No. 145: Cost-of-Insurance Charges and an Unusual Type of Lawsuit against John Hancock

On December 22, 2015, a policyholder filed an unusual type of cost-of-insurance (COI) class action lawsuit against John Hancock Life Insurance Company USA. The case is unusual because, rather than alleging unlawful increases in COI charges, it alleges an unlawful failure to decrease COI charges in response to decreasing mortality rates. It also alleges unlawful charges for a certain rider. (See 37 Besen Parkway v. John Hancock, U.S. District Court, Southern District of New York, Case No. 1:15-cv-9924.)

The Policy
The plaintiff owns a survivorship universal life policy on the lives of a husband and wife. John Hancock issued the policy on June 1, 2000. The husband was 70 at the time, and the wife was 65. One spouse is now deceased, but the policy remains in force on the life of the other. The current face amount is $1.445 million. The plaintiff says there have been no COI decreases despite the company's improving mortality experience.

The COI Decrease Class
The plaintiff seeks to represent two classes of policyholders, one of which is the "COI Decrease Class." It consists of policyholders who allegedly paid "unlawful and excessive" COI charges. The allegations are based on this policy provision relating to "Applied Monthly Rates," which are used to calculate monthly COI charges:

The Applied Monthly Rates will be based on our expectations of future mortality experience. They will be reviewed at least once every 5 Policy Years. Any change in Applied Monthly Rates will be made on a uniform basis for Insureds of the same sex, Issue Age, and Premium Class, including tobacco user status, and whose policies have been in force for the same length of time.

The COI Decrease Class includes owners of survivorship universal life and other survivorship policies. It also includes owners of individual universal life, variable life, and variable universal life policies.

The plaintiff alleges that John Hancock did not reduce COI charges despite improvement in the company's mortality experience. In its initial answer, filed January 13, 2016, the company says that "nationwide mortality rates as a whole have generally decreased over the last several decades." However, the company denies that the case "can properly be pursued or maintained as a class action," that "the Plaintiff is a qualified class representative," or that "class relief is available from John Hancock."

The Rider Overcharge Class
The other class is the "Rider Overcharge Class," which consists of policyholders who allegedly were charged "unlawful and excessive premiums" for the "Age 100 Waiver of Charges Rider." The rider provides that the company will waive certain charges, including COI charges, after the younger insured attains or would have attained age 100.

The policy attached to the complaint as an exhibit contains what may be a drafting error that prompted this aspect of the lawsuit. The rider includes a "Table of Monthly Rates per thousand of Net Amount at Risk." The table has two columns: "Age," which refers to the age of the younger insured, and "Age 100 Waiver Monthly Rate," which is multiplied by the net amount at risk to determine the monthly COI charge for the rider. The "Age" column runs only from 1 to 32. The "Age 100 Waiver Monthly Rate" column shows 0.0000 for each age from 1 through 5, and 0.0533 for each age from 6 through 32. Paragraph 13 of the complaint reads:

Notwithstanding the plain language of the policy, John Hancock charged plaintiff additional premiums for the Age 100 Rider even though the insureds were older than 32 years old. This action therefore seeks monetary relief for these impermissible additional premiums charged by John Hancock and paid by plaintiff and other similarly situated policyholders.

In its initial answer, John Hancock does not address the matter directly. Here is the answer to paragraph 13 of the complaint:

John Hancock refers to the Plaintiff's policy and to the individual policies of each purported class member for their respective true, complete and accurate terms. John Hancock denies the remaining allegations in paragraph 13.

Later in its initial answer, John Hancock asserts that the copy of the policy attached to the complaint as an exhibit "is not a full, accurate, and complete copy" of the policy. The answer provides no explanation for that assertion. It remains to be seen whether "a full, accurate, and complete copy" will be filed later in the proceedings.

General Observations
The policy language focusing solely on mortality experience as a basis for changing COI rates is unusual. It is more common for a policy to allow changes in COI rates for any reason, including changes in investment experience, expense experience, or mortality experience. I have seen cases where plaintiffs had success with the "mortality experience only" language, but awards to those plaintiffs were refunds after COI charges were increased without adverse mortality experience. I have never before seen a case involving a claim for failure to decrease COI charges after improvement in mortality experience. This case warrants close attention.

Available Material
I am making available a complimentary 66-page PDF consisting of the 19-page complaint, the 33-page policy attached to the complaint as an exhibit, and the company's 14-page initial answer to the complaint. Email jmbelth@gmail.com and ask for the February 2016 COI/John Hancock package.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 144: Genworth's Life Insurance Companies Experience a Significant Reduction in Their Financial Strength Ratings

On February 4, 2016, Genworth Financial, Inc. (NYSE:GNW) issued a lengthy press release entitled "Genworth Financial Announces Fourth Quarter 2015 Results." The subtitle was "Net Operating Loss Of $0.17 Per Share And Net Loss Per Share Of $0.59 Driven By Annual Assumption Updates In Life Insurance; Loss On Sale From Previously Announced Business Divestitures Also Impacted Net Loss." Genworth attached the press release as an exhibit to an 8-K (material event) report filed with the Securities and Exchange Commission.

A. M. Best Company, Fitch Ratings, Moody's Investors Service, and Standard & Poor's (S&P) are the major firms that assign financial strength ratings to insurance companies. Within a few days after Genworth's recent press release, all four firms significantly reduced the ratings of Genworth's life insurance companies: Genworth Life Insurance Company, Genworth Life and Annuity Insurance Company, and Genworth Life Insurance Company of New York.

Genworth's Strategic Update
Genworth's recent press release includes a section entitled "Strategic Update." Here are a few excerpts from that section:

• In 2016, the company plans to initiate a series of internal restructuring actions aimed at separating and isolating its LTC [long-term care insurance] business, subject to regulatory and other potential third-party approvals. These actions are focused on addressing LTC legacy block issues that continue to pressure ratings across the organization.
• Also, the company has elected to suspend all sales of traditional life insurance and fixed annuity products in the first quarter of 2016 given the continued impact of ratings and recent sales levels of these products....
• In January 2016, the company completed the sale of certain blocks of term life insurance to Protective Life Insurance Company....
• In December 2015, the company completed the sale of its lifestyle protection insurance business to AXA....

Secure Versus Vulnerable Ratings
"Secure" financial strength ratings are often called "investment-grade ratings." "Vulnerable" financial strength ratings are often called "below-investment-grade ratings" or, pejoratively, "junk ratings." The table here shows the secure and vulnerable ratings assigned by the four rating firms.

Rating Categories	Best	Fitch	Moody's	S&P
Secure Ratings	A++	AAA	Aaa	AAA
	A+	AA+	Aa1	AA+
	A	AA	Aa2	AA
	A–	AA–	Aa3	AA–
	B++	A+	A1	A+
	B+	A	A2	A
		A–	A3	A–
		BBB+	Baa1	BBB+
		BBB	Baa2	BBB
		BBB–	Baa3	BBB–
Vulnerable Ratings	B	BB+	Ba1	BB+
	B–	BB	Ba2	BB
	C++	BB–	Ba3	BB–
	C+	B	B1	B
	C	CCC	B2	CCC
	C–	CC	B3	CC
	D	C	Caa1	R
	E		Caa2
	F		Caa3
			Ca
			C

Ratings as of August 2, 2013
The final special ratings issue of The Insurance Forum was the September 2013 issue, which listed ratings as of August 2, 2013. At that time, the ratings assigned to Genworth's life insurance companies were not high enough to place the companies among those I suggested for consumers who were conservative regarding financial strength, but all the ratings were in the secure range. The table here shows the ratings at that time.

Ratings as of 8/2/13	Best	Fitch	Moody's	S&P
Genworth Life	A	A–	A3	A–
Genworth Life & Annuity	A	A–	A3	A–
Genworth Life of NY	A	A–	A3	A–

Ratings as of February 1, 2016
During the 30 months prior to Genworth's recent press release, the ratings of Genworth's life insurance companies declined somewhat. However, all the ratings remained in the secure range. The table here shows the ratings just before the recent press release.

Ratings as of 2/1/16	Best	Fitch	Moody's	S&P
Genworth Life	A–	BBB	Baa1	BBB–
Genworth Life & Annuity	A–	BBB	Baa1	BBB–
Genworth Life of NY	A–	BBB	Baa1	BBB–

Ratings as of February 10, 2016
As indicated earlier, all four rating firms reduced the ratings of Genworth's life insurance companies within a few days after Genworth's recent press release. Best's ratings remained in the secure range, Fitch's ratings declined into the vulnerable range, two of Moody's ratings declined into the vulnerable range, and S&P's ratings declined into the vulnerable range. The table here shows the current ratings.

Ratings as of 2/10/16	Best	Fitch	Moody's	S&P
Genworth Life	B++	BB+	Ba1	BB
Genworth Life & Annuity	B++	BB+	Baa2	BB
Genworth Life of NY	B++	BB+	Ba1	BB

In my 2013 special ratings issue, I showed a watch list of life-health insurance companies which had or might be developing financial problems. I suggested that consumers should exercise caution in dealing with companies on the list. One criterion for inclusion on the list was a rating in the vulnerable range from at least one of the four rating firms. I no longer construct a watch list.  If I did, Genworth's life insurance companies, each of which has multiple vulnerable ratings, would now be on it.

Share Prices
On February 4, Genworth's shares closed at $2.79. On February 5, the shares declined sharply to $2.18 on heavy trading volume. The shares declined further to $1.86 on February 8 and $1.67 on February 9. The shares closed at $1.73 on February 10, $1.61 on February 11, and $1.70 on February 12.

Earnings Conference Call
Genworth held a one-hour earnings conference call on February 5. A replay is available through February 19 at (888) 203-1112. The telephone number for those outside the U.S. is (719) 457-0820. The conference ID number is 858342. I listened to the replay and found it interesting.

My First Contact with Genworth
My first article about Genworth was in the May 1997 issue of The Insurance Forum. I had seen a long-term care insurance promotional letter distributed by Genworth's predecessor, General Electric Capital Assurance Company. The letter included this sentence, with the indicated underlining: "Your premiums will never increase because of your age or any changes to your health." I wrote the company expressing the opinion that, although the sentence may have been technically correct, it was nonetheless deceptive because the company had the contractual right to increase premiums on a class basis. I said the promotional letter should have mentioned explicitly the company's right to increase premiums on a class basis.

A company officer responded that he understood my concern, because some companies had increased premiums, but he gave three reasons why the sentence was not deceptive. First, he said the company had never increased premiums and had an "internal commitment to rate stability." Second, he said the letter was an "invitation to inquire" rather than a "direct sales piece." Third, he said the company's representatives are trained to review a sales brochure that mentions the right to increase premiums. The incident was ironic in view of Genworth's substantial premium increases in recent years and the increases yet to come.

Later I saw a promotional letter that was virtually identical except that the company had removed the sentence about which I had expressed concern. I reported the change in the February 1998 issue of The Insurance Forum.

General Observations
I believe that the problems at Genworth may be traced, at least in part, to the company's heavy involvement in long-term care insurance. The company was one of the earliest in the long-term care insurance business, and has long been one of the most prominent in that business. It is interesting that the company now appears to be placing even greater emphasis on long-term care insurance, while exiting lines of business in which the company's relatively low financial strength ratings place it at a competitive disadvantage.

There is no doubt that the need for long-term care can be financially devastating for individuals and their families. However, I believe that the long-term care exposure cannot be handled effectively through the mechanism of private insurance. I first discussed the problem briefly in the August 1991 issue of The Insurance Forum, and I elaborated on the problem in the July 2008 issue. In the latter article I identified and discussed several important insurance principles that the long-term care exposure violates, thereby causing private insurance to be unsuitable for addressing the long-term care exposure.

Available Material
I am making available a complimentary 31-page PDF consisting of Genworth's recent press release and my articles in the August 1991, May 1997, February 1998, and July 2008 issues of The Insurance Forum. Email jmbelth@gmail.com and ask for the February 2016 Genworth package.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 143: Cost-of-Insurance Charges and a Lawsuit against AXA Equitable for Alleged Inequitable Treatment of Policyholders

On February 1, 2016, a policyholder filed a cost-of-insurance (COI) class action lawsuit against AXA Equitable Life Insurance Company alleging inequitable treatment of certain policyholders. The case resembles lawsuits filed several years ago against operating subsidiaries of Phoenix Companies, Inc., relating to stranger-originated life insurance (STOLI) transactions. The current case focuses on AXA Equitable's singling out of certain policyholders for substantial COI increases and alleges breach of contract. (See Brach Family Foundation v. AXA Equitable, U.S. District Court, Southern District of New York, Case No. 1:16-cv-740.)

The Policy

According to the complaint, the plaintiff is a family foundation and not-for-profit corporation. The plaintiff owns a flexible premium universal life insurance policy on the life of a woman who was 81 when AXA Equitable issued the policy on May 21, 2007. The policy remains in force. The face amount is $20 million. The policy, including the application for the policy, is attached to the complaint as an exhibit.

The rating class was standard non-tobacco user. The minimum initial premium payment, due on or before delivery of the policy, was about $145,000. The planned periodic annual premium was about $930,000. The surrender charge at the beginning of the first policy year was about the same as the first-year planned annual premium. The surrender charges, which decline steadily, will be zero after 15 policy years.

The Application for the Policy

Part 1 of the application for the policy had personal information redacted (blacked out). Part 2, the paramedical or medical examination, was redacted in its entirety.

The unredacted portion of Part 1 showed the application was dated April 30, 2007, in Brooklyn, New York. Joel Berger of JB Brokerage Corp. was the "licensed financial professional/insurance broker" who signed the application. The owner of the policy was shown as the primary beneficiary and there was no contingent beneficiary. The owner's name and street address were redacted, but it was located in Brooklyn. The owner was described as a trust under a trust agreement dated April 1, 2007, although, as mentioned earlier, the complaint described the owner as a family foundation and not-for-profit corporation. The application showed the insured as having annual earned income of $80,000 and annual rental income of $2 million. The application said the face amount was determined by the family and its legal advisers. No cash accompanied the application, but the application said the premium was to be paid in cash and there was no intent to "finance any of the premium required to pay for this policy through a financing or loan agreement." An important item in the application—"Please state the reason you are purchasing this policy (e.g., estate planning, business insurance, etc.)"—was not answered.

The Allegation

The plaintiff alleges in the complaint that certain policyholders will be subjected to "unlawful and excessive" COI increases that the company announced in October 2015 to take effect in March 2016. The plaintiff seeks to represent a class of policyholders who own policies that allow policyholders to pay the minimum premiums needed to keep the policies in force by covering the COI charges and certain other expenses. Any premiums paid above those minimum premiums are added to the account values of the policies.

The plaintiff alleges that AXA Equitable is increasing COI charges on almost 1,700 policies selected in part for the pattern of premium payments. The allegation is based on press reports. Thus the plaintiff alleges that the company is targeting policyholders who minimize their premiums to keep account values as small as possible, despite the fact that the policies expressly allow policyholders to do so. The policy paragraph entitled "Changes in Policy Cost Factors" reads:

Changes in policy cost factors (interest rates we credit, cost of insurance deductions and expense charges) will be on a basis that is equitable to all policyholders of a given class, and will be determined based on reasonable assumptions as to expenses, mortality, policy and contract claims, taxes, investment income, and lapses. Any change in policy cost factors will never result in an interest crediting rate that is lower than that guaranteed in the policy, or policy charges that exceed the maximum policy charges guaranteed in the policy. Any change in policy cost factors will be determined in accordance with procedures and standards on file, if required, with the insurance supervisory official of the jurisdiction in which this policy is delivered.

General Observations

This case presents a crucial unanswered question. What precisely is the meaning of the word "class" that appears in the policy provision quoted above? That question was at the heart of years of legal proceedings in the Phoenix COI cases, and I think it is at the heart of this case also.

The question can be asked in another way. Is it fair and equitable to treat those paying minimum premiums—to keep flexible premium universal life policies in force—as a separate class for pricing purposes, or should policies be classified in the traditional manner by such variables as age, gender, occupation, and health status? The question was not answered in the Phoenix cases, because the cases were settled and not adjudicated.

On a separate matter, and for various reasons, I think the policy owned by the plaintiff in this case may be viewed as the result of a STOLI transaction, despite the fact that there is no mention of the policy having been resold in the secondary market. The nature of the insurable interest of the owner/beneficiary/applicant (the trust or family foundation) in the life of the insured is unclear, as is the relationship between the amount of insurance and the financial status of the insured. The application did not explain how the amount of insurance was determined and did not indicate the purpose of the insurance, although it is possible that the broker provided that information to the company in a separate communication. The policy was issued in 2007, during the STOLI heyday before most life insurance companies tightened their underwriting practices.

Available Material

I am making available a 49-page PDF consisting of the 18-page complaint and the 31-page exhibit containing the policy and the application. Email jmbelth@gmail.com and ask for the February 2016 Brach/AXA Equitable package.

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Email: jmbelth@gmail.com 

Blog: www.josephmbelth.com

No. 142: Imperial Holdings, Emergent Capital, and the End of a Criminal Investigation into STOLI Premium Financing

On January 4, 2016, Emergent Capital (Boca Raton, FL), formerly Imperial Holdings, announced the end of a criminal investigation into premium financing of stranger-originated life insurance (STOLI). The investigation, led by the U.S. Attorney's Office in New Hampshire (USAO), became public in 2011 when federal agents raided the company's headquarters. I wrote about the investigation in the May 2012, July 2012, and October 2013 issues of The Insurance Forum, and in No. 132 (posted December 11, 2015).

Background

On September 27, 2011, federal agents conducted a surprise raid at Imperial's headquarters in Boca Raton. The same day, the company issued a press release saying some of its employees were under investigation regarding the company's life insurance premium financing business.

On April 30, 2012, Imperial and the USAO entered into a non-prosecution agreement under which Imperial terminated its life insurance premium financing business, terminated its employees involved in that business, admitted to and accepted responsibility for certain improper conduct, and paid a civil penalty of $8 million. Also, Jonathan Neuman, Imperial's president and chief operating officer, resigned.

On October 31, 2012, the USAO charged Robert Wertheim with one criminal count of conspiracy to commit mail fraud and wire fraud. Wertheim was one of two co-founders of a company named Premium Finance Group. (See U.S. v. Wertheim, U.S. District Court, District of New Hampshire, Case No. 1:12-cr-136.)

On February 20, 2013, the USAO charged two brothers—Abraham and Maurice Kirschenbaum—with one criminal count of conspiracy to commit mail fraud and wire fraud. They were tax advisers. The USAO said the investigation into others was ongoing.

On February 26, 2013, Wertheim pleaded guilty to the criminal charge and entered into a plea agreement with the USAO. On March 7, 2013, the Kirschenbaums pleaded guilty to the criminal charge and entered into plea agreements with the USAO. Wertheim said he had been working with Imperial, he had recruited the Kirschenbaums to identify prospects for the STOLI scheme, and he and his associates had made false statements in life insurance applications.

May 2015 Developments

On May 22, 2015, the USAO filed a motion to dismiss the criminal charge against Maurice Kirschenbaum. He had been diagnosed with cancer in March 2014, his condition had become more serious by March 2015, and he was undergoing aggressive treatment. Attached to the motion was a deferred prosecution agreement that said the USAO could refile the criminal charge at its discretion within five years. The judge granted the motion to dismiss the charge.

On May 27, 2015, the judge held separate, back-to-back, 55-minute sentencing hearings for Wertheim and Abraham Kirschenbaum, including sealed discussions of the ongoing investigation in which Wertheim and Abraham Kirschenbaum were cooperating. USAO sought probation and small fines for those two defendants. Among the USAO's arguments were the promptness with which the two defendants had pleaded guilty, their remorse, and their assistance in prosecuting others who might be charged.

The judge, however, felt that Wertheim and Abraham Kirschenbaum should serve at least some prison time. He deviated downward from the sentencing guidelines and ordered each of them to serve 18 months in a federal minimum-security facility, followed by two years of supervised release. The judge fined each of them $7,500, and Abraham Kirschenbaum forfeited $1 million. The judge left open the possibility that the USAO and/or the two defendants would refile within a year for a further reduction in, or elimination of, prison time as a result of their continuing cooperation in the ongoing investigation. Therefore the judge allowed them to postpone reporting to prison until May 27, 2016.

Recent Developments

On December 31, 2015, the USAO sent Emergent's attorney a letter saying the investigation is over, the company fully complied with the terms of the April 2012 non-prosecution agreement, and all obligations imposed on the company by the agreement are satisfied. Emergent attached the letter to an 8-K (material event) report filed with the Securities and Exchange Commission on January 4, 2016.

As for the investigation of former Imperial employees, the USAO required civil forfeiture and did not file criminal charges. The ongoing investigation had focused on three individuals who left Imperial in 2011: Jonathan Neuman, Jonathan Moulton, and James Purdy.

On December 31, 2015, the USAO filed a civil forfeiture complaint relating to each individual. However, instead of naming an individual as the defendant, each complaint names a dollar amount as the defendant. The complaints call for civil forfeitures for alleged mail fraud. Each complaint is an "in rem proceeding," which is a legal action directed at property instead of a person. The effect of such a proceeding is to eliminate the person's name from the case name, although the person's name appears in the text of the complaint. [See U.S. v. $5,000,000, U.S. v. $750,000, and U.S. v. $750,000, U.S. District Court, District of New Hampshire, Case Nos. 1:15-cv-526 (relating to Neuman), 1:15-cv-527 (relating to Moulton), and 1:15-cv-528 (relating to Purdy).]

The civil forfeiture complaints relating to the three former Imperial employees are similar in their descriptions of the alleged wrongdoing. For example, here are five paragraphs from the 19-paragraph "Facts" section of the complaint relating to Neuman:

At all relevant times, certain insurance companies required that a prospective insured, and sometimes the Imperial internal life agent, applying for a life insurance policy disclose information relating to premium financing on applications for life insurance policies. These questions typically required the prospective insured to disclose if he or she was using premium financing in connection with the policy.

In certain instances, Neuman knew that answering insurance application questions to indicate that the potential insured was not using premium financing to pay the premiums increased the likelihood that an insurance company would issue the policy. The issuance of a policy, in turn, offered Imperial the opportunity to make a premium finance loan and thereby make a profit.

It was therefore in Imperial's interest that these prospective insureds in the retail non-seminar business indicated on applications that they were not using premium financing to pay insurance premiums. However, in certain instances, such answers were false because the insureds were interested in a life insurance policy only on the condition that the premiums would be financed.

At Neuman's direction, in certain instances, Imperial internal life agents facilitated and/or made misrepresentations on insurance applications that the prospective insureds in the retail non-seminar business were not using premium financing to pay premiums when the insurance carrier was likely to deny the policy on the basis of premium financing.

Neuman profited from this fraudulent scheme by receiving compensation from Imperial in excess of $5,000,000.00. After a discussion with counsel for the government, during which counsel for Neuman was given wire transfer instructions, counsel for Neuman advised in writing that he had arranged for a voluntary payment of the defendant in rem, $5,000,000, to be made to the United States Secret Service on December 30, 2015, and that an agreement has been reached to waive notification of this Complaint under Rule G(4) of the Supplemental Rules for Admiralty Or Maritime Claims And Asset Forfeiture Actions, as well as to allow the United States to move immediately for a Final Order of Forfeiture in this matter.

On January 7, 2016, the USAO filed motions seeking a final order of forfeiture in each of the three cases. The motions refer to the amounts as "voluntary payments" that were made "without admitting liability." On January 8, the judge issued final orders of forfeiture relating to Neuman and Purdy. The judge has not yet issued a final order of forfeiture relating to Moulton.

General Observations

Imperial was required to pay a civil penalty of $8 million and shut down its life insurance premium financing business. Neuman, Moulton, and Purdy lost their jobs but avoided criminal charges. Wertheim and Abraham Kirschenbaum were criminally charged, pleaded guilty, entered into plea agreements with the USAO, and face the possibility of 18-month prison terms that are currently set to begin on May 27, 2016.

It is ironic that headquarters employees who developed the scheme escaped criminal charges, while others pleaded guilty to criminal charges. I believe that the decision not to pursue criminal charges against the former Imperial employees was prompted by the USAO's concern that it might not be able to meet the tough standards of proof that are required to obtain criminal convictions.

Available Material

I am making available a 25-page complimentary PDF consisting of the three articles in The Insurance Forum, three court documents relating to Neuman (the civil forfeiture complaint, the motion for final order of forfeiture, and the final order of forfeiture), and the 8-K report. Email jmbelth@gmail.com and ask for the February 2016 Imperial package.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 141: The Age 100 Problem in Cash-Value Life Insurance

The two most important income tax benefits enjoyed by owners of cash value, whole life insurance policies are (1) the inside interest is income tax deferred and (2) the death benefit is income tax exempt. Also, the policyholder's ability to fold the income tax deferred inside interest into the income tax exempt death benefit may be considered a third income tax benefit of life insurance. Almost always missing from discussions of the income tax treatment of life insurance is "the age 100 problem," which I believe has not been resolved.

The Terminal Age
The pricing of a life insurance policy is based in part on a mortality table, which shows death rates (probabilities of death) by age. The terminal age of a mortality table is the age at which the table shows no survivors among those insured. Stated another way, the death rate in the year prior to the terminal age is 1 (or 100 percent, or 1,000 per 1,000).

Five mortality tables have been widely used during the history of the life insurance business in the U.S. They are the American Experience, the 1941 Commissioners' Standard Ordinary (CSO), the 1958 CSO, the 1980 CSO, and the 2001 CSO tables. The terminal age is 96 in the American Experience table, 100 in the 1941 CSO, 1958 CSO, and 1980 CSO tables, and 121 in the 2001 CSO table.

An Example of the Problem
Alfred "Alf" Landon was born on September 9, 1887. He served as governor of Kansas from 1933 to 1937. He won only Maine and Vermont when he ran against President Franklin Delano Roosevelt in 1936. (The saying that grew out of that election was "As Maine goes, so goes Vermont." I was seven years old at the time. My father disliked FDR, probably voted for Landon, and probably persuaded my mother to do so.)

Landon's name appeared in an Associated Press story on September 8, 1983, the day before his 96th birthday. The story also appeared in The New York Times the next day. The headline was "Alf Landon, at 96, Eligible to Collect Life Insurance." Undoubtedly his policy was based on the American Experience mortality table. John Caspari, who was in the advertising department at Northwestern Mutual, was quoted as saying: "It is unusual for someone to outlive the mortality tables." The story said that Landon was eligible to collect $33,156 on his 96th birthday, but that he "planned to allow the sum to continue earning interest." (Caspari, with whom I occasionally spoke, retired in 2002 and died in 2012 at age 69.)

I was intrigued by the story, because I thought Landon might have an income tax problem whether he took the money at age 96 or not. If he asked Northwestern to hold the money until his death, I thought it could be argued that he had constructive receipt of the money for income tax purposes when he asked the company to defer payment until his death. He died on October 12, 1987, about a month after turning 100. I do not know whether Landon and his beneficiaries avoided the income tax problem.

Articles about the Problem
I wrote two articles about the age 100 problem; they are in the January 2001 and May 2001 issues of The Insurance Forum. They were prompted by two unsolicited letters I received. One was from a man who expressed the startling belief that an insured who reaches the terminal age would receive nothing.

The other letter was from a man who said he was in his upper 80s, was in excellent health, expected to live to the terminal age, and had policies in two companies totaling $5 million. He wanted his beneficiaries to receive the money income tax exempt after his death, but he feared he would have taxable income if he survived to the terminal age. He asked the companies how he could avoid the income tax problem, but he did not get straight answers.

In the January 2001 article, I explained the problem. I also said I planned to conduct a survey of major companies.

In the May 2001 article, I reported on the survey. I asked 20 companies to confirm they would pay the death benefit at the terminal age, and I asked them how the insured could avoid the income tax problem. Only three companies responded. They confirmed they would pay the death benefit. They also said the policyholder could elect to postpone the payment until the insured's death, but they did not mention the issue of constructive receipt. The low response rate was my first knowledge that most companies were reluctant to talk about the age 100 problem.

Recent Exploration of the Problem
Recently I have been exploring the age 100 problem for the first time since I wrote those articles in 2001. Everything I have found thus far relates to the definition of life insurance in the Internal Revenue Code and in pronouncements by the Internal Revenue Service (IRS).

The need to define life insurance for income tax purposes grew out of abuses by life insurance marketers who figured out clever ways to use the favorable income tax treatment of life insurance as a sales promotion device. One example was the "minimum deposit plan." (It should have been called the "maximum commission plan.") The policyholder would borrow as much as possible each year under the policy's loan clause, and pay as little as possible each year to cover the loan interest and keep the policy in force. The policyholder would then take an income tax deduction for the loan interest. The plan was promoted as a method by which to change nondeductible life insurance premiums into deductible loan interest payments. It also had the effect of changing a level premium, level death benefit whole life policy into an increasing premium, decreasing death benefit, one-year renewable term policy. Also, the plan allowed agents to collect commissions for a whole life policy rather than the relatively small commissions for a one-year renewable term policy.

Another example of the abuses grew out of the development of universal life insurance. The policyholder would buy a policy with a small amount of life insurance protection and put large amounts into the savings component to take advantage of the favorable income tax treatment of the inside interest.

Variable Universal Life Prospectuses
I am not aware of anything in life insurance policies about the age 100 problem, but the problem is mentioned in prospectuses for variable universal life policies. Those discussions illustrate the difference between the weak disclosure requirements imposed by insurance regulators and the strong disclosure requirements imposed by securities regulators.

A current prospectus issued by New York Life Insurance and Annuity Corporation (NYLIAC), for example, mentions the availability of a "life extension benefit rider" that would extend the policy beyond the terminal age. However, it warns that the policyholder "may be subject to adverse tax consequences" and "a tax advisor should be consulted."

Also, an IRS revenue procedure became effective August 23, 2010 (Rev. Proc. 2010-28). The IRS had issued a notice in 2009 inviting comments. Here is one of the questions the IRS asked in the notice:

If a preexisting contract actually matures at age 100, such that the cash surrender value and death benefit under the contract are the same, is the insured taxed at that time on the maturity value of the contract under the doctrine of constructive receipt?

The IRS received numerous comments, one of which was a 22-page letter from the American Council of Life Insurers (ACLI). The ACLI included, on pages 17-19 of the letter, a discussion of the doctrine of constructive receipt. The ACLI cited, among other things, a Treasury regulation about the doctrine. The ACLI pointed out that, at age 100, there would be no constructive receipt because the policyholder would forfeit a number of "valuable rights," such as "the forfeiture of annuity purchase rate guarantees." The ACLI expressed the opinion that it would not be appropriate to impose requirements "to address a concern that may exist under the constructive receipt doctrine."

In the adopted revenue procedure, the IRS alludes to the question it had asked about constructive receipt. However, the adopted procedure does not appear to address it.

General Observations
In its comment letter, the ACLI explains why it believes that the doctrine of constructive receipt does not apply when the insured reaches age 100. I am not convinced by the ACLI's arguments.

Undoubtedly many whole life policies are in force today based on the American Experience mortality table with its terminal age of 96. And undoubtedly huge numbers of policies are in force with a terminal age of 100. (We are a long way from having policies approaching the terminal age of 121 in the 2001 CSO table.) In short, I still do not know what the ubiquitous "tax advisor" could tell a policyholder who inquires about how to avoid a potentially devastating income tax problem at age 96 or 100.

My wife and I are in our 80s. All the policies on our lives have a terminal age of 100. They are whole life, do not define "life," and say nothing about the age 100 problem. In late January we wrote to the four companies about the problem. We hope to receive "straight answers." I plan a follow-up to describe what we learn from the companies.

Available Material
I am offering a complimentary 37-page PDF consisting of the two-page January 2001 article, the two-page May 2001 article, one page of excerpts from a current NYLIAC prospectus, the 8-page IRS request for comments in 2009, the 22-page comment letter from ACLI in 2009, and the two-page IRS Revenue Procedure 2010-28. Email jmbelth@gmail.com and ask for the February 1, 2016 package about the age 100 problem.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 140: Senator Elizabeth Warren and the Insurance Company Letters to Her about Annuity Sales Incentives

On April 28, 2015, U.S. Senator Elizabeth Warren (D-MA), the Ranking Member of the Subcommittee on Economic Policy of the Committee on Banking, Housing, and Urban Affairs, wrote to 15 major issuers of annuities seeking "information on rewards and incentives offered by your company to brokers and dealers who sell annuities to families and small investors." I discussed Senator Warren's investigation in No. 97 (May 4, 2015) and in a follow-up in No. 124 (November 2, 2015). This is a second follow-up.

My Request to Senator Warren's Office

Shortly after the May 11, 2015 response date in Senator Warren's letters to the companies, I submitted to her office, pursuant to the U.S. Freedom of Information Act, a request for copies of the companies' response letters. Her office denied my request.

My Request to New York

The New York Department of Financial Services (DFS) asked the companies for copies of their letters to Senator Warren. On May 29, I submitted to DFS, pursuant to the New York Freedom of Information Law (FOIL), a request for copies of the letters. DFS acknowledged the request promptly, but said there would be a delay in responding.

On November 24 DFS sent me the 15 letters. The letter from Prudential is marked confidential, includes a request for confidentiality under the FOIL exemption for trade secrets and confidential financial information, and has portions redacted (blacked out) pursuant to that exemption. The letters from Allianz Life and Jackson National are unredacted. The other 12 letters are not marked confidential but contain redactions made by DFS.

My Requests to the Companies

On January 4, 2016, I wrote by regular mail to the 13 companies whose letters contain redactions. I enclosed a copy of the letter showing the redactions, and asked each company to send me—by January 15—an unredacted copy of its letter. I did not write to Allianz Life or Jackson National because their letters are unredacted.

Responses to My Requests

In response to my requests, Lincoln Financial, New York Life, and Pacific Life sent me their unredacted letters. AXA Equitable Life and Athene Annuity and Life acknowledged my request but declined to send their unredacted letters. The other eight companies did not acknowledge my request: American International Group, American Equity Investment Life, MetLife, Nationwide Life, Prudential, RiverSource Life, TIAA-CREF, and Transamerica.

Redactions by Regulators

Members of the public do not often have the opportunity to evaluate the redactions made by insurance regulators when they respond to requests pursuant to public records laws. Such an opportunity arose in connection with the company responses to Senator Warren's investigation of annuity incentives. That is why I decided, with regard to companies for which I have the unredacted and redacted versions of their letters, to include both versions in the package I am offering. By comparing the two versions, readers can judge for themselves the reasonableness of the redactions.

A similar opportunity arose in connection with the 1986 testimony of four officials of Executive Life Insurance Company of New York during a reinsurance investigation by what was then the New York Department of Insurance. I was able to identify a substantial amount of material that the company wanted redacted and that the Department did not redact. The incident is described briefly on pages 85-88 in my new book, The Insurance Forum: A Memoir, and the full details are in the October 1988 issue of The Insurance Forum.

General Observations

When I compared the unredacted letters with the redacted versions, I was surprised by some of the redactions that DFS made. Here, as examples, are three sentences that DFS redacted but that I think do not warrant trade secret protection:

• Lincoln uses an independent model to distribute our annuity products, which are sold through affiliated and non-affiliated channels.
• New York Life does not sponsor trips, contests, or prizes for third party distributors.
• Registered representatives and producers must be state insurance licensed and appointed by Pacific Life in each state where they sell Pacific Life annuities.

I have said on previous occasions that the life insurance industry is built on the nondisclosure of information that is vital to life insurance consumers. Regrettably, state insurance regulators aid and abet such nondisclosure through their redaction practices in response to requests pursuant to public records laws.

Available Material

I am offering a complimentary 78-page PDF consisting of a one-page cover note listing the contents of the PDF, a sample of Senator Warren's five-page request letter to the companies, and all the unredacted and redacted company response letters I have. Email jmbelth@gmail.com and ask for the January 2016 Warren/DFS package.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 139: Stephen Hilbert Returns to the Insurance Business

On January 7, 2016, BestDay carried an article entitled "Former Conseco CEO Hilbert Makes Return to Life Insurance Business as CEO of Sterling Investors Life." That was my first knowledge that Stephen Calvert Hilbert, who will turn 70 on January 23, is returning to the insurance business. When I sought more information, I found other articles about him, including in The New York Times on May 20, 2000, The Indianapolis Star on November 13, 2013, and the Indianapolis Business Journal on September 12, 2015.

Background

In 1979 Hilbert co-founded Security National of Indiana, which later became Conseco. The other co-founder was David Deeds, who soon left the company. They started with $10,000. As chairman, president, and chief executive officer, Hilbert built Conseco into a company with $100 billion of assets under management, and he became one of the highest paid executives in the insurance business. Much of the growth was through acquiring companies, but some of the acquisitions turned out badly. In retrospect, the worst was Green Tree Financial, a subprime mobile home mortgage lender later renamed Conseco Finance. Thus Hilbert was prominent in subprime residential mortgage lending years before it became a major cause of the 2008 crash. In 2000, because of severe losses at Conseco Finance, Hilbert was forced out of Conseco (he uses the word "retired"). Conseco filed for bankruptcy protection in 2002, emerged from bankruptcy in 2003, and changed its name to CNO Financial Group.

Hilbert also has engaged in philanthropic activities. For example, the Circle Theater in downtown Indianapolis is the home of the Indianapolis Symphony Orchestra. In 1996 it was renamed Hilbert Circle Theater after Hilbert and his wife Tomisue Tomlinson Hilbert.

Hilbert has long been associated with Donald Trump. In 1998, for example, Conseco and Trump bought the General Motors Building in New York City. They sold it in 2003.

The Hilberts have been prominent in thoroughbred racing. In 1999, for example, their horse Stephen Got Even finished 14th in the Kentucky Derby, 4th in the Preakness Stakes, and 5th in the Belmont Stakes.

In 1999 the home of the Indiana Pacers became Conseco Fieldhouse. In 2011 CNO Financial renamed it Bankers Life Fieldhouse after Bankers Life and Casualty Company, a CNO subsidiary.

In 2005 Hilbert joined with John Menard, a wealthy hardware store owner, to form MH Private Equity, a money management company. Later Menard and Hilbert had a bitter quarrel that led to litigation in 2011. The litigation remains ongoing.

In September 2008 Hilbert's mother-in-law, Germaine Tomlinson, died as the result of either an accident or foul play. American General Life Insurance Company had issued a $15 million stranger-originated life insurance policy on her life in January 2006. Although the policy was beyond the two-year period of contestability when she died, the company filed a lawsuit against Tomlinson's insurance trust in December 2008 asking the court to declare the policy null and void from inception for lack of insurable interest. The case was settled on confidential terms. (I discussed the case in the April 2009 issue of The Insurance Forum.)

The Formation of SILAC

In April 2015 Hilbert formed SILAC LLC, a Delaware limited liability company, to acquire Sterling Investors Life Insurance Company, a small company domiciled in Georgia, and to redomesticate it (change its state of domicile) from Georgia to Indiana. I think SILAC stands for Sterling Investors Life Acquisition Corporation. SILAC assembled about $10.5 million of capital. It proposed to buy Sterling for about $7.2 million, with some adjustments. It may add some additional capital to Sterling, and may acquire other companies in the business of life insurance, health insurance, and annuities.

SILAC's inside investors are the Hilbert Joint Trust, James Adams, Scott Matthews, and William Stone. SILAC has two outside investors. One is Great American Life Insurance Company. The other is Rollin Dick, according to one document, and JLT PR LLC, an Indiana limited liability company, according to another document. I think Dick and JLT PR LLC are connected.

Sterling, which was owned by a company in Texas, was involved only in running off its existing business. It will focus on working, middle class consumers. It is licensed in all but a few states, but at the outset will concentrate on only eight states. It will offer life insurance and annuities.

According to its statutory quarterly statement as of June 30, 2015, Sterling had net admitted assets of $15.8 million, capital and surplus of $6.5 million, and virtually no net income. It was rated B (Fair) by A. M. Best Company from 2009 to 2013. In 2014 Best withdrew the rating at Sterling's request.

The Form A

On August 17, 2015, SILAC filed a Form A with the Indiana Department of Insurance seeking approval of the acquisition and redomestication of Sterling. The Form A was signed by Hilbert as chairman and chief executive officer of SILAC, and by Matthews as secretary. The "public copy" of the Form A consists of only 13 pages.

The Hearing

On August 26, eight business days after receiving the Form A, the Department held a so-called public hearing. I say "so-called" because no one attended other than representatives of the Department and SILAC. Stephen Robertson, the Indiana insurance commissioner, recused himself because for many years he had been a Conseco executive under Hilbert. He directed Doug Webber, chief of staff in the Department, to conduct the hearing as administrative law judge (ALJ) and issue the necessary order after the hearing.

The public notice of the hearing appeared in The Indianapolis Star on August 19, only one week before the hearing. The notice said the hearing was to begin at 1:30 p.m. However, it did not begin until 1:55 p.m. The delay, according to the transcript of the hearing, "was at the request of counsel for a conference" (in other words, an off-the-record, confidential conference). The ALJ repeatedly expressed satisfaction that Sterling was not going to offer long-term care insurance. The hearing ended at 4:34 p.m.

Attorneys for SILAC, attorneys for the Department, and several other staff members of the Department attended the hearing. The witnesses were Hilbert and Adams. Matthews and Tomisue Hilbert also attended. Absent from the hearing were Stone and three officers who had been with Sterling and were to remain with the company after the acquisition.

Confidential Documents

A substantial amount of material was withheld from the public in accordance with Indiana's holding company law. It exempts from public disclosure many documents filed with the Department in the course of an investigation of transactions such as the one in this case. Here is the relevant exchange reflected in the hearing transcript (Brent Coudron is a Department attorney, and Derrick Smith is a SILAC attorney):

ALJ: I strongly favor as much transparency as you can have. Have you been through that and are there statutory reasons that support why those documents are being held as confidential?
Coudron: Yes, I believe there is.
ALJ: Okay. Mr. Smith, I take it that you feel likewise?
Smith: Yes, Your Honor.
ALJ: Okay. All right.

In response to my request, the Department promptly provided the public copy of Form A, the hearing transcript, the ALJ's order, and two affidavits—by Hilbert and Adams—that were offered in evidence at the hearing. However, the Department denied my request for the biographical affidavits of the four principals—Hilbert, Adams, Matthews, and Stone. The Department said the biographical affidavits are exempt from disclosure in their entirety.

The Form A contains an interesting statement about the biographical affidavits of the four principals. Here is the language:

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.

I think the second sentence of the above statement is incorrect. Adams was the subject of disciplinary proceedings in July 2006, nine years and one month before the filing of the Form A in August 2015. The matter began on March 10, 2004, when the Securities and Exchange Commission (SEC) filed a civil lawsuit against Adams, a certified public accountant (CPA), who had been the chief accounting officer of Conseco. Another defendant was Rollin Dick, who had been the chief financial officer of Conseco, and who is an outside investor in the SILAC acquisition of Sterling. The SEC alleged that Conseco and Conseco Finance, in filings with the SEC and in public statements, had made false and misleading statements about their earnings, overstating their results by hundreds of millions of dollars. The lawsuit ended on July 3, 2006, with judgments under which Dick and Adams paid to the SEC civil penalties of $110,000 and $90,000, respectively. Each was barred for five years from acting as an officer or director of a publicly held company. They consented to the judgments without admitting or denying the allegations in the complaint. Adams was also barred from appearing or practicing before the SEC as an accountant. He could have applied for reinstatement after five years, but has not done so, according to the transcript of the August 2015 hearing. Also, effective March 31, 2011, Adams' membership in the American Institute of Certified Public Accountants was terminated following an indefinite suspension of his CPA license by the Indiana Board of Accountancy in connection with his suspension from practice as an accountant before the SEC. The information in this paragraph is from documents in the public domain. Presumably the information is disclosed in Adams' biographical affidavit, which the Indiana Department of Insurance says is confidential. (See, for example, SEC v. Dick and Adams, U.S. District Court, Southern District of Indiana, Case No. 1:04-cv-457; SEC Litigation Release No. 19756, July 7, 2006; and SEC Accounting and Auditing Enforcement Release No. 2466, July 25, 2006.)

The Order

On August 26, the very day of the hearing that ended at 4:34 p.m., the ALJ signed and filed his 16-page order containing findings of fact and conclusions of law. The order grants, with conditions, final approval of the acquisition and redomestication of Sterling. Among the conditions, for example, on page 15 of the order is a requirement that a conflict-of-interest policy be prepared "specifically disqualifying Stephen Hilbert and Tomisue Hilbert from participating in votes [by Sterling's board of directors] relating to their compensation, benefits, and related party agreements."

General Observations

The approval of the acquisition and redomestication of Sterling was the result of an expedited process. Only eight business days elapsed between SILAC's filing of the Form A on Monday, August 17, 2015, and the ALJ's filing of his order on Wednesday, August 26. Regrettably, it seems to be fairly standard practice for a state insurance department to prepare an order in advance of a perfunctory hearing and file the order immediately after the hearing. Finally, I think it is wrong for biographical information about the principals in an acquisition and/or redomestication to be withheld from public scrutiny.

Available Material

I am making available a complimentary 48-page PDF consisting of the 13-page Form A SILAC filed, the 11-page combination of the Adams and Hilbert affidavits submitted in evidence at the hearing, the 16-page order the ALJ filed the day of the hearing, and the 8-page July 2006 federal court judgment against Adams. Email jmbelth@gmail.com and ask for the January 2016 Hilbert package.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com