to substantially all investment real estate, owned and occupied real estate, and real estate joint ventures and cable venture capital partnerships. In the Company's opinion, this method results in a closer matching of expenses and revenues and, therefore, is a more realistic presentation of the Company's results of operations. This change increased additions to surplus before dividends and adjustments by approximately $129,522,000, which includes the cumulative effect from years prior to 1988 of $117,503,000."

23. The obvious impact of this change was to increase reported surplus by approximately $130,000,000. In spite of their claim that this change resulted in a more realistic presentation of the Company's operating results, three years later MONY changed back to the straight-line method of depreciation for acquisitions subsequent to January 1, 1991.

Life Insurance and Annuity Reserves

24. Life insurance entities record reserves for policyholder benefits which represent estimates, of the present value of benefits to be paid to policyholders less the present value of the estimated future premiums to be received by the company. MONY changed its methods of estimating life insurance and annuity reserves nine times during the period from 1993 though 1995. These repeated changes reflect a pattern of surplus manipulation. The following chart summarizes the effects of these changes on surplus:

Increase
Year (Decrease) in
Ended Surplus
( In Thousands)
1983 $ (25,225)
1985 4,239
1988 9,469
1989 21,218
1990 19,445
1991 (23,765)
1992 18,003
1993 55,546
1995 5,081

Sale and Lease-back Transactions

25. MONY entered into a series of transactions to sell and lease back certain of its assets. These transactions were designed to enhance its reported surplus in the year of the sale and in reality mortgaged the Company's future. These one-time transactions included the sale and lease back of MONY's furniture and equipment, its Syracuse, NY office building and its home office building located in New York City. Each sale allowed MONY to increase reported surplus in the year of the transaction but each lease required MONY to pay rent for these same assets in the future. The future lease obligations (and the related reductions in surplus) will not be recorded until the rent is due.

Furniture and Equipment

26. Furniture and equipment are not available to pay policyholder claims and are, therefore, not included as an asset. Until 1987, MONY properly excluded furniture and equipment from admitted assets and thus from surplus. In 1987, however, MONY sold its furniture and equipment and leased it back. By selling the furniture and equipment for cash or other assets, MONY converted these non-admitted assets to admitted assets. The related commitment to lease the furniture and equipment back was not recorded as a liability but was simply disclosed as a future lease obligation.

27. The short-term result of this-transaction was to allow MONY to increase its reported surplus in 1987 by $39,000,000 (the estimated book value of the furniture and equipment that would have been non-admitted). This surplus enhancement was only temporary and would disappear as the future rent payments become due.

Syracuse Building

28. On December 22, 1988, MONY entered into an agreement to sell its office building in Syracuse, NY. The sales price of the building was disclosed to be $66,200,000 which resulted in a pretax gain of approximately $32,000,000. MONY financed $56,200,000 of the sales price. The note was payable interest only at 9.75% until January 1, 1994 when the outstanding principal was due. At the same time, MONY entered into a lease for the building with an initial term of 20 years with two 5 year renewal options. The lease terms specified annual rent of not less than $5,850,000 for a total rent obligation over the initial 20 year term of $117,000,000. The rent was scheduled to increase at a rate of 2% per annum.

29. The above one-time transaction allowed MONY to report a realized capital gain on the sale of its Syracuse building of $32,000,000 which, after deducting estimated capital gains taxes, increased surplus by $28,800,000. While at the same time that it recognized this increase in its reported surplus, MONY obligated itself to pay future rent of $161,400,000, a burden on surplus that would only be recognized as the future rent was paid.

Home Office Building

30. On December 17, 1990, MONY entered into an agreement to sell its home office building to 1740 Broadway Associates. The sales price was $107,692,030 which resulted in a gross gain of $48,455,133 and, after capital gains taxes, a net addition to surplus of approximately $42,000,000. In connection with the sale, MONY agreed to lease back the space under two separate lease agreements. Once again MONY recognized an increase in reported surplus while incurring an unrecorded obligation for future rent of $63,200,000 - another burden on surplus that would only be reflected as the future rent was paid.

Non-admitted Ceding Commission

31. MONY entered into a reinsurance agreement with ITT Lyndon Life Insurance Company for certain whole life insurance business. There were no assets transferred or reserve credits taken as a result of this treaty; however, based on this agreement MONY reported ceding commissions receivable of $10,000.000, $5,000,000, $30,000,000 and $10,000,000 in 1989, 1990, 1991 and 1992, respectively, which were included in income and consequently increased surplus. However, the New York State Department of Insurance found that as late as July 16, 1993 none of these receivable had been collected and that these receivables were not in compliance with applicable insurance law.

Surplus Notes

32. During 1994, MONY initiated yet another transaction designed to enhance surplus in the short run while placing a substantial burden on it in the future. This burden is in the form of $125,000,000 in surplus notes which after a discount of approximately 42% from the face amount and issuance expenses of approximately $2.3 million netted the Company $70,000,000. The term of the notes provide for accretion of the discount until August 15, 1999 after which interest is scheduled to be paid at the rate of 11 1/4% beginning February 15, 2000.

33. In exchange for $70,000,000 received in 1994, MONY has agreed to pay back the $125,000,000 plus additional interest of $351,562,000 through the year 2024. If MONY continues to earn its historical investment yields, it will not have sufficient spread to fund the 11 1/4% interest, it has promised to pay its creditors. MONY has disclosed to the purchasers of the surplus notes that its investment yields were 7.40%, 7.5% and 8.2% for the years ended December 31, 1993, 1992, and 1991, respectively, and including realized capital gains were 7.5% in 1993 compared to 8.1% and 9.6% in 1992 and 1991, respectively.

Conclusion

34. In summary, the actions taken by MONY during the period from January 1, 1982 to 1995 as described above and displayed graphically on Exhibits 1 and 2, were specifically designed to enhance its reported surplus to the detriment of its future surplus and dividend paying ability.


R. Larry Johnson

The foregoing instrument was sworn and subscribed before me this 21 day of May, 1997 by Larry Johnson, who is personally known to me.

Shirley A. Cantin
Notary Public

Bush / Pitt