Wednesday, January 17, 2018

No. 249: Beneficiary Designations and How an Insurance Agent's Actions Can Create a Dispute

On December 29, 2017, the Milwaukee Journal Sentinel carried an article by reporters Cary Spivak and Mary Spicuzza entitled "Who gets $1.6 million inheritance—relatives of a virtual hermit or his financial adviser?" The case focuses on Blanche Berenzweig, an insurance agent in Wisconsin, and illustrates how an agent's actions can lead to a major dispute over who should receive annuity proceeds.

The Berenzweig Case
LeRoy Ern, a Wisconsin resident, purchased an annuity from Lincoln Benefit Life Company in October 1993 with an initial deposit of about $33,000. He named his estate the primary beneficiary. Berenzweig signed the application as agent. Less than two weeks later Ern made an additional deposit of about $67,000 into the annuity.

In May 2006 Ern applied for an annuity with Integrity Life Insurance Company. He named his sister the primary beneficiary, and Berenzweig was the agent. Less than two weeks later he transferred about $166,000 from an ING annuity into the Integrity annuity as an initial deposit.

In November 2009 Berenzweig faxed a Broker Dealer Change of Record form to Lincoln Benefit. On the fax cover sheet, she hand-wrote: "Please make me agent of record for [this contract]. I have tried repeatedly to become the agent on this contract. My insurance license is attached w/this fax."

Less than two weeks later Ern executed three estate planning documents: a last will and testament, a durable power of attorney for property and finances, and a durable power of attorney for health care. Attorney Susan M. Drewitz drafted, witnessed, and notarized the estate planning documents. At the time Drewitz shared office space with Berenzweig, who referred Ern to Drewitz and accompanied him on his first meeting with Drewitz.

In the last will and testament, Ern named Berenzweig his personal representative and beneficiary of all tangible personal property and the residual estate. In the durable power of attorney for property and finances, Ern appointed Berenzweig his attorney-in-fact. In the durable power of attorney for health care, Ern designated Berenzweig his primary health care agent.

In April 2010, when Ern was aged 86, he transferred about $315,000 from a bank account to the Lincoln Benefit annuity. About two weeks later a request for beneficiary change was submitted to Lincoln Benefit naming Berenzweig primary beneficiary, identifying her as "friend," and naming Ern's estate contingent beneficiary. Two days later a request for beneficiary change was submitted to Integrity naming Berenzweig primary beneficiary, identifying her as "friend," and naming no contingent beneficiary. In April 2015 Berenzweig faxed the durable power of attorney for property and finances to Lincoln Benefit.

Ern's Death
Ern died on April 13, 2016 at age 92. According to the death certificate, the cause of death was "failure to thrive due to or as a consequence of advanced dementia." The interval between onset of the dementia and death was listed as "years." He died at a hospice facility. On May 12 Berenzweig submitted a death claim to Integrity. On May 26 she submitted a death claim to Lincoln Benefit. On May 27 Integrity issued a check for about $277,000 to Berenzweig. On June 15 Lincoln Benefit issued a check for about $734,000 to Berenzweig.

The Dispute
On August 3, 2017 an attorney for some of Ern's surviving family members filed a complaint with the Office of the Commissioner of Insurance (OCI) of Wisconsin. On September 1, based on an agreement among the parties, a Milwaukee County Circuit Court judge issued a temporary injunction that prevented Berenzweig from spending the remaining funds from the proceeds of the annuities.

OCI investigated the case and made the findings that are summarized briefly above. OCI alleged it is an unfair trade practice and a violation of a Wisconsin statute for an agent to knowingly be listed as a beneficiary of a life insurance policy or annuity unless the agent has an insurable interest in the life of the customer. OCI further alleged it had grounds to revoke or suspend Berenzweig's license as an agent and to order forfeiture in the amount of twice the profit gained from the violations.

On September 18 OCI announced a two-day public hearing to be held November 28 and 29 before an administrative law judge (ALJ). The hearing was held.

On December 8 OCI filed its initial brief. OCI requested a seven-part order: (1) permanent revocation of Berenzweig's license as an insurance agent, (2) payment of restitution of $2,022,232.62 (twice the profit from the violations), (3) forfeiture of $3,000 ($1,000 for each of three violations of insurance law), (4) bar of Berenzweig from receiving or retaining any proceeds of the Lincoln Benefit and Integrity annuities, (5) return of the full annuity proceeds to Lincoln Benefit and Integrity, (6) change of beneficiary on the Integrity annuity to provide for the proceeds to be paid to Carole Carter per stirpes (she was the original beneficiary), and (7) change of beneficiary on the Lincoln Benefit annuity to provide for the proceeds to be paid to the brothers and sisters of Ern and the issue of any deceased brother or sister of Ern per stirpes.

On December 29 Berenzweig's attorney filed a response brief. Here are the two concluding paragraphs:
There is no dispute but that Blanche Berenzweig was perhaps the only person in LeRoy Ern's life since the death of his long time girlfriend and her son. Ms. Berenzweig gave him the time of day when others did not. He obviously eschewed his family. She was deemed by Mr. Ern to be the worthy beneficiary of his entire estate. He was a frugal man who amassed significant wealth. Nevertheless, he was fully aware of his financial status and dictated the terms of his investments. Blanche Berenzweig simply carried out his wishes. She also undertook the rather onerous duties associated with his durable power of attorney and health care power of attorney. She looked after LeRoy Ern until his death. She did not violate any of the prohibited practices described under Wisconsin's Administrative Code. Moreover, her actions were excepted from the Code requirements because of the lapse of time, the arms-length nature of the transactions and Mr. Ern's natural affinity towards her. It must not be forgotten that Susan Drewitz and Blanche Berenzweig urged him to find different beneficiaries of his estate. He rejected that and insisted upon Blanche Berenzweig. His knowing intentions must be carried out.
Blanche Berenzweig is a good and honest woman. She has never had a single blemish on her record. The character evidence was unequivocal. This case should be dismissed.
On January 12, 2018 OCI filed its reply brief. Here is the concluding paragraph:
Respondent has placed herself in a dire position. Because she has admitted the conduct constituting three violations of insurance law and faces license revocation and a significant financial penalty, she hopes the reputation testimony from her friends and her time invested in Ern will mitigate the penalty for her conduct. However, the substantial evidence supports the maximum penalty. Respondent abused the trust of Ern and acted in her own self-interest in naming herself the beneficiary of two annuities that she sold and was servicing for Ern. Respondent obtained the financial power of attorney for the purpose of isolating Ern and preserving Ern's finances for the eventual transfer to herself. Respondent's conduct violated the ethical obligations of an insurance agent and she was unjustly enriched $1,011,116.31. The maximum financial penalty and permanent insurance license revocation are warranted.
The ALJ is expected to issue her recommendation within 30 days. Wisconsin Commissioner of Insurance Ted Nickel will then rule on the case. If he rules against Berenzweig, she could appeal the ruling to the Milwaukee County Circuit Court.

General Observations
This is a troublesome case. Ern's relatives did not keep in close touch with him, and it is not known exactly when the dementia set in. The briefs are more detailed than my summary under "The Berenzweig Case" at the beginning of this post. My summary was based on OCI's hearing notice. Berenzweig's attorney portrays her as someone who befriended and aided a lonely, elderly person.

The Wisconsin law prohibiting an agent from being the beneficiary of a client's life insurance policy or annuity in the absence of an insurable interest cannot be ignored. Berenzweig claimed ignorance of the law, but the conflict of interest was obvious. Attorney Drewitz should have refused to prepare the estate planning documents. Berenzweig should have contacted family members and obtained their assistance in caring for Ern. I plan to report further developments in this case.

Available Material
I am offering a complimentary 60-page PDF consisting of OCI's hearing notice (6 pages), OCI's initial brief (16 pages), the response brief prepared by Berenzweig's attorney (21 pages), and OCI's reply brief (17 pages). E-mail and ask for the January 2018 package relating to the Berenzweig case.


Thursday, January 11, 2018

No. 248: Shadow Insurance—An Update Involving Two Surprises

In No. 107 (posted June 30, 2015) I wrote about a federal class action lawsuit filed in June 2015 on behalf of Rachel Silva and Don Hudson, who had purchased Aviva annuities in 2010. The elaborate complaint alleged that Aviva, Athene, and Apollo—together with other companies and individuals—participated in an unlawful Racketeer Influenced and Corrupt Organizations Act (RICO) enterprise involving phony reinsurance with affiliates. (See Silva v. Aviva, U.S. District Court, Northern District of California, Case No. 5:15-cv-2665.)

Since 2015 I had not followed the case. Recently a reader asked what happened to the case, so I decided to write an update. In the process of preparing the update, two developments came as surprises to me.

The Transfer to Iowa
The plaintiffs in the Silva case originally filed their lawsuit in California. The case was assigned to U.S. Magistrate Judge Paul Singh Grewal. In August 2015 the defendants filed motions to dismiss the complaint and transfer the case to Iowa, where most of them were based. In March 2016 Judge Grewal issued an order denying without prejudice the motions to dismiss and granting the motions to transfer the case to Iowa.

The Iowa Case
In Iowa the case was assigned to U.S. District Judge Stephanie M. Rose and U.S. Magistrate Judge Helen C. Adams. In April 2016 the defendants filed a motion to reinstate their motions to dismiss. In May 2016 Judge Adams denied the defendants' motion. Shortly thereafter Hudson filed an amended complaint against Athene and Apollo. Silva was no longer a plaintiff, and Aviva, whose U.S. business had been acquired by Athene, was no longer a defendant. In June 2016 the defendants filed a motion to dismiss the amended complaint.

In November 2016 Judge Rose issued an order staying the defendants' motion to dismiss the amended complaint. In her order, she mentioned a pending decision in a similar case in the U.S. Court of Appeals for the Eighth Circuit, which covers Iowa, Missouri, and five other midwestern states.

In May 2017 Judge Rose lifted the stay and granted the defendants' motion to dismiss the amended complaint. In the order she relied on the Eighth Circuit ruling. (See Hudson v. Athene, U.S. District Court, Southern District of Iowa, Case No. 4:16-cv-89.)

The Ludwick Case
The Eighth Circuit case to which Judge Rose referred was indeed similar to the Hudson case. The appellate ruling grew out of a district court case in Missouri. (See Ludwick v. Harbinger, U.S. District Court, Western District of Missouri, Case No. 4:15-cv-11.)

In April 2015, two months before Silva filed her RICO complaint in California, Dale Ludwick filed a class action RICO complaint against Harbinger Group, Inc., Fidelity and Guaranty Insurance Company, Raven Reinsurance Company, and Front Street Re (Cayman), Ltd. The case was assigned to U.S. Chief District Judge David Gregory Kays. In February 2016 Judge Kays dismissed the complaint. Here, without citations, are the fifth paragraph and the concluding paragraph of his order:
Plaintiff alleges that F&G [Life Insurance Company], Harbinger, and Harbinger's chairman and CEO, Philip A. Falcone, created a fraudulent accounting scheme to hide F&G's liabilities and artificially inflate F&G's reported assets. This scheme ignored the Statutory Accounting Principles promulgated by the National Association of Insurance Commissioners designed to protect annuity holders and certify that F&G had assets sufficient to meet current and future annuity holder obligations. Harbinger and Falcone orchestrated a series of transactions using wholly-owned captive subsidiaries and a reinsurance company named Wilton Re to transfer F&G's liabilities from its financial statements. Throughout 2011, 2012, and 2013, F&G created a false appearance of capital adequacy by transferring F&G liabilities to and among entities Raven Re, Front Street Cayman, and Wilton Re. F&G also used these transactions to report its holdings of non-agency mortgage-backed securities in its admitted asset base at cost, rather than at their true market value. Plaintiff contends that, absent these financial maneuvers, F&G would have had to report a negative statutory surplus after its acquisition by Harbinger....
Because the McCarran-Ferguson Act preempts RICO claims, the Court need not address whether Plaintiff has plausibly pled these claims. Plaintiff's complaint fails to state a claim upon which relief can be granted and Defendants' Motion to Dismiss is GRANTED.
The Eighth Circuit Ruling
Ludwick appealed the ruling to the Eighth Circuit. In November 2016 the case was assigned to a three-judge appellate panel consisting of Chief Judge William J. Riley and Circuit Judges Roger L. Wollman and Jane Kelly. (See Ludwick v. Harbinger, U.S. Court of Appeals, Eighth Circuit, Case No. 16-1561.)

In April 2017 the appellate panel, in a unanimous ruling written by Chief Judge Riley, affirmed the district court's dismissal of Ludwick's complaint. Here are the introductory and concluding paragraphs of the appellate ruling:
  • The question in this case is whether letting Dale Ludwick pursue her federal racketeering claims against an insurance company and its affiliates would impair state regulation of the insurance business in Iowa, Maryland, or Missouri. We agree with the district court that it would, and the McCarran-Ferguson Act forbids that result. See 15 U.S.C. § 1012(b). We affirm the dismissal of Ludwick's claims....
  • Litigating Ludwick's RICO claims would interfere with state regulation of the insurance business, and the claims are barred by the McCarran-Ferguson Act. The district court was right to dismiss. We affirm.
General Observations
I was surprised by Judge Kays' ruling and the Eighth Circuit's affirmation for two reasons. First, I was surprised by the involvement of Philip Falcone, about whom I wrote in Nos. 242 (posted November 20, 2017) and 244 (December 11, 2017). The Ludwick lawsuit was filed less than two years after Falcone's August 2013 settlement with the Securities and Exchange Commission. In that settlement he and his company paid civil penalties of more than $18 million, he was barred from the securities industry for at least five years, and he admitted wrongdoing.

Second, I had not heard of cases where the McCarran-Ferguson Act was used to dismiss federal RICO lawsuits. However, based on a review of documents in the Ludwick case, it appears that there have been other such cases. It is sobering to consider the implications for insurance consumers when some state insurance regulators are allowed by other state insurance regulators to deviate significantly from statutory accounting principles adopted by all state insurance regulators.

Available Material
In No. 107 I offered a complimentary PDF containing the Silva RICO complaint. The package is still available. Email and ask for the June 2015 package containing the Silva RICO complaint.

Now I am offering a complimentary 48-page PDF consisting of Judge Grewal's order granting the motion to transfer the Silva case to Iowa (13 pages), Judge Rose's order staying the defendants' motion to dismiss the amended complaint in the Hudson case (2 pages), Judge Rose's order dismissing the amended complaint in the Hudson case (7 pages), Judge Kays' order dismissing the complaint in the Ludwick case (13 pages), and the Eighth Circuit panel's ruling in the Ludwick case (13 pages). E-mail and ask for the January 2018 package relating to shadow insurance and the RICO complaints.


Friday, January 5, 2018

No. 247: Donald Trump and the Emoluments Clauses of the U.S. Constitution—A Further Update

In No. 213 (posted April 14, 2017) and No. 216 (May 4, 2017), I wrote about a lawsuit that Citizens for Responsibility and Ethics in Washington (CREW) filed on January 23 against President Donald J. Trump. CREW filed an amended complaint on April 18 and a second amended complaint on May 10. The amended complaints expanded on the allegations and involved additional plaintiffs. Here I provide a further update. (See CREW v. Trump, U.S. District Court, Southern District of New York, Case No. 1:17-cv-458.)

The Judges
The case was assigned initially to U.S. District Judge Ronnie Abrams. President Obama nominated her in July 2011, and the Senate confirmed her in March 2012. On July 11 the case was reassigned to U.S. District Judge George B. Daniels. President Clinton nominated him in August 1999, and the Senate confirmed him in February 2000. No reason for the reassignment of the case was given.

The Amicus Briefs
To say the case has drawn a great deal of attention is an understatement. The case generated many amicus briefs from legal scholars, legal historians, former government ethics officers, members of Congress, and others.

The Motion to Dismiss
On June 9 the defendant filed a motion to dismiss the case. The parties filed briefs in support of and in opposition to the motion. On October 18 Judge Daniels held a conference on the motion. On February 6, 2018, a transcript of the conference will become readily available to members of the public.

The Memorandum and Order
On December 21 Judge Daniels issued a memorandum opinion and order granting the defendant's motion to dismiss the case. Here are five key sentences (without citations) and one footnote from the introductory section of the memorandum opinion and order:
  • Plaintiffs principally allege that Defendant's "vast, complicated, and secret" business interests are creating conflicts of interest and have resulted in unprecedented government influence in violation of the Domestic and Foreign Emoluments Clauses of the United States Constitution.
  • Plaintiffs seek (i) a declaratory judgment declaring that Defendant has violated and will continue to violate the Domestic and Foreign Emoluments Clauses; (ii) an injunction enjoining Defendant from violating the Emoluments Clauses; and (iii) an injunction requiring Defendant to release financial records in order to confirm that he is not engaging in further transactions that would violate the Emoluments Clauses.
  • Defendant argues that Plaintiffs lack standing to sue and moves to dismiss this lawsuit for lack of subject matter jurisdiction pursuant to Federal Rule of Civil Procedure Rule 12(b)(1).
  • Defendant also moves to dismiss this case for failure to state a claim under the Emoluments Clauses pursuant to Federal Rule of Civil Procedure Rule 12(b)(6).
  • Defendant's motion to dismiss for lack of standing under Rule 12(b)(1) is GRANTED.
  • Footnote: Because Plaintiffs' claims are dismissed under Rule 12(b)(1), this Court does not reach the issue of whether Plaintiffs' allegations state a cause of action under either the Domestic or Foreign Emoluments Clauses, pursuant to Rule 12(b)(6). Nor does this Court address whether the payments at issue would constitute an emolument prohibited by either Clause.
A notice of appeal to the U.S. Court of Appeals for the Second Circuit must be filed within 30 days of the ruling, or 60 days if an officer of the U.S. is a party, and an extension may be requested. The timetable for the filing of briefs is set by the appellate court.

A Related Case
In No. 213 I mentioned a related case. On February 10 William R. Weinstein filed a lawsuit on behalf of himself and the U.S. people. He is an attorney, a citizen of the United States and New York State, and a resident of the Southern District of New York. He represents himself and is counsel for a proposed class. Weinstein filed an amended complaint on March 7 and a second amended complaint on June 2.

The defendants are Donald J.Trump, Donald J. Trump, Jr., Eric Trump, and Allen Weisselberg. The latter three defendants are trustees of a publicly described but not publicly named trust. On July 7 the defendants filed a motion to dismiss the case. The case was assigned initially to Judge Abrams, and on July 11 it was reassigned to Judge Daniels. On December 21 Judge Daniels issued a memorandum and order granting the defendants' motion to dismiss the case. (See Weinstein v. Trump, U.S. District Court, Southern District of New York, Case No. 1:17-cv-1018.)

General Observations
I am disappointed and troubled by the failure of the CREW case to survive the defendant's motion to dismiss. However, I think the case is not over, because I believe that CREW will appeal the ruling to the Second Circuit. I do not know whether Weinstein will appeal the ruling in his case. I plan to report further when significant developments occur at the appellate level.

Available Material
I am offering a complimentary 40-page PDF consisting of Judge Daniels' memorandum opinion and order in the CREW case (29 pages) and his memorandum and opinion in the Weinstein case (11 pages). Email and ask for the January 2018 package relating to the emoluments lawsuits against Trump.


Tuesday, January 2, 2018

No. 246: Pension Problems—Lost Pensioners and Stolen Pension Benefits

In recent years I have observed two serious problems facing the pension business. One is lost pensioners. The other is stolen pension benefits. Here I discuss the two problems.

Lost Pensioners
On December 15, 2017, MetLife, Inc. (NYSE:MET) filed an 8-K (significant event) report with the Securities and Exchange Commission. The report provided a "Consolidated Company Outlook—Near-Term Guidance." These two paragraphs are at the end of the report:
Further, MetLife has been in the retirement business for many decades. As practices have evolved, we are improving the process used to locate a small subset of our total group annuitant population of approximately 600,000 that have moved jobs, relocated, or otherwise can no longer be reached via the information provided for them. We currently believe the portion of the subset that is most impacted is less than 5% of our total group annuitant population and they tend to be smaller size cases with average benefits of less than $150 per month.
We are making our process more robust to include a wider set of search techniques and better utilize available technology. Taking these actions would result in strengthening reserves, which in the period recorded may be material to our results of operations and is not reflected in the outlook presented herein. We do not have an estimate at this point but we plan to provide further disclosure on our fourth quarter earnings call and in our annual report on Form 10-K for the year ended December 31, 2017.
The same day, John Hele, MetLife's chief financial officer, made similar comments during a "Business Update Call" with analysts. The next day, The Wall Street Journal ran an article by reporter Leslie Scism entitled "MetLife Discloses Pension Bungle" and subtitled "Some Wall Street analysts assumed that payments could be 10 or more years overdue."

In light of these developments, I contacted MetLife. A spokesman provided this statement:
What used to be standard protocol for finding retirees who are owed benefits is no longer sufficient. While it is still difficult to track everyone down, we have not been as aggressive as we could have been. When we realized this was a significant issue, we launched an effort to do three things: figure out what happened, strengthen our processes so that we do a better job locating retirees, and promptly pay anyone we find—as we always do. We are implementing enhanced techniques within MetLife's Retirement and Income Solutions business to better locate and promptly pay any group annuitant who may be entitled to benefits. We are deeply disappointed that we fell short of our own high standards. Our customers deserve better. We are committed to making this right for our customers. We found the issue, we self-reported it, and we are committed to doing better. We are fully cooperating with regulators.
MetLife said in its 8-K, and Hele said in his comments, that further information will be included in the company's 10-K report for the year ended December 31, 2017. MetLife filed its 10-K for 2016 on March 1, 2017. Therefore the company probably will file its 10-K for 2017 on or about March 1, 2018. I plan to post a follow-up then.

Stolen Pension Benefits
In No. 177 (posted August 31, 2016) and No. 179 (September 15, 2016), I wrote about two cases involving stolen pension benefits. Recently I learned of a third case.

In the first case, an individual was charged with grand larceny after stealing over $100,000 from a pension fund. His mother was receiving a pension payable monthly until her death. The payments were sent to her bank account. When she died, no one informed the fund. Her son, claiming power of attorney for her, wrote checks to himself for ten years until he was arrested.

In the second case, an individual was charged not only with grand larceny but also criminal impersonation after he stole over $180,000 from a pension fund. The payments were sent to a trust account for which the pensioner's brother was the trustee. Seven years after the pensioner's death, the fund learned of the problem and stopped the payments. The brother then contacted the fund by telephone, said he was the pensioner, and requested that the payments be resumed. The brother was arrested shortly thereafter.

In the third case, an individual was charged with bank larceny (a federal crime) after he stole more than $100,000 of pension benefits intended for his sister. He did not inform the pension fund of her death, and thereafter stole the benefits.  He pleaded guilty and was ordered to pay restitution. However, his financial and health problems were so serious that he was sentenced to probation for three years and ordered to pay the restitution without interest at the rate of $25 per month.

The Unpaid Death Benefits Analogy
The problem of lost pensioners is reminiscent of a problem that burst on the scene seven years ago involving life insurance death benefits. On July 28, 2010, Bloomberg News ran an article by reporter David Evans entitled "Duping the Families of Fallen Soldiers" and subtitled "Life insurers are secretly profiting from death benefits owed to the survivors of service members and other Americans."

The article involved "retained asset accounts" (RAAs). They are used by many life insurance companies that send a book of drafts to the beneficiary instead of sending a check for the death benefit. The beneficiary then can use the drafts to make withdrawals from the RAA as desired. The article said that many RAAs had gone dormant, and that the companies had lost contact with many RAA owners. The article was a bombshell because of its focus on beneficiaries of life insurance covering deceased members of the military services. The article prompted many investigations of unpaid death benefits involving not only members of the military services but also members of the general public.

I first wrote about unpaid death benefits in the August 1980 issue of The Insurance Forum. After the Evans article appeared, I wrote about RAAs in the October 2010 issue, and about unclaimed property more generally in the November 2010 issue.

General Observations
I think the problems of lost pensioners and stolen pension benefits are far more serious than the isolated cases discussed here. Both problems stem from the mobility of our population and the administrative challenge of dealing with huge numbers of insureds, pensioners, and beneficiaries. I invite the thoughts of readers—especially those with direct knowledge of how records are maintained—about the magnitude of the problems and potential solutions to the problems. The identity of any reader who responds to this invitation will not be divulged unless the reader gives permission.

Available Material
I am offering a complimentary 17-page PDF consisting of MetLife's 8-K filed December 15, 2017 (6 pages), the article in the August 1980 issue of the Forum (2 pages), the article in the October 2010 issue (4 pages), and the article in the November 2010 issue (5 pages). Email and ask for the January 2018 package about lost pensioners and stolen pension benefits.


Thursday, December 21, 2017

No. 245: Shadow Insurance and Cost-of-Insurance Increases—Recent Lawsuits Involving the Confluence of Those Topics

"Shadow insurance" (also called "captive reinsurance") and "cost-of-insurance (COI) increases" are topics on which I have blogged extensively. Recently I learned of five lawsuits—four in federal courts and one in a state court—involving the confluence of those two topics. Here I identify the cases, describe their general thrust, and quote from one of them.

The General Thrust of the Cases
For several years some life insurance companies have been engaging in transfers—through captive reinsurance subsidiaries—of large amounts of liabilities on universal life insurance policies. Some of the captive reinsurance subsidiaries are based offshore and some are based in states that have enacted laws and adopted regulations allowing the creation and operation of limited purpose subsidiaries (LPSs). To offset the liabilities that the LPSs acquire, the LPSs often use as assets items such as parental guarantees, letters of credit, credit-linked notes, and other phony assets that are permitted by the regulators in the domiciliary states of the LPSs but are not permitted under generally accepted accounting principles or under statutory accounting principles promulgated by the National Association of Insurance Commissioners. After unloading their liabilities, the parent insurance companies of the LPSs are able to pay large dividends to their ultimate parent companies, and the ultimate parent companies are able to pay large dividends to their shareholders. In that fashion the ultimate shareholders receive large dividends long before earnings materialize to justify those dividends. When the problem emerges, as it invariably does, the parent insurance companies try to survive by imposing large COI increases on their policyholders with the argument that future expectations are far below what had been anticipated.

The First Banner Case
In January 2016 Richard Dickman and one other individual filed a 79-page, four-count complaint against Banner Life Insurance Company and two Banner affiliates. Here, with italics as in the original and without citations, is the nine-paragraph introduction to the complaint:
  1. Banner Life Insurance Company ("Banner") is a for-profit life insurer organized under Maryland law. Legal and General America, Inc. ("LGA"), Banner's immediate parent, owns all of Banner's Class A common stock, Class B common stock, and preferred stock. Full control of LGA ultimately resides with Legal and General Group Plc ("L&G"), a United Kingdom company.
  2. Banner, LGA, and L&G, working in concert with each other, embarked upon a scheme to take funds, which were designated as support for reserves [liabilities] and set aside to pay American policyholders' death claims, and convert them to L&G's investors' and executives' benefit.
  3. For more than a decade, Banner, under the direction of its ultimate parent, L&G, put investors and executives ahead of their own policyholders. In doing so, Banner pretended to offload billions of dollars of liabilities, a la Enron, from Banner's balance sheet to its wholly-owned "captives" and other affiliates. As false "surplus" was created by this scheme, L&G caused Banner to pay more than $800 million in "extraordinary stockholder dividends."
  4. Importantly, L&G executives have stated, in press releases to its United Kingdom investor audience, that it was repatriating capital and profits from Banner, its American insurer, through an "internal reinsurance arrangement."
  5. This "internal reinsurance arrangement" has been called "financial alchemy" by New York's former Superintendent of Financial Services, Benjamin M. Lawsky. In reality, Banner merely dumped approximately $4 billion worth of liabilities into wholly-owned captive reinsurance companies that are incapable of satisfying their assumed obligations, thereby freeing up hundreds of millions of dollars Banner would otherwise be legally required to hold as reserves.
  6. Banner's captive reinsurance companies are strategically domiciled in jurisdictions that, amazingly, allowed the "reinsurers" not to file any public financials, hiding the true nature and details of these transactions.
  7. After engaging in this financial alchemy for a decade, Banner decided to embark upon a new scheme to take U.S. policyholder funds and send them to L&G, ultimately to benefit shareholders. In September 2015, Banner suddenly increased the Cost of Insurance ("COI") charged to certain universal life insurance policyholders; in some cases, by as much as 620 percent.
  8. Through mailers, press releases, and myriad other mediums, Banner has told policyholders that dramatic COI increases are necessary because "the company did not adequately account for future experience." Banner and LGA define "experience" as "the number and timing of death claims; how long people would keep their policies; how well the company's investments would perform; and the cost to administer policies." Apparently suffering from corporate amnesia, Banner, LGA, and L&G forgot that they told insurance examiners, policyholders, rating agencies, and shareholders the exact opposite for more than a decade to justify paying extraordinary dividends and encourage investment by both policyholders and shareholders.
  9. Since September 2015, Banner has systematically raided policyholder accounts, arguing that its action is permitted by the policies' terms. In reality, the justifications offered by Banner are false, and merely a guise to accomplish two objectives: (1) find new cash with which to fund future dividends, and (2) rid itself of near-term liabilities, and delay inevitable financial disaster.
In December 2016 the two affiliates were dropped from the case. The case is progressing. (See Dickman v. Banner, U.S. District Court, District of Maryland, Case No. 1:16-cv-192.)

The Transamerica Case
In November 2016 Tommy Hill filed an 86-page, nine-count complaint against Transamerica Life Insurance Company and three Transamerica affiliates. In January 2017 the three affiliates were dropped from the case. The case is progressing. (See Hill v. Transamerica, Circuit Court of Jefferson County, State of Alabama, Case No. 2016-6000401.)

The Voya/Lincoln Case
In February 2017 Monte Swenson and five other individuals filed a class action complaint against Voya Financial Inc. and one Voya affiliate, and against Lincoln National Corp. and two Lincoln affiliates. The case was filed initially in federal court in Washington State. In June the judge granted a motion by the defendants to transfer the case to New York. The number of plaintiffs expanded to 15 individuals. In August the plaintiffs filed a first amended complaint. In October the plaintiffs filed a 98-page, 14-count second amended complaint that included two RICO (Racketeer Influenced and Corruption Organizations Act) counts. In November the plaintiffs filed a notice of voluntary dismissal "without prejudice to Plaintiffs' right to refile." (See Swenson v. Voya, U.S. District Court, Eastern District of Washington, Case No. 2:17-cv-48, and Southern District of New York, Case No. 1:17-cv-4843.)

The Second Banner Case
In March 2017 irrevocable insurance trusts of Robert Appel and one other individual filed a 32-page, one-count class action complaint against Banner. In June the plaintiffs stipulated that the case was stayed until final resolution of the first Banner case. (See Appel v. Banner, U.S. District Court, District of Maryland, Case No. 1:17-cv-759.)

The William Penn Life Case
In July 2017 Lesley Rich filed a complaint against William Penn Life Insurance Company of New York. In October the plaintiff filed an 83-page, two-count amended complaint. The case is progressing. (See Rich v. William Penn Life, U.S. District Court, District of Maryland, Case No. 1:17-cv-2026.)

The Book about Enron
The third paragraph quoted above from the introduction to the complaint filed in the first Banner case refers to Enron. In 2003, two years after Enron filed for bankruptcy, a 435-page book about the Enron case was published. The book is entitled The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron. The authors are Bethany McLean and Peter Elkind. A tenth anniversary edition was published in 2013; it includes a foreword by Joe Nocera and an afterword by the authors. Many view the book as the definitive account of the Enron scandal, and I strongly recommend the book.

General Observations
I refer to the use of shadow insurance as a shell game often used to impose large COI increases on the owners of universal life insurance policies. It is a shell game because the details of the phony assets are shielded from public scrutiny. I have tried to see those details, but have been rebuffed. In Iowa, where Transamerica Life is domiciled, I tried to examine the phony assets used by the company's Iowa LPSs. After the Iowa insurance division denied my requests under the Iowa open records law, I filed a lawsuit against the division seeking access to the documents. I lost the case on the grounds that Iowa laws and regulations (drafted by insurance company attorneys) render the documents confidential.

I do not know when or how, but there is no doubt that the shell game will collapse. When it does, I fear that the primary victims will be life insurance policyholders who placed their faith in the companies.

Available Material
I am offering a complimentary 103-page PDF consisting of the complaint in the first Banner case (79 pages) and the Lawsky report alluded to in the fifth paragraph of the complaint in that case. (24 pages). Email and ask for the December 2017 package about shadow insurance and COI increases.


Monday, December 11, 2017

No. 244: Long-Term Care Insurance and Philip A. Falcone

In No. 242 (posted November 20, 2017), I discussed the sale of a closed block of long-term care (LTC) insurance policies to a subsidiary of HC2 Holdings, Inc., a public company controlled by Philip A. Falcone. He is the founder of Harbinger Capital Partners LLC, a New York hedge fund. I expressed deep concern about the fate of the 30,000 LTC insurance policyholders remaining in the closed block. The reason for my concern is that in 2013 Falcone entered into a settlement with the Securities and Exchange Commission (SEC) under which he paid a large fine, admitted wrongdoing, and agreed to be barred from the securities industry for at least five years. Here I provide further details about the Falcone case.

SEC Complaints Against Falcone
On June 27, 2012, the SEC filed two related complaints. One was against Falcone and two units of Harbinger Capital. The other was against Falcone, Harbinger Capital, and Peter A. Jenson. The first paragraph of the first complaint summarized the allegations:
This case stems from an illegal "short squeeze"—a form of market manipulation that occurs when a trader constricts the available supply of a security with the intention of forcing settlement from short sellers at the trader's arbitrary and inflated prices. Falcone engineered and carried out a squeeze in a series of distressed high-yield bonds issued by MAAX Holdings, Inc., through two unregistered investment managers he controls [two units of Harbinger Capital].
The second complaint contained other allegations. The first two paragraphs of the second complaint summarized the allegations:
First, Falcone and Harbinger, aided and abetted by Jenson, engaged in a fraudulent scheme to misappropriate $113.2 million from a Harbinger fund in order to pay a personal tax obligation owed by Falcone. Instead of paying his personal taxes with his own assets, which may have required Falcone to curtail his lifestyle and personal expenditures, Falcone obtained $113.2 million from a hedge fund that Falcone and Harbinger managed during a period when Harbinger had precluded investors in the fund from redeeming their interests. The Defendants neither sought nor obtained investor approval for the related party transaction. Having structured the transfer of fund assets to Falcone as a loan with a highly favorable interest rate, Falcone and Harbinger, aided by Jenson, concealed the related party transaction from fund investors for approximately five months. To give the appearance of legality, the Defendants engaged a law firm to advise them; however, the Defendants failed to disclose all material information to the law firm. In addition, the Defendants did not act in accordance with the advice that they did receive from the law firm.
Second, in order to obtain investor approval to impose more stringent redemption restrictions on investors in a second Harbinger fund, Falcone and Harbinger engaged in a scheme to grant certain large investors favorable redemption and liquidity terms in return for their vote to approve the restrictions. Falcone and Harbinger concealed this scheme from the fund's board of directors and the other investors, even though Falcone and Harbinger knew, or should have known, that only the board, and not Falcone or Harbinger, had the authority to grant such preferential rights.
The complaints alleged violations of federal securities laws and rules. The first complaint included two claims for relief, and the second complaint included five claims for relief. In the first complaint, the SEC sought a permanent injunction against future violations, disgorgement of ill-gotten gains, and civil monetary penalties, and, in the second complaint, a permanent prohibition against Falcone serving as an officer or director of a public company. (See SEC v. Falcone, U.S. District Court, Southern District of New York, Case Nos. 1:12-cv-5027 and 5028.)

Settlement with the SEC
On August 16, 2013, Falcone and the Harbinger units settled with the SEC on both complaints through a consent agreement and an attachment. They admitted the facts in the attachment, agreed to issuance of a final consent judgment, and agreed to appointment of an independent monitor for two years. Falcone and the Harbinger units agreed to payment of civil penalties of more than $18 million.  Falcone also agreed to be barred from the securities industry for at least five years, but he was not barred from serving as an officer or director of a public company. On October 1, 2014, Jenson agreed to pay a civil penalty of $200,000.

Admission of Wrongdoing
In No. 242 I said that the defendants' admission of wrongdoing was important, and that the case was one of the first SEC settlements requiring such an admission. In a January 2014 speech, then SEC Chair Mary Jo White discussed the subject. Here are excerpts from her speech:
As you know, for many years, the SEC, like virtually every other civil law enforcement agency, typically did not require entities or individuals to admit wrongdoing in order to enter into a settlement. This no admit/no deny settlement protocol makes a great deal of sense and has served the public interest very well. More and quicker settlements generally mean that investors receive as much (and sometimes more) compensation than they would after a successful trial—and without the litigation risk or the inevitable delay that comes with every trial. Settlements also can achieve more certain and swifter civil penalties, and bars of wrongdoers from the [securities] industry or from serving as officers or directors of public companies—all very important remedies for deterrence and the public interest.
So, why modify the no admit/no deny protocol at all?... Because admissions can achieve a greater measure of public accountability, which can be important to the public's confidence in the strength and credibility of law enforcement and the safety of our markets. It is not surprising that there has also been renewed public and media focus on the accountability that comes with admissions following the financial crisis, where so many lost so much....
As United States Attorney, I made the decision that companies should, in certain circumstances, admit their wrongdoing, even if they were not criminally charged, but where there was a special need for public accountability and acceptance of responsibility. That is why, when I negotiated the first deferred prosecution for a company, back in 1994, I required an admission of wrongdoing, and I brought that mindset to the SEC when I became Chair last April [2013]....
To be sure there was no ambiguity about the misconduct of a defendant who was continuing to deal with investors, we required a hedge fund adviser [Falcone] to not only agree to a bar from the securities industry for five years, but to also admit to misuse of more than one hundred million dollars of fund assets in order to pay his personal taxes through a personal loan that was not timely disclosed to investors....
HC2 Filings with the SEC
As mentioned in No. 242, Falcone is now chairman, president, and chief executive officer of HC2 Holdings. I searched through many of its filings with the SEC, including the 10-K annual reports filed after the settlement with the SEC. Falcone's positions with HC2 are shown, but I found no disclosure of the SEC settlement. However, the HC2 10-K report for the year ended December 31, 2016 contains a three-sentence paragraph on page 36 about an arrangement between Falcone and the New York Department of Financial Services (NYDFS). The arrangement grew out of the 2013 settlement with the SEC. Here is the paragraph:
On October 7, 2013, the New York State Department of Financial Services announced that Philip A. Falcone, now our Chairman, President and Chief Executive Officer, had committed not to exercise control, within the meaning of New York insurance law, of a New York-licensed insurer for seven years (the "NYDFS Commitment"). Mr. Falcone, who at the time of the NYDFS Commitment was the Chief Executive Officer and Chairman of the Board of HRG Group Inc. ("HGI"), also committed not to serve as an officer or director of certain insurance company subsidiaries and related subsidiaries of HGI or to be involved in any investment decisions made by such subsidiaries, and agreed to recuse himself from participating in any vote of the board of HGI relating to the election or appointment of officers or directors of such companies. However, it was also noted that in the event compliance with the NYDFS Commitment proves impracticable, including in the context of merger, acquisition or similar transactions, then the terms of the NYDFS Commitment may be reconsidered and modified or withdrawn to the extent determined to be appropriate by the NYDFS Insurance regulatory authorities may [sic] consider the NYDFS Commitment in the course of a review of any prospective acquisition of an insurance company or block of insurance business by us or our insurance segment, increasing the risk that any such transaction may be disapproved, or that regulatory conditions will be applied to the consummation of such an acquisition which may adversely affect the economic benefits anticipated to be derived by us and/or our Insurance segment from such transaction.
It is ironic that HC2 disclosed the NYDFS Commitment, but apparently failed to disclose the SEC settlement agreement that prompted the NYDFS Commitment. With regard to Falcone's disclosure practices, see White's comments in the final paragraph of what I quoted above from her January 2014 speech.

NYDFS Press Release
On October 7, 2013, NYDFS issued a press release describing the NYDFS Commitment. I am including the press release in the complimentary package offered at the end of this post. The press release includes a link to the SEC settlement but does not include a link to the NYDFS Commitment. Therefore, pursuant to the New York Freedom of Information Law (FOIL), I asked NYDFS for the NYDFS Commitment. NYDFS denied my request on the grounds that the document is confidential under the New York Insurance Holding Company Law. I have not yet decided whether to appeal the denial.

Continental General's Statutory Filings
In the statutory financial statements filed by Continental General Insurance Company, a subsidiary of HC2, I found no disclosure of Falcone's settlement agreement with the SEC or the NYDFS Commitment. I reviewed Continental's statutory annual statements for 2015 and 2016, and its statutory statement for the quarter ended September 30, 2017. The latter financial statement, under "subsequent events," includes a note about the acquisition of the closed block of LTC insurance policies and the need for various regulatory approvals, such as from the South Carolina and Texas insurance departments.

The three statutory statements did not mention Falcone, despite his positions with Continental's parent company. Also, Falcone was not mentioned as a member of Continental's board of directors. The only familiar name I saw among the directors, in all three of the statutory statements, was James P. Corcoran. He served as New York State's superintendent of insurance from 1983 to 1990.

Biographical Affidavits
When an individual or entity seeks to acquire an insurance company, the relevant state insurance regulator must approve the acquisition. To obtain approval, the acquirer must submit information to allow the regulator to determine that the acquisition does not present a danger to the public. The required information includes biographical affidavits of the principals involved in the acquisition. State statutes relating to the information that must be provided to regulators refer to those affidavits, which include these two sentences:
No such person has been convicted in a criminal proceeding (excluding minor traffic violations) during the past ten years. No such person has been the subject of any disciplinary proceedings with respect to a license or registration with any federal, state or municipal government agency, during the past ten years.
The second sentence above seems highly relevant to Falcone, who must have been required to describe his settlement with the SEC and the NYDFS Commitment. However, the biographical affidavits invariably are deemed confidential. Presumably the reason for confidentiality is that a biographical affidavit includes information of a personal nature. In No. 139 (January 19, 2016), I described my inability to obtain copies of biographical affidavits in an Indiana situation.

General Observations
I am disturbed that the public is not entitled to relevant information about the principals in acquisitions. It would be appropriate to redact from the biographical affidavits the private information and leave unredacted the information that should be in the public domain.

With regard to the closed block of LTC policies referred to in this post and in No. 242, insurance regulators in South Carolina and Texas probably are aware of Falcone's settlement with the SEC, but nonetheless have approved or will approve the acquisitions relating to the closed block. I hope the regulators have imposed or will impose safeguards to protect the interests of the policyholders in the closed block.

Available Material
I am offering a complimentary 60-page PDF consisting of the first SEC complaint (27 pages), the second SEC complaint (28 pages), the consent order relating to both complaints (3 pages), the NYDFS press release (1 page), and the note in the Continental General statutory statement (1 page). Email and ask for the December 2017 package about Falcone.


Friday, December 1, 2017

No. 243: Guardian Life's Problematic Dividend Announcement

On November 16, 2017, Guardian Life Insurance Company of America issued a press release entitled "Guardian Announces Largest Policyholder Dividend in Company's History." It is subtitled "Board of Directors Approves $911 Million Dividend Allocation to Participating Individual Life Policyholders." The press release quotes Deanna M. Mulligan, Guardian's president and chief executive officer, as referring to "our 5.85% dividend rate." A small-type footnote at the bottom of the press release, below the section entitled "About Guardian," reads:
Dividends are not guaranteed. They are declared annually by Guardian's Board of Directors. The total dividend calculation includes mortality experience and expense management as well as investment results.
I immediately emailed Guardian's media contact person. I forwarded my blog post No. 10 (November 25, 2013) entitled "The Danger of Announcing Dividend Interest Rates," which relates to a November 2013 dividend announcement by Massachusetts Mutual Life Insurance Company. I asked that the email be forwarded to Ms. Mulligan. I received neither an acknowledgment nor a reply to my email.

The Problem
I have long expressed the opinion that announcing dividend interest rates associated with traditional participating life insurance policies is a deceptive sales practice. The footnote in Guardian's press release fails to disclose the seriousness of the problem. As indicated in the footnote, dividend calculations generally include interest, mortality, and expense components. For as long as I can remember, life insurance companies have maintained total secrecy about the calculation of dividends on their participating life insurance policies.

In recent years, during a period of low interest rates on new investments, some life insurance companies have begun to relax the secrecy on the calculation of the interest component of the dividend while continuing to maintain secrecy on the calculation of the mortality and expense components of the dividend. The problem is that there can be no assurance that the disclosed dividend interest rate is in fact the dividend interest rate. For example, it would be possible for a company to decrease the expense component of the dividend and thereby seemingly increase the interest component of the dividend. Moreover, there is no limit to the possible extent of such a practice, because it would be possible to decrease the expense component of the dividend all the way into negative territory.

The Regulators
It is natural to wonder what state insurance regulators are doing about the problem. In that regard, most states do not have the resources to address the problem. The last time I checked, most state insurance departments did not have a full-time actuary on staff. I believe that only the New York State Department of Financial Services pays attention to dividend matters.

A Solution to the Problem
A solution to the problem is to require all companies that issue or have issued participating life insurance policies to disclose fully the details of their dividend calculations. I do not suggest that disclosure of such complex information should be made directly to policyholders. Rather, I suggest that the companies should be required to file such information every year with state insurance regulators, and that such information should be made available to interested members of the public through state open records laws.

It is my understanding that some years ago Northwestern Mutual seriously considered the idea of voluntarily providing such disclosure to state regulators. In the end, however, the company decided such unilateral disclosure would place the company at a disadvantage, because competitors would be able to criticize the company's methods without themselves being subjected to scrutiny. In other words, a solution to the problem is to require that all companies file the information publicly.

Another Solution to the Problem
Another solution to the problem is for regulators and legislators to require life insurance companies to provide rigorous point-of-sale and post-sale disclosure to life insurance consumers. I have long suggested imposing such a requirement, but have met with no success. My most complete description of a rigorous disclosure system is in an article published in the December 1975 issue of the Drake Law Review. The system includes disclosure of, among other things, point-of-sale and post-sale year-by-year disclosure of the yearly price per $1,000 of the protection component of life insurance policies, and point-of-sale and post-sale year-by-year disclosure of the yearly rate of return on the savings component of cash-value life insurance policies.

General Observations
I do not intend to suggest that any of our few remaining great mutual life insurance companies—Guardian Life, Massachusetts Mutual, New York Life, Northwestern Mutual, and Penn Mutual—would engage in the kind of manipulation discussed in "The Problem" above. However, many stock life insurance companies (some of them former mutual companies) have issued and may still be issuing participating policies, and some stock life insurance companies that have never been mutual companies have issued and may still be issuing participating policies.

Available Material
I am offering a complimentary 27-page PDF consisting of the recent Guardian Life press release (1 page) and my 1975 article in the Drake Law Review (26 pages). Email and ask for the November 2017 package relating to dividend interest rates.