Monday, December 30, 2013

No. 16: A STOLI Civil Case in Federal Court in Utah

On December 3, 2013, U.S. District Judge Robert J. Shelby issued a 19-page Memorandum Decision and Order (Order) in a stranger-originated life insurance (STOLI) civil lawsuit. The plaintiff was PHL Variable Insurance Company, a unit of Phoenix Companies, Inc. The defendants were the Sheldon Hathaway Family Insurance Trust and Windsor Securities, LLC. The Order was issued five days after the Minnesota order discussed in my posting No. 13. (PHL v. Sheldon Hathaway Trust et al., U.S. District Court, District of Utah, Case No. 2:10-cv-67.)

The Sale
The lawsuit arose out of a $4 million life insurance policy issued by PHL on the life of Sheldon Hathaway, a retired heavy equipment operator and welder. PHL issued the policy on January 31, 2008. The beneficiary was a family insurance trust of which Hathaway's son David was trustee.

Hathaway lives on 15 acres of rural property in Payson, Utah. He owns a residence and a non-commercial farm. The residence is worth about $380,000. The farmland was valued at $530,000 in 2008, but by 2012 it had decreased in value to $340,000. He owns other minor assets, including farm equipment, an old Jeep, and a Ford truck. He receives annual income of about $30,000 from Social Security and company pensions.

Jay Sullivan, Hathaway's neighbor, showed Hathaway a brochure about investor-financed life insurance that supposedly carried no liability for the insured. Sullivan said the policy would cost nothing and Hathaway would receive $300,000 when the policy was sold after two years.

The Misrepresentations
Sullivan initially estimated Hathaway's net worth as $4 million. Hathaway later testified he questioned Sullivan's estimate, but Sullivan assured Hathaway the property was worth more than Hathaway thought. On the final application, Sullivan listed Hathaway's net worth as $6,250,000 and annual income as $484,500. Also, the application said that premiums would not be financed, and that neither Hathaway nor the trust intended to transfer an interest in the policy to a third party. Hathaway signed the application.

Brock Diediker, an insurance intermediary working with Sullivan, passed the application to Gabriel Giordano, a licensed insurance producer, and Giordano's company, PRG Financial Resources, Inc. Giordano submitted the application to PHL. Giordano also submitted a producer's report on December 10, 2007, saying he had met Hathaway. However, neither Diediker nor Giordano ever met Hathaway.

The Infolink Report
PHL sought confirmation of Hathaway's net worth from Infolink, which submitted an inspection report dated December 5, 2007. The report said the information in the application appeared accurate based on a conversation with Hathaway. PHL later learned that Infolink never contacted Hathaway or otherwise confirmed his net worth.

The Money Trail
Sullivan and other intermediaries worked with David to transfer to the trust's bank account enough money to pay the $200,000 initial policy premium. The source of the money was the San Diego law firm of Sadr & Barrera APLC (S&B), which was active in the secondary market for life insurance. On March 7, 2008, the day before the initial premium was due, S&B transferred $200,000 to the trust's bank account. The money stayed there about one day before it was sent to PHL. David saw Sullivan perform the transfers telephonically during a bank visit.

When the policy was issued, PHL paid a commission to Giordano. PHL also paid a commission to Crump Life Insurance Services, Inc., a PHL broker. Crump had an agreement under which Giordano received a portion of Crump's commission under certain conditions. Giordano paid a portion of his commission to Diediker and New Concepts Financial Corporation, with which Sullivan was affiliated. Through PRG, Giordano also paid Windsor $40,000. Windsor paid $200,000 to S&B. PHL contended the latter payment was to refund the money S&B provided to pay the initial premium. Windsor said it had no knowledge of S&B's involvement and believed the payment was a reimbursement to the trust.

The Investigations
On December 18, 2008, the Utah Department of Insurance wrote to PHL requesting information about Giordano. Alerted to the department's investigation, PHL undertook its own investigation of five policies connected to Giordano, including the Hathaway policy. When PHL was unable to confirm certain information, PHL began legal action to rescind the policies.

The PHL Lawsuit
On January 28, 2010, PHL filed a civil lawsuit against the trust. On April 13, 2011, Judge Shelby granted Windsor's motion to intervene. On September 17, 2012, PHL filed a motion for summary judgment and Windsor filed a cross motion for summary judgment. On December 3, 2013, Judge Shelby's Order granted PHL's motion for summary judgment and denied Windsor's cross motion for summary judgment. The Order instructed the court clerk to enter judgment rescinding the Hathaway policy, allowing PHL to retain the initial policy premium, and permanently dismissing Windsor's claims.

This is another of many STOLI civil lawsuits involving gross misrepresentations in policy applications. Here is a sentence in Judge Shelby's Order:
The court finds that there are no genuine issues of disputed fact and that the false statements in the policy application were material misrepresentations upon which PHL Variable relied.
I am offering the Order as a complimentary PDF. Send an e-mail to and ask for Judge Shelby's Order.


Thursday, December 26, 2013

No. 15: A Legal Victory for Life Partners

On May 18, 2011, Sean Turnbow and others filed a six-count complaint in federal court against four defendants: Life Partners, Inc. (LPI), an intermediary in the secondary market for life insurance; Life Partners Holdings, Inc. (NASDAQ:LPHI), the parent of LPI; Brian D. Pardo, chief executive officer of LPHI, and R. Scott Peden, general counsel and secretary of LPHI. On August 25, 2011, the plaintiffs filed a significantly amended four-count complaint alleging breach of fiduciary duty, aiding and abetting breach of fiduciary duty, breach of contract, and violation of the California Unfair Competition Law (UCL). (Turnbow v. Life Partners, U.S. District Court, Northern District of Texas, Case No. 3:11-cv-1030.)

On September 15, 2011, the defendants moved to dismiss the case. On March 12, 2012, the plaintiffs moved for class certification. On September 28, 2012, U.S. District Judge Barbara M. G. Lynn denied the motion to dismiss, except that she dismissed the UCL count subject to repleading within 21 days. On October 25, 2012, the defendants answered the amended complaint. On January 8, 2013, the judge set the jury trial to begin December 9, 2013. On July 9, 2013, she denied the plaintiffs' motion for class certification. On December 2, 2013, the plaintiffs moved for voluntary dismissal of the case, and the judge granted the motion.

The 8-K Report
On December 4, 2013, LPHI filed an 8-K (material event) report with the Securities and Exchange Commission. Here is the full text:
On December 3, 2013, Life Partners Holdings, Inc. issued a press release announcing that the plaintiffs in the case styled Turnbow v. Life Partners, Inc. (Case No. 3:11-cv-1030-M, 2013 U.S. Dist. Ct., N.D. Tex., Dallas Div.) have voluntarily dismissed their lawsuit. The dismissal follows the court's denial of a motion for class certification in the lawsuit.
The Press Release
LPHI attached to the 8-K an eight-paragraph press release entitled "Plaintiffs Dismiss Lawsuit Against Life Partners," the fourth paragraph of which contains three sentences from Judge Lynn's July 9 order denying the plaintiffs' motion for class certification. Here are the third, fourth, and fifth paragraphs of the press release:
While the plaintiffs in the case could have appealed the denial of the class action or continued to pursue the case as individuals, they elected instead to voluntarily dismiss the case against the Life Partners defendants. A key allegation was that Life Partners' medical consultant used an unreasonable method of estimating life expectancies. However, this allegation was criticized by the Court as part of its 34-page order denying certification as a class action:
"Proof only of results does not address these factors. Nor could an after-the-fact analysis of the insured's deaths, in the aggregate, establish that LPI was unreasonable in using Dr. Cassidy when and how it did.... The Court is highly skeptical that an analysis of results alone could lead a reasonable juror to determine that Dr. Cassidy's methods were flawed."
Life Partners CEO Brian Pardo commented, "This is yet another example of attorney-driven litigation which damages the entire economy, not to mention the companies that are the targets of such litigation. We are very pleased that the plaintiffs decided to walk away from this case and we hope to see other similar cases end the same way."
General Observations
The sentences LPHI quoted are from page 11 of Judge Lynn's 34-page memorandum opinion and order. The first sentence quoted was the final sentence of a nine-sentence paragraph. The second sentence quoted was the first sentence of the next paragraph, which was a four-sentence paragraph. The third sentence quoted was the third sentence of that four-sentence paragraph. I think LPHI selected the three sentences to serve its purposes.

Moreover, I think it is inappropriate for a public company to use a press release about the results of a court case as a vehicle for expressing the chief executive officer's personal opinions about the court system. It is also ironic when the chief executive is known as litigious.

I think readers must examine for themselves the extent to which the three sentences quoted were judiciously selected. For that reason, I am making the 34-page memorandum opinion and order available as a complimentary PDF. Send an e-mail request to for Judge Lynn's order.


Monday, December 23, 2013

No. 14: New York Slams Markel for Overcharging on Student Health Insurance

On December 3, 2013, the Office of the New York State Attorney General (OAG) announced a $3.75 million Assurance of Discontinuance (AOD) with Markel Insurance Company for overcharging on college student health insurance plans. The AOD resolves an investigation by OAG and the New York State Department of Financial Services (DFS) revealing that the company's student health plans, college accident plans, and sports accident plans failed to meet legal requirements for minimum loss ratios.

Markel overcharged about 22,000 students at 34 New York colleges, some of which are units of the State University of New York (SUNY). Under the AOD, the company will pay about $2.75 million in restitution to students and colleges, and a combined penalty of $990,000 equally divided between OAG and DFS. The colleges at which the estimated number of students receiving refunds exceeded 500 are Albany College of Pharmacy & Health Science (1,000), Bard College (5,800), Clarkson University (750), Colgate University (1,400), Nyack College (1,850), St. Bonaventure University (1,000), St. Lawrence University (1,150), SUNY Binghamton (2,250), SUNY Oneonta (1,497), SUNY Potsdam (600), and Wells College (1,200).

The AOD also requires Markel to end an improper commission practice. Here is one paragraph of the AOD:
In addition, Markel paid bonuses or override commissions to at least one agent, based on factors such as the loss ratio. Markel entered into broker compensation agreements that provided that it would only pay the agent a bonus if the loss ratio was kept below 60%, which is below the 65% minimum loss ratio required by 11 NYCRR 52.45(f). Such agreements create conflicts of interest for the agent because they provide financial incentives for the agent to keep loss ratios low in violation of the law and contrary to the best interest of the schools' students. As a result of such agreements, Markel has paid hundreds of thousands of dollars in improper bonuses and commissions.
Also, pursuant to the Patient Protection and Affordable Care Act of 2010 (PPACA), the federal Department of Health and Human Services (HHS) issued a regulation in March 2012 covering the applicability of PPACA to student health insurance policies. HHS regulations, effective for policy years beginning July 1, 2012, require a minimum loss ratio of 80% for student health insurance policies.

OAG alleged that Markel violated three New York statutes and regulations: a statute that "prohibits persons or business entities from engaging in repeated fraudulent or illegal acts or otherwise demonstrating persistent fraud or illegality in the carrying on, conducting or transaction of business," a statute that "prohibits deceptive acts or practices," and a regulation that "requires that group and blanket health insurance achieve a 65% minimum loss ratio." The company neither admitted nor denied the allegations.

Markel said it exited the domestic student health insurance business nationwide and did not issue any blanket student health insurance plans for the 2012-2013 policy year. The company also said it will exit the blanket student accident insurance business and the blanket student intercollegiate sports accident insurance business in New York at the end of the 2012-2013 policy year.

I have combined the OAG press release and the AOD itself into a 17-page complimentary PDF. Send me an e-mail request at for the OAG/Markel package.


Monday, December 16, 2013

No. 13: A STOLI Case in Federal Court in Minnesota

On November 27, 2013, U.S. District Judge Ann D. Montgomery issued a Memorandum Opinion and Order (Order) in a stranger-originated life insurance (STOLI) lawsuit. The plaintiff is PHL Variable Insurance Company, a unit of Phoenix Companies, Inc. The defendant is Bank of Utah. The case is not yet fully resolved. (PHL v. Bank of Utah, U.S. District Court, District of Minnesota, Case No. 12-cv-1256.)

The Sale
The lawsuit arose out of a $5 million life insurance policy issued by PHL on the life of William Close, then a retiree aged 74. The policy was issued on September 11, 2007. Close died of lung cancer on November 18, 2011.

In May 2006, Harold Pomper, a broker for Lextor Insurance LLC, approached Close. Pomper said premiums would be paid by a loan, said Close's beneficiary would collect a death benefit if he died during the two-year contestability period, and submitted a preliminary application to PHL.

On August 11, 2007, Pomper and Brad Friedman, a Lextor representative, met with Close and his wife Kathleen. Pomper and Friedman later testified they completed an application at the meeting, but Kathleen did not recall paperwork there. The application listed Close as the proposed insured and the William Close 2007 Irrevocable Trust as the proposed owner of the policy. Friedman testified he and Close went through the questions on the application and Friedman hand wrote the answers provided by Close. Friedman did not request documentation to verify Close's answers. Friedman and Pomper testified they had no reason to doubt the accuracy of Close's answers.

The Misrepresentations
The application said Close had a net worth of $6,675,000, had an annual income of $350,000, had never applied for life insurance and been declined, and had never been convicted of a felony. Actual net worth was less than one-tenth the amount represented. Tax returns for 2006 and 2007 showed adjusted gross income below $20,000 each year. Close had applied for life insurance with another company and had been declined; Friedman's signature as a witness had been on the rejected application. Close had been convicted of a felony in 2002 for receiving illicit kickbacks while serving as a trustee for labor union pension funds.

The application included a client intent form. It asked whether the insured or owner would be borrowing to pay the premiums and, if so, the name of the financing program; the answer was checked "yes" and "CFC of Deleware [sic]" was indicated. The form asked whether the policy was being purchased in connection with any program under which the insured or owner may have been advised of the opportunity to transfer the policy to a third party within five years of issuance; the answer was checked "no." The form asked if the insured or owner had an understanding or agreement providing for a party other than the owner to obtain a legal interest in the policy or entity owning the policy; the answer was checked "no." The form was signed by Close, Friedman, and the trustee.

Kathleen testified they were told "right up front that [the policy] was going to be sold." She recalled Pomper and Friedman saying they would look for an investor to buy the policy within two years, and the Closes would receive $500,000 after the policy was sold. When asked whether there was any discussion about who would pay the premiums, she said: "Well, it definitely wasn't us... we didn't have that kind of income to support the policy."

Friedman and Pomper testified they told Close he could sell the policy after two years and it would be worth a percentage of the death benefit, but testified they did not promise Close $500,000. Friedman testified he informed Close of the option to repay the loan and keep the policy, and it was not his understanding Close obtained the policy to sell it.

The Infolink Report
On receiving the application, PHL obtained an "Infolink Advanced Amplified Life Report" to verify Close's financial and medical representations. The report, dated August 16, 2007, is under seal in the court file pursuant to a protective order. Infolink reports have turned up in other PHL STOLI cases, suggesting the company used them routinely.

The Infolink report was completed using answers given by Close in a telephone interview. The section about financial information was incomplete and inconsistent. Nearly all spaces for breakdowns of income and net worth were blank. The report showed annual income of $375,000 entirely from dividends, and net worth of $6.7 million. The report said the information provided by Close was confirmed by an unnamed personal reference who had known Close for five years. The PHL underwriter who underwrote the policy, when asked about the report, testified he would have wanted to obtain further verification of the information.

The application showed a planned annual premium of $272,025, amounting to 77 percent of Close's claimed income of $350,000. The underwriter and PHL's chief underwriter testified the ratio was unusually high and was something an underwriter would question. The underwriting file lacks evidence showing PHL sought or obtained further information about Close's finances before issuing the policy.

The Trust
The trust was established to own the policy and perform the obligations under a financing agreement with CFC of Delaware LLC. Kathleen was beneficiary of the trust, and BNC National Bank was trustee. Ryan K. Crayne was trust protector. He testified he served as trust protector for "at least a hundred trusts" associated with CFC.

The Premium Finance Loan
To pay the premium and meet other costs, Close applied for a loan from CFC, which made loans to irrevocable life insurance trusts under a program financed by New Stream Insurance LLC. The loan application provided Close would not pledge any assets, but would personally guarantee 25 percent of the loan if the trust defaulted. The record includes no evidence of attempts by CFC to verify Close's financial information.

CFC approved the loan and entered into an agreement with the trust on September 18, 2007. CFC agreed to lend the trust $330,225, consisting of $272,025 of premium, closing fees of $16,000, an origination fee of $11,200, and $1,000 to terminate the trust. The term of the loan was two years. The trust granted CFC a security interest in the policy. BNC, the trustee, executed a collateral assignment of the policy to CFC and submitted it to PHL, which recorded the assignment on or about October 1, 2007. There is no evidence that CFC performed any underwriting about the trust's ability to repay the loan. The funds were provided by New Stream, a hedge fund that invested in life insurance products; it later entered bankruptcy proceedings.

The Policy Surrender
In July 2009, CFC wrote to the Closes and Crayne, the trust protector, saying the loan to the trust would mature in December 2009. CFC said the four options to repay the loan were (1) refinance with CFC, (2) refinance elsewhere, (3) repay the loan with personal funds, or (4) sell the policy and use the proceeds to repay the loan.

Close spoke with Friedman about selling the policy. Close sent his medical records to Friedman on October 8, 2009. The records showed a mass in his left lung and possible metastatic lesions in both lungs, said Close was under the care of an oncologist, and noted Close's "possible cancer."

Friedman testified he tried to sell the policy but did not recall to or through whom he made the attempt. He further testified the "policy wasn't worth a lot of money at the time" because Close "was relatively healthy, I think." The policy was not sold.

On January 7, 2010, Crayne, the trust protector, without speaking with Close about Close's intent concerning the policy, and without knowledge of Close's medical diagnosis, sent a letter instructing BNC, the trustee, to deliver forms to PHL to change the owner and beneficiary of the policy to New Stream. Crayne directed BNC to wait to receive signed documents from Close and Kathleen. When asked if surrender of the policy was the best option available to Close, Crayne testified he would have expected Close to "scramble to find refinancing" and keep the policy if he was ill.

A week later, Close and BNC executed documents surrendering the policy to CFC in full satisfaction of the trust's obligations to CFC. CFC designated New Stream as assignee of the policy in full satisfaction of CFC's obligations to New Stream relating to the policy. Kathleen executed a document acknowledging the trust's surrender of the policy to New Stream. New Stream submitted change of ownership and change of beneficiary forms to PHL, which recorded the changes.

New Stream transferred the policy to Bank of Utah as securities intermediary. PHL was informed and recorded the transfer. On June 2, 2011, New Stream sold its interest in the policy to Limited Life Assets Services Limited (LLAS) in connection with the liquidation of New Stream's assets in bankruptcy. Bank of Utah became securities administrator for LLAS. In January 2012, after Close's death, Bank of Utah submitted a claim to PHL for the $5 million death benefit.

The PHL Lawsuit
On May 24, 2012, PHL filed a lawsuit against Bank of Utah seeking a declaratory judgment that the policy was null and void ab initio (from the beginning) due to a lack of insurable interest when the policy was issued, and that PHL may retain the premiums. On July 3, 2012, Bank of Utah answered the complaint and filed a counterclaim for breach of contract and unjust enrichment based on PHL's refusal to pay the death claim and retaining the premiums. On August 1, 2013, PHL and Bank of Utah each filed motions for summary judgment, and each filed motions to exclude expert testimony.

The Order
In her Order, Judge Montgomery granted in part and denied in part PHL's motion for summary judgment. She ruled the Close policy was void ab initio, but denied PHL's request to retain the premiums pending resolution of Bank of Utah's counterclaim for unjust enrichment. She denied Bank of Utah's motion for summary judgment on its counterclaim for unjust enrichment, thereby leaving the matter to be resolved at trial. She dismissed Bank of Utah's motion for summary judgment on its counterclaim for breach of contract. She denied motions by both PHL and Bank of Utah to exclude expert testimony.

General Observations
This is one of many STOLI lawsuits involving gross misrepresentations in the application and grossly deficient underwriting by the insurance company. Here are a few excerpts from Judge Montgomery's Order illustrating these characteristics:
There is no dispute the completed Application included gross misrepresentations.
When viewed in totality, the transactions demonstrate that the loan and Trust arrangements among Close, CFC, and New Stream were, in practice, hollow formalities designed to circumvent the insurable interest requirement. The transactions' form will not be allowed to prevail over their substance.
...the record shows PHL had some knowledge of facts that would have put it on notice that the Policy was being procured as a cover for a wager, and that PHL did not investigate those facts.
It remains to be seen whether there will be appeals, and whether Bank of Utah's counterclaim for unjust enrichment will go to trial. Meanwhile, I am offering the 34-page Order as a complimentary PDF. Send me an e-mail request at for Judge Montgomery's Order.


Thursday, December 5, 2013

No. 12: The Expanded and Improved Medicare For All Act of 2013

On February 13, 2013, U.S. Representative John Conyers (D-MI) introduced H.R. 676, the "Expanded and Improved Medicare For All Act." The bill has 53 cosponsors (all Democrats) in the House of Representatives. On February 22, the bill was referred to the Subcommittee on Indian and Alaska Native Affairs of the Committee on Natural Resources. There has not been any other action on the bill. Here is the bill summary prepared by the Congressional Research Service:
Establishes the Medicare for All Program to provide all individuals residing in the United States and U.S. territories with free health care that includes all medically necessary care, such as primary care and prevention, dietary and nutritional therapies, prescription drugs, emergency care, long-term care, mental health services, dental services, and vision care.
Prohibits an institution from participating unless it is a public or nonprofit institution. Allows nonprofit health maintenance organizations (HMOs) that deliver care in their own facilities to participate.
Gives patients the freedom to choose from participating physicians and institutions.
Prohibits a private health insurer from selling health insurance coverage that duplicates the benefits provided under this Act. Allows such insurers to sell benefits that are not medically necessary, such as cosmetic surgery benefits.
Sets forth methods to pay institutional providers of care and health professionals for services. Prohibits financial incentives between HMOs and physicians based on utilization.
Establishes the Medicare for All Trust Fund to finance the Program with amounts deposited: (1) from existing sources of government revenues for health care, (2) by increasing personal income taxes on the top 5% income earners, (3) by instituting a modest and progressive excise tax on payroll and self-employment income, (4) by instituting a modest tax on unearned income, and (5) by instituting a small tax on stock and bond transactions. Transfers and appropriates to carry out this Act amounts that would have been appropriated for federal public health care programs, including Medicare, Medicaid, and the Children's Health Insurance Program (CHIP).
Requires the Medicare for All Program to give first priority in retraining and job placement and employment transition benefits to individuals whose jobs are eliminated due to reduced administration.
Requires creation of a confidential electronic patient record system.
Establishes a National Board of Universal Quality and Access to provide advice on quality, access, and affordability.
Requires the eventual integration of the Indian Health Service into the Program, and an evaluation of the continued independence of Department of Veterans Affairs (VA) health programs.
A Few Thoughts
During the 40 years of The Insurance Forum, I rarely wrote about the tragic situation of those in our great nation who have no insurance covering the cost of health care and those who have inadequate coverage. A few exceptions were articles contributed by Alan Press in our March 2008, June 2008, October 2009, and December 2009 issues, and my article in the June 2010 issue about the then recently enacted Patient Protection and Affordable Care Act (PPACA).

I have said on occasion that I support the concept of a single-payer system of universal health care. I have not embraced the PPACA, because I think it is a complex compromise that will not solve the problems we face. Also, I am pessimistic about the likelihood of enactment of a single-payer system, such as H.R. 676. Whenever anyone asks me why we do not have universal health care of the type found in every other advanced society in the world, my one-word answer is "Politics."

In my opinion, the enactment of Social Security in 1935 and Medicare in 1965 were the two greatest political achievements of the past century. Each occurred as the result of an extraordinary combination of events. I think it will require a similar combination of events for the U.S. to enact a system of universal health care, which thus far has eluded Presidents Theodore Roosevelt, Harry Truman, and Barack Obama.

Tuesday, December 3, 2013

No. 11: More on the Dilemma for Consumers When an Insurance Company Is Sold

In the December 2013 issue of The Insurance Forum, published November 7, I wrote about the dilemma faced by policyholders when an insurance company is sold by its parent company in such a way as to cause a downgrade in the insurance company's financial ratings. In the article I cited the recent divestitures of Aviva Life & Annuity Company by Aviva plc and Lincoln Benefit Life Company by Allstate Life Insurance Company. I suggested that the problem would be alleviated if rating firms assign stand-alone ratings to the subsidiary unless the parent company provides an unlimited, permanent, and unconditional parental guarantee to the subsidiary.

Moody's Special Comment
On November 20, Moody's Investors Service, a major rating firm, issued a six-page "Special Comment" entitled "US Life Insurance: Recent Divestitures Raise Questions about Parental Commitment." Moody's cited five recent divestitures in addition to the two I cited: Sun Life Assurance Company of Canada US by Sun Life Financial, MONY Life Insurance Company and MONY Life Insurance Company of America by AXA Financial, and Commonwealth Annuity & Life Insurance Company and First Allmerica Life Insurance Company by Goldman Sachs Group. Here is the opening paragraph of the special comment:
Insurance subsidiaries' creditworthiness often benefits from implied support stemming from a unit's strategic importance to a stronger parent and/or group of other operating subsidiaries that are managed as a tightly integrated group. This implied support has been validated in practice over time and is typically reflected in higher ratings for those subsidiaries than they would merit on their own. However, recent subsidiary dispositions, most prominently in the US life insurance sector, raise new questions about the reliability of this implied support over time as parent strategies change.
An Interesting Table
The special comment includes an interesting table listing eleven U.S. life insurance companies that receive "rating uplift" from their parent companies. Here are the companies, with the number of "notches of rating uplift" in parentheses: Allianz Life Insurance Company of North America (1), Allstate Life Insurance Company (2), AXA Equitable Life Insurance Company (2), Combined Insurance Company of America (1), Great-West Life & Annuity Insurance Company (1), Hartford Life Insurance Company (1), HCC Life Insurance Company (1), Jackson National Life Insurance Company (1), John Hancock Life Insurance Company USA (1), USAA Life Insurance Company (1), and Zurich American Life Insurance Company (2).

In the concluding section of the special comment, Moody's says "implicit support may lack permanence" and "shifts in strategic importance of subsidiaries can result in rating transitions." However, Moody's does not mention the possibility of a subsidiary obtaining an unlimited, permanent, and unconditional guarantee from its parent. I will provide the special comment in the form of a complimentary PDF. Just send me an e-mail request for Moody's special comment on recent divestitures.

Monday, November 25, 2013

No. 10: The Danger of Announcing Dividend Interest Rates

I have expressed the opinion that announcing dividend interest rates associated with traditional participating life insurance policies is a deceptive sales practice. Also, I have expressed the opinion that announcing gross interest rates associated with universal life policies is a deceptive sales practice. For example, see "How Not To Advertise Universal Life" in the May 1984 issue of The Insurance Forum.

MassMutual's Press Release
On November 4, 2013, MassMutual issued a two-page, seven-paragraph press release entitled "MassMutual Approves Record $1.49 Billion Dividend Payout for Policyowners." The release contains three footnotes and some descriptive material entitled "About MassMutual." The lead paragraph of the release reads:
Massachusetts Mutual Life Insurance Company (MassMutual) announced today that its Board of Directors has approved the company's largest dividend payout ever in the company's history for 2014: a record payout estimated at $1.49 billion to eligible participating policyowners. The dividends to be paid in 2014 reflect a dividend interest rate1 of 7.10 percent for eligible participating permanent life and annuity blocks of business, an increase over last year's rate of 7.00 percent.
A footnote is indicated after the words "dividend interest rate" in the above lead paragraph. The footnote reads:
The dividend interest rate is not the rate of return on the policy. Dividends consist of an investment component, a mortality component and an expense component. Therefore, dividend interest rates should not be the sole basis for comparing insurers or policy performance. Additionally, dividends for a given policy are influenced by such factors as policy series, issue age, gender, underwriting class, policy year and policy loan rate, as well as changes in experience.
The footnote says what the dividend interest rate is not, but does not say what it is. Further, saying dividend interest rates should not be the sole basis for comparisons implies they are a basis for comparisons.

A Brokerage E-mail
On November 5, a MassMutual brokerage office in Georgia sent an e-mail to producers. The subject is "MassMutual Announces 2014 Dividend." The title, in large boldface type, is "7.10% Dividend Announced." Here is the full text, except for contact information:
MassMutual has officially announced our 2014 dividend. We will payout [sic] a record $1.49 Billion. The dividend interest rate is 7.10%. Please see attachment for official news release.
The full press release, including its three footnotes, was attached to the e-mail. A recipient of the e-mail shared it with me.

Another Brokerage E-mail
On November 12, a MassMutual brokerage office in Indiana sent an e-mail to producers. The subject is "2014 Dividend Announcement," and there is no title. The third paragraph of the five-paragraph text includes this sentence: "Additionally, a 7.10% dividend interest rate1 represents a 10 basis point increase for all participating permanent life and annuity blocks of business (from 7.00% to 7.10%)." [The boldface type is in the original.] Footnote 1 is shown at the bottom of the e-mail in exactly the form shown in the company's press release. A recipient of the e-mail shared it with me.

A Newspaper Article
On November 4, an article appeared in The Republican, a newspaper in MassMutual's home city of Springfield, based on the press release. The title is "MassMutual announces record dividend estimated at $1.49 billion." Here are the first two sentences of the text:
MassMutual Financial Group has approved the insurer's largest dividend payout in history for 2014. The record payout to eligible policy holders is estimated at $1.49 billion. The dividends to be paid in 2014 reflect a dividend interest rate of 7.1 percent for eligible policy holders, an increase over last year's rate of 7 percent flat.
The article does not mention anything that appears in footnote 1 of the press release. Thus it does not warn the reader against drawing the inference that 7.1 percent is a policy rate of return or that the figure may be used for comparison purposes.

My Inquiry and MassMutual's Statement
I contacted a MassMutual spokesman, explained my concerns, said I was planning to post an article, and requested a statement from the company to include in the article. In response, the company said:
Based on the information you shared, the initial e-mail message that you forwarded is accurate and links through appropriately to our news release with full disclosures. Regarding your latter question on a news story, although our release cited full disclosures, we cannot dictate what a news organization includes in its coverage.
I am more concerned about what producers say to policyholders and prospects than what MassMutual says to producers. I think producers, in their sales work, and especially in the current environment of low market interest rates, will emphasize the 7.10 percent dividend interest rate in such a way as to imply that it is the rate of return on the policy, and that it may be used for comparison purposes. Thus I think the figure will be used in such a way as to constitute a deceptive sales practice. For these reasons, it is my opinion that companies should not announce dividend interest rates, even with cautionary footnotes.

I have long argued for a rigorous system of disclosure to life insurance consumers. Among other things, the system includes information about yearly rates of return on the savings component of cash-value life insurance, and reflects the combined effect of interest, mortality, and expenses. My most complete description of the system is in the December 1975 issue of the Drake Law Review. I am making the 26-page article available as a complimentary PDF. Just e-mail me a request for the Drake Law Review article.

Thursday, November 21, 2013

No. 9: The Unsealing of Some Phoenix Court Documents

I have written extensively about cost-of-insurance (COI) increases that subsidiaries of Phoenix Companies, Inc. imposed on owners of universal life policies of the type used in stranger-originated life insurance transactions. I discussed five federal court lawsuits. I also discussed investigations of the "2010 increase" by what is now the New York State Department of Financial Services (DFS), the California Department of Insurance (CDI), and the Wisconsin Office of the Commissioner of Insurance (OCI).

Phoenix rescinded the 2010 increase imposed on New York policyholders after DFS ordered the company to do so. Phoenix later imposed the "2011 increase" on New York policyholders, apparently without objection by DFS. Numerous important court documents relating to the COI increases have been sealed or heavily redacted, but I am continuing my efforts to obtain them. My June 2012 public records request to DFS remains pending. Although my public records request to CDI was denied, I obtained some documents through a public records request to OCI. See the October 2012, December 2012, and November 2013 issues of The Insurance Forum

The September 2011 DFS Letter to Phoenix
On September 6, 2011, Michael Maffei, chief of the life bureau of DFS, sent a three-page letter to Kathleen McGah, vice president and counsel of Phoenix. He described the results of the DFS investigation into the 2010 increase and alleged that Phoenix committed five violations of New York insurance laws. He ordered Phoenix to reduce the COI rates to the rates used prior to the 2010 increase; credit the difference, with interest, to policy values; and refrain in the future from using the "funding ratio" (the ratio of a policy's accumulated value to the policy's face amount) as a basis for COI increases. The Maffei letter remains sealed in court files, but I obtained it through my August 2013 public records request to OCI. I am making the letter available as a complimentary PDF. Just e-mail me a request for the Maffei letter. 

The Mills Reports
Robert Mills is an economist and director at Micronomics, Inc., an economic research and consulting firm. The plaintiffs' attorneys retained him to calculate damages in the event Phoenix is found liable for breach of contract as alleged in court complaints.

On September 16, 2013, Mills submitted a report based on data provided by Phoenix. On September 30, he submitted a supplemental report based on additional data provided by Phoenix. The reports were sealed pursuant to a protective order. On November 6, they were unsealed. The figures below are from the supplemental report.

Mills focused on the 2011 increase Phoenix imposed on New York policyholders. He said owners of 87 policies were affected by the 2011 increase, and 55 of them remained in force as of June 30, 2013. The total estimated COI overcharges for the 55 policies was $1,517,849 through August 30, 2013, and that figure will increase over time. Mills also estimated prejudgment interest (through March 31, 2014 on estimated overcharges through August 30, 2013) of $172,277 at a 9 percent interest rate (the statutory rate in New York) or $76,568 at a 4 percent interest rate (the rate Phoenix argues should be used).

Mills discussed 22 policies that lapsed between notification of the 2011 increase and June 30, 2013. He estimated that $7.95 million in premiums were paid into those policies. He also gave some lower damages figures based on the assumption that a small percentage of the policies lapsed for reasons other than the 2011 increase.

Two Important Unanswered Questions
After their investigations, CDI and OCI ordered Phoenix to rescind the 2010 increase imposed on policyholders in those states, but Phoenix refused to do so. Question: Why did Phoenix refuse to comply with the CDI and OCI orders to rescind the 2010 increase imposed on California and Wisconsin policyholders after having complied with the DFS order to rescind the 2010 increase imposed on New York policyholders? OCI began an administrative proceeding, the results of which will not be known for some months. To my knowledge, CDI has done nothing further.

Although DFS ordered Phoenix to rescind the 2010 increase, DFS apparently did not object to the 2011 increase. Question: How did Phoenix implement the 2011 increase on New York policyholders in such a way as to avoid the problems that caused DFS to order rescission of the 2010 increase? Hopefully the question will be answered when further court documents are unsealed or DFS complies with my public records request.

Other Documents
Numerous court documents relating to Phoenix's COI increases remain sealed, and I still await numerous documents in response to my public records request to DFS. When more documents become available, I will report on them.

Thursday, November 14, 2013

No. 8: More on the Reversal of the Neasham Conviction

In No. 6, I discussed the reversal of the conviction of Glenn Neasham, a California agent who sold an Allianz annuity to Fran Schuber in 2008, just before her 84th birthday. An important issue was whether Schuber was suffering from dementia at the time of the sale. A reader expressed some thoughts about my posting, and we engaged in further correspondence. The exchange prompts me to elaborate on three points.

The $14,000 Commission
The first point relates to Neasham's $14,000 commission, which I view as an appropriation of Schuber's funds to Neasham's use. The reader asked whether I am opposed to commissions. I said I am not. I have often said commissions are essential in situations where financial services are sold rather than bought. The consumer's tendency is to procrastinate, and someone must perform what I call the "anti-procrastination function." A person has to be paid to perform that function, and commissions are a reasonable form of compensation. I have often said many people die without wills because no one is paid to perform the anti-procrastination function.

I failed to make sufficiently clear in my previous posting that the annuity in question was not a single-premium annuity, but rather a flexible-premium annuity in which the first premium was large and no further premiums were contemplated. The first-year commission rate on a flexible-premium annuity is significantly higher than the commission rate on a single-premium annuity. In other words, I think the annuity sold in this case generated an excessive commission.

Jochim's Financial Interest
The second point relates to the financial interest of Louis Jochim, Schuber's 82-year-old live-in boyfriend, who precipitated the sale by bringing Schuber to Neasham's office. The reader said the question of Jochim's financial interest in the sale had nothing to do with Neasham. In response, I said it had everything to do with Neasham. In my opinion, the purpose of the sale was to allow Jochim--rather than Schuber's son Ted--to take eventual control of Schuber's property.

As described in my June 2012 article, Jochim's plan was thwarted. After Neasham's conviction, and after Allianz refunded the entire annuity premium to Schuber with interest, Ted obtained a court order. It designated Ted the conservator of Schuber's person and property. Jochim moved out of Schuber's house, and Ted moved her to the memory loss unit of an assisted living facility.

The Suitability Issue
The third point relates to suitability of the annuity. As I said in No. 6, the fact that the California Department of Insurance had approved the annuity contract form for sale to persons up to age 85 does not mean it is necessarily suitable. The reader said he sees no problem with an annuity that provides a period certain. In my view, when a person selects an annuity consisting of a period certain and a deferred life annuity, the arrangement would not be suitable for a person in poor health because the portion of the funds going to the purchase of the deferred life annuity would be forfeited entirely if the person dies during the period certain.

Wednesday, November 13, 2013

No. 7: John Grisham Strikes Again

John Grisham, one of our most popular novelists, has done it again. His latest book is Sycamore Row (Doubleday, 2013). It is set in 1988 in the fictional Mississippi town of Clanton. It involves many of the characters in his first book, A Time to Kill, which was set in 1985.

Seth Hubbard, a white man in his 60s, is dying of lung cancer and commits suicide by hanging himself from an old sycamore tree. He leaves a suicide note containing instructions about his funeral, a letter to Jake Brigance, the attorney hero of Grisham's first book, and a handwritten will executed the day before he committed suicide.

The handwritten will revokes Hubbard's previous will, which was of the usual type prepared by a law firm. The handwritten will disinherits Hubbard's two adult children, their children, and his two ex-wives. It leaves the bulk of his estate, which turned out to be large, to his black housekeeper, with relatively small bequests to a church and a long lost brother. The housekeeper had been with Hubbard for three years and had cared for him during his difficult final days. The handwritten will names the executor and instructs him to appoint Jake the attorney for the estate. The letter to Jake instructs him to carry out the terms of the handwritten will "at all costs," and warns there will be a big fight. The letter to Jake includes these sentences: "The doctors have given me only weeks to live and I'm tired of the pain.... If you smoke cigarettes, take the advice of a dead man and stop immediately."

Hubbard was correct about the fight. All through the book I wondered whether the second word of the title was "row," rhyming with "grow," or whether it was "row," rhyming with "brow." At the end of the book we learn there was a row (rhyming with grow) of sycamore trees of which the hanging tree was a remnant. However, the legal war that ensued certainly qualified as a row (rhyming with brow).

I have read all of Grisham's books, and I think this one may be his best yet. It is 447 pages but is a page-turner.

Thursday, October 31, 2013

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.

Wednesday, October 30, 2013

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.

Monday, October 21, 2013

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.

Tuesday, October 15, 2013

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. 

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.

Friday, October 11, 2013

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. 

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.

Monday, October 7, 2013

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."

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.