No. 6: Reversal of the Neasham Conviction and Some Lessons To Be Learned from the Case

I devoted the entire eight-page June 2012 issue of The Insurance Forum to the conviction of Glenn Neasham, a California agent who sold an annuity to Fran Schuber in February 2008, shortly before her 84th birthday. The annuity was a "MasterDex 10 Annuity" or "Flexible Premium Deferred Annuity Policy with an Index Benefit" issued by Allianz Life Insurance Company of North America. An important issue in the case was whether Schuber was suffering from dementia at the time of the sale.

The Sale

The sale of the annuity occurred three days after Louis Jochim, Schuber's 82-year-old boyfriend, brought her to Neasham's office. Jochim was living with Schuber in her home, and he had bought such an annuity from Neasham several years earlier. Jochim was named the primary beneficiary of Schuber's annuity, and Jochim's daughter was named the contingent beneficiary. Schuber's son, who Jochim claimed was estranged from Schuber, was not named a beneficiary. The first-year premium for the annuity was $175,000, and no further premiums were contemplated. The funds were taken from a maturing certificate of deposit owned by Schuber.

When Jochim brought Schuber to the bank to obtain a check payable to Allianz for the $175,000 premium, bank employees were concerned that Schuber did not understand what she was doing. They issued the check, but filed a report of possible elder financial abuse. The report led to investigations by the Lake County Adult Protective Services, the California Department of Insurance (CDI), and the Lake County District Attorney.

The Trial and the Appeal

In December 2010, criminal charges were filed against Neasham and he was arrested. In October 2011, after a ten-day trial in the Lake County Superior Court, the jury found Neasham guilty of felony theft with respect to the property of an elder and dependent adult. Neasham was sentenced to 90 days in the Lake County jail. The sentence was stayed pending appeal.

Neasham appealed his conviction to the California Court of Appeal. On October 8, 2013, a three-judge panel reversed the conviction. Justice Stuart Pollak wrote the opinion. Justices William McGuiness and Matthew Jenkins concurred. (The People v. Neasham, Court of Appeal, State of California, First Appellate District, Division Three, Case No. A134873.)

My Observations

I agree with the appellate panel's finding that one of the trial court judge's jury instructions was incorrect. The instruction failed to make clear that the jury had to find not only that the defendant committed theft but also that the defendant intended to commit theft. However, I doubt the jury verdict would have been different if the instruction had been correct.

I disagree with--and am surprised by--at least six of the appellate panel's findings. First, the panel said "there was no evidence that [Neasham] appropriated [Schuber's] funds to his own use or to the benefit of anyone other than [Schuber]." Although the panel mentioned Neasham's 8 percent commission (amounting to $14,000), the panel did not consider it an appropriation of Schuber's funds to Neasham's benefit. I disagree. Also, although the panel mentioned surrender charges generally, the panel did not mention the first-year surrender charge of $19,578.

Second, the panel said there was no evidence that Neasham "made any misrepresentations or used any artifice in connection with the sale." The panel ignored the "Annuity vs. CD" form the CDI had found misleading. For a detailed description of the form, see my June 2012 article.

Third, the panel found persuasive the fact that the CDI had approved the annuity contract form for sale to persons up to age 85. Yet the fact that a contract form is approved by a regulator does not mean it is suitable. I am reminded of a case where a woman with advanced emphysema converted her $1.3 million retirement accumulation, virtually her entire estate, to a straight life annuity with no refund. Her illness resulted in her death six months later. The annuity was an approved contract form but surely was not suitable. See "An Unsuitable Life Annuity from TIAA" in the January 2010 issue of The Insurance Forum.

Fourth, the panel accepted the idea that it was appropriate for Jochim to be the primary beneficiary of the annuity and for his daughter to be the contingent beneficiary. The panel also referred to Schuber's son as "largely estranged," a characterization Jochim used. Yet Jochim had a strong financial interest in promoting the so-called estrangement.

Fifth, the panel said there was "conflicting evidence as to [Schuber's] ability to understand the nature of the transaction." Jochim and Neasham's office assistant said Schuber knew what she was doing, but I think the panel should have given much more weight to comments by the bank employees, the various investigators, and Schuber's son.

Sixth, the panel gave significant weight to the "CYA" letter Neasham had handwritten. I think the letter should have been given no weight. Although Schuber and Jochim signed it, no one else witnessed it.

Lessons To Be Learned

It is natural for insurance agents to feel relieved by the reversal of Neasham's conviction. The case attracted so much attention that the Society of Financial Service Professionals submitted an amicus brief to the appellate court on Neasham's behalf. Yet the case ruined Neasham: the CDI revoked his agent's license, the legal expenses were enormous, and he was forced to accept financial help from friends. Moreover, the case provides important lessons for agents and insurance companies who deal with elderly prospects.

First, it is important to examine a prospect's estate planning documents, such as a will, a power of attorney (POA), a living will, and the appointment of a health care representative. For example, if there had been a POA in this case, it would have been appropriate to consult with the holder of the POA. As I said in my June 2012 article, Schuber had asked a lawyer to prepare a POA years before the purchase of the annuity. However, the lawyer felt Schuber was not legally competent to execute a POA and therefore refused the assignment.

Second, it is important for the agent to be diligent about whether the prospect is cognitively impaired. It requires neither medical training nor rocket science to ask the prospect to count backward from 20 or to ask a few routine questions: What year is this? What day of the week is this? What are the names of your brothers and sisters? What is your spouse's name? What are the names of your children? How many grandchildren do you have? Who is the President of the United States? In the Schuber case, nine months after the sale, she told an investigator her husband had bought the annuity, when in fact her husband had died in the 1980s.

Third, it is important for the agent to bring the prospect's family into the picture. In this case, Jochim, who was not a family member and was not a disinterested party, seemed to be the only one present and seemed to answer all the questions for Schuber in discussions with Neasham, with the bank employees, and later with the investigators.

In short, an agent should not make a sale unless the agent is convinced that the product is suitable for the prospect. Further, the agent should not sell an annuity with life contingencies unless the agent is convinced that the prospect is not suffering from a cognitive impairment or other major illness affecting life expectancy. To sell an unsuitable product or deal with a cognitively impaired prospect is asking for trouble.

No. 5: The Conviction of Three STOLI Promoters on Federal Criminal Charges

In the May 2012 and April 2013 issues of The Insurance Forum, I discussed the federal criminal charges filed against three promoters of stranger-originated life insurance (STOLI). The defendants are Michael Binday (Scarsdale, NY), James Kevin Kergil (Peekskill, NY), and Mark Resnick (Orlando, FL). (U.S.A. v. Binday et al., U.S. District Court, Southern District of New York, Case No. 1:12-cr-152.)

The Charges

Each defendant was charged with three criminal counts: (1) conspiracy to commit mail fraud and wire fraud, (2) mail fraud, and (3) wire fraud. Kergil and Resnick were charged with a fourth count: conspiracy to destroy records and obstruct justice. Binday initially was charged with one count of obstruction of justice, but U.S. District Court Judge Colleen McMahon dismissed that count in December 2012.

The indictment described five areas where information provided to the companies was alleged to be false: applicants' finances, intent to sell the policies in the secondary market, third-party premium financing, purpose of the insurance, and existence of other policies or applications. The indictment also described four ways in which insurance companies are harmed when they are tricked into issuing STOLI policies: "earlier and greater payout of death benefit," "less premium income," "providers' financial projections rendered unreliable," and "delayed payments causing decreased cash flow."

Trial and Conviction

The trial originally was scheduled to begin on April 8, 2013. However, Judge McMahon delayed it more than five months after an extraordinary development that I discuss below.

Jury selection began on September 17, and there were 11 trial days. On October 7, at 2:25 p.m., the jury began its deliberations. It reached its verdict 15 minutes later. It found the defendants guilty on all counts. Judge McMahon scheduled sentencing for January 15, 2014.

An Extraordinary Development

Binday was represented by Steptoe & Johnson, a major law firm. The lead attorney was Michael Miller. On February 27, 2013, Miller wrote a letter informing Judge McMahon of "a recent development concerning a potential conflict of interests matter and the measures we have taken to address it." He also said: "We do not believe that an adjournment of the trial will be necessary."

On March 7, one month before the trial date, Miller wrote another letter to Judge McMahon. He said: "Regrettably, I write to apprise the Court that my firm believes it is required by Rule 1.16(b) of the New York Rules of Professional Conduct to move to withdraw from the representation of Mr. Binday in his pending case before Your Honor." He said the rule "provides that a lawyer and/or law firm must withdraw from further representation of a client if the lawyer knows that continued representation will violate other ethics Rules." He also said:

When my firm was first retained, we were aware that several of the purported "victim" insurance companies identified in the Indictment were clients of my firm in connection with matters which appeared at the time to be wholly unrelated to the transactions underlying the defendant's supposed conduct in this case.... Some time later, other issues arose and, upon my firm's recommendation, conflict counsel was retained at my firm's expense who would cross-examine at trial any Government witness who is currently, or was previously, employed by an insurance company that is also being represented by my firm in other matters....

Miller had been arguing that Binday was not guilty because the representations in STOLI applications were not material to the companies' decisions to issue the policies. Several companies subpoenaed in the case were moving to quash or modify the subpoenas. Moreover, a major Steptoe client (not identified) said it might terminate its business relationship with Steptoe if Steptoe continued to represent Binday.

(It is likely that the mystery client is Metropolitan Life. One of the subpoenaed companies was MetLife Investors USA, a Metropolitan affiliate. According to public filings, Metropolitan paid Steptoe $14.7 million in 2009, $14.6 million in 2010, $14.3 million in 2011, and $15.4 million in 2012.)

Binday did not consent to Miller's withdrawal. However, he retained Andrew Lankler of Lankler, Carragher & Horwitz as "conflicts counsel."

On March 11, the defendants and all the attorneys met with Judge McMahon in camera (in private in the judge's chambers). On March 14, Judge McMahon issued an order granting Miller's motion to withdraw and requiring Steptoe to (1) return to Binday "every penny he has ever paid to the firm, with interest," (2) continue paying for the services of Lankler until Binday decides to retain Lankler or Lankler's services are no longer required, and (3) cooperate at Steptoe's expense with the new attorney's investigation of the case. Judge McMahon also postponed the trial until September 17. Here is the beginning of Judge McMahon's order (citations omitted, and "in chancery" means "in litigation"):

Virtually on the eve of trial, the law firm of Steptoe and Johnson, counsel for defendant Michael Binday, have petitioned the court for permission to withdraw due to what it has concluded is an unwaivable conflict of interest. After consulting with the firm, both in open court and in an in camera session, I have reluctantly reached the conclusion that Steptoe must be relieved. This will result in the postponement of an imminent trial for three defendants--a particularly painful result for the men who are in chancery, for the Government, and for the court, which calendared this case long ago. However, on the record before me, the presumption in favor of a defendant's choice of counsel has been overcome by "a showing of a serious potential for conflict."

I am providing a complimentary 16-page PDF consisting of Miller's two letters and Judge McMahon's order. Click here to open the PDF.

No. 4: Metlife's Incomplete Explanation about Runs

Steven A. Kandarian is chairman, president, and chief executive officer of MetLife, Inc. (NYSE:MET). On August 1, 2013, during the firm's second quarter earnings conference call, he explained why he thinks the company should not be designated a "systemically important financial institution." I am not suggesting whether or not the company should be so designated, but I think his explanation was incomplete.

Mr. Kandarian said the long-term nature of a life insurance company's liabilities "protects against bank-like runs and the need to sell assets quickly." Regarding products with a savings component, he said "there are strong disincentives to surrender and cash out." He mentioned surrender charges, tax penalties, and the fact that new policies need to be underwritten. He also said insurance regulators "have the ability to halt surrenders in the event of financial distress, and have typically done so." 

Everything Mr. Kandarian said is accurate, but there are at least two important points he did not mention. First, policy loans are important, as evidenced by the potentially fatal runs experienced by several large companies because of low fixed policy loan interest rates when market interest rates spiked in 1981. New policies issued today usually have variable loan interest rates, but many have fixed maximum rates and many old policies with low fixed rates are still in force. 

Second, when insurance regulators step in, the reverberations can be widely felt. Regulators did indeed intervene to stop runs at companies such as Executive Life and Mutual Benefit Life, but many policyholders of those companies suffered significant losses.

No. 3: Medicaid and Life Settlements

Recently Texas enacted a law--and other states are considering laws--allowing the owner of a life insurance policy to sell it in the secondary market and use the funds toward long-term care expenses. Also, the arrangement supposedly would increase the assets the individual could retain and still qualify for Medicaid, and supposedly would lessen the state's Medicaid costs. Here I discuss such laws.

The Nature of Life Settlements

A life settlement involves the sale of an existing life insurance policy to an investor who speculates on human life. A typical life settlement involves a policy with a death benefit of at least $1 million on the life of a person at least aged 70. 

Life settlements almost never involve traditional cash-value policies, because such policies contain substantial cash values and secondary market participants are not willing to risk the large amounts necessary to acquire such policies. That is why virtually all life settlements involve universal life policies with small cash values or term life policies with no cash values. 

The net purchase price paid to the policyholder must exceed the policy's cash value because otherwise the policyholder would surrender the policy to the insurance company. However, the net purchase price must be well below the policy's fair market value because of the compensation of intermediaries and other expenses associated with life settlements. 

Illusory Savings

The Texas law and other proposed laws are an example of efforts by life settlement promoters to win public acceptance. For several reasons, however, the purported advantages for consumers and states are illusory. First, the Texas law refers to policies of more than $10,000, but the typical candidate for Medicaid owns little or no life insurance. Second, even for those who own policies of more than $10,000, life settlements are not usually feasible because, as mentioned, life settlements typically involve policies of at least $1 million. Third, most small policies are traditional cash-value policies and, as mentioned, are almost never used in life settlements. 

Other Efforts

Another example of efforts by life settlement promoters to win public acceptance is their attempt to have states enact laws requiring life insurance companies to disclose to policyholders the option to enter into a life settlement. That effort is made despite the fact that very few policyholders are candidates for life settlements, as previously discussed. 

The effort by life settlement promoters to enact Medicaid life settlement laws is analogous to the effort by long-term care insurance companies to persuade states to promote private long-term care insurance. A few states have developed "partnership programs" under which states encourage citizens to buy private long-term care insurance. The programs provide that, when the policyholder receives policy benefits, the benefits received increase by that amount the assets the person can own and still qualify for Medicaid. However, the assets are increased only to the extent policy benefits are paid. If a claim is denied, there would be no increase in the assets the person can own and still qualify for Medicaid. In the programs in California and Indiana, for example, letters were written on the governors' stationery urging citizens to return a reply card. The programs are schemes by list developers who sell the respondents' names to insurance agents. 

Conclusion

The Texas law and similar proposals will not reduce state Medicaid costs. Nor will they help consumers. In the July 2008 and January 2012 issues of The Insurance Forum, I described the California and Indiana partnership programs. Also, in the July 2008 issue, I explained why the characteristics of the long-term care exposure make it impossible for private insurance to solve the serious problem of financing long-term care.

No. 2: Revisiting My Suggestion about How to Avoid Problems Associated with Life Annuities

An annuity is a series of payments. In a life annuity, the payments are contingent on the survival of the annuitant. In an annuity certain, the payments are not contingent on the survival of the annuitant.

I do not have any particular concerns about annuities certain. Over the years, however, I have expressed serious concerns about life annuities from the consumer's point of view. In the August 2012 and November 2012 issues of The Insurance Forum, I offered a suggestion on how consumers may avoid the problems associated with life annuities. I was disappointed by the lack of response to the suggestion, and I revisit the suggestion here. 

My Concerns about Life Annuities
The buyer of a life annuity purchases insurance protection against living too long. One major concern is that it is impossible--without making crucial assumptions that are likely to be unreliable--to measure the price of the protection from the consumer's point of view. In other words, the consumer in effect has to buy insurance protection with an unknown price. 

Another major concern is what happens upon the death of the annuitant. In a straight life annuity, in which there are no further payments after the death of the annuitant, the annuitant's survivors receive nothing. In a life annuity with ten years certain, the survivors would receive nothing if the annuitant dies after the ten-year period, and would receive only the payments remaining in the ten-year period if the annuitant dies during the ten-year period. 

My Suggestion

The above concerns caused me, in my personal affairs, to search for an alternative that does not incorporate the life annuity concept. I decided to take systematic monthly withdrawals from my retirement accumulation. Each year I calculate the amount to be withdrawn during the year by following the procedure promulgated by the Internal Revenue Service in connection with required minimum distributions. I divide the yearly amount by 12 and round up slightly to determine the amount to be withdrawn each month. Because my retirement plan involves pre-tax dollars, I must meet the minimum distribution requirements. However, the system works just as well for retirement plans involving after-tax dollars. 

I have used the system for 15 years, and it has been functioning extremely well--even through the financial crash of 2008. To put it simply, there is little if any likelihood that I will outlive the funds. Furthermore, upon my death it is likely there will be significant funds remaining to be divided among my surviving family members. 

Conclusion

I do not know why I received no responses to my suggestion about using systematic monthly withdrawals instead of a life annuity. A possible reason is that following the suggestion does not provide agents' commissions. Yet the suggestion surely presents an opportunity for agents to provide a valuable service to their clients.

No. 1: Criminal and Civil Charges against Two Credit Derivatives Employees at JPMorgan Chase

In the June 2013 issue of The Insurance Forum, I discussed the report of an investigation by a U.S. Senate subcommittee staff into a $6.2 billion loss incurred by the London office of a unit of JPMorgan Chase & Company (NYSE:JPM) in the trading of credit derivatives. The staff report explains credit derivatives, mentions how articles published by Bloomberg and The Wall Street Journal (WSJ) in April 2012 initially broke the story, and describes in great detail how the loss occurred.

The Criminal Complaints
On August 9, 2013, a U.S. Attorney filed criminal complaints against Javier Martin-Artajo and Julien Grout, two JPM employees involved in the case. The complaints, filed under seal, were prepared by a Special Agent of the Federal Bureau of Investigation and approved by two Assistant U.S. Attorneys. The government charged the traders with conspiracy to falsify books and records, commit wire fraud, and falsify filings with the Securities and Exchange Commission (SEC). On August 14, the complaints were unsealed. (U.S.A. v. Martin-Artajo and U.S.A. v. Grout, U.S. District Court, Southern District of New York, Case Nos. 1:13-mj-1975 and 1976.)

The Civil Complaint
On August 14, the SEC filed a civil complaint against Martin-Artajo and Grout. The SEC charged them with violations of federal securities laws and regulations. (SEC v. Martin-Artajo and Grout, U.S. District Court, Southern District of New York, Case No. 1:13-cv-5677.)

The Indictment
On September 16, a federal grand jury issued a five-count indictment against Martin-Artajo and Grout. They were charged with: conspiracy to falsify books and records, commit wire fraud, make false filings with the SEC, and commit securities fraud; false books and records; wire fraud; false filings with the SEC; and securities fraud. (U.S.A. v. Martin-Artajo and Grout, U.S. District Court, Southern District of New York, Case No. 1:13-cr-707.)

According to a September 18 letter from an Assistant U.S Attorney to the judge in the case, Martin-Artajo was arrested in August in Spain, and a request to extradite him to the U.S. was pending. The letter also said Grout was residing in France, where he remained a fugitive. 

The "London Whale"
The headline of the April 2012 WSJ article was "London Whale Rattles Debt Market." The article identified Bruno Iksil as the JPM London employee whose huge volume of trades in credit derivatives roiled the market. The case became widely known as the "London Whale" case. 

Iksil has not been charged. He is cooperating with the prosecutors in their investigation. He is not mentioned by name in the criminal complaints, the civil complaint, or the indictment. In the criminal complaints and the civil complaint, he is called a "cooperating witness." In the indictment, he is called a "co-conspirator."

Conclusion
The JPM case is not directly related to insurance, but it contains important lessons for persons interested in the welfare of the insurance industry. I think such persons should follow developments in the case.