Tuesday, September 30, 2014

No. 69: Indexed Universal Life—The Debate over Sales Illustrations

A debate is in progress over sales illustrations for indexed universal life (IUL) policies. Here I review some background on illustrations and identify some companies and organizations involved in the debate.

Universal Life
Prior to the advent of universal life (UL), I advocated disclosing to consumers yearly prices per $1,000 of the protection component and yearly rates of return on the savings component of traditional cash-value life insurance policies. However, dividing cash-value life insurance into its protection and savings components was anathema to life insurance companies.

When UL burst on the scene in 1979, an official at E. F. Hutton Life, which issued the first UL policy, said to me: "Belth, I hope you are satisfied." His comment was prompted by the fact that UL splits cash-value life insurance into its protection and savings components. However, I was not satisfied, because UL created a whole new world of possibilities for the use of deceptive sales illustrations. 

At that time, market interest rates were high, and they were headed to all-time highs in the early 1980s. UL made it possible to create fabulously attractive sales illustrations based on the notion that double-digit interest rates would persist far into the future. In other words, the interest rates used in UL sales illustrations were based on new-money interest rates. The practice led to "vanishing premiums" and other problems, all of which developed into a major scandal. Consequently, reforms were put in place regarding the preparation of UL sales illustrations.

Indexed Universal Life
Now we have exactly the opposite situation. Market interest rates are at all-time lows, and the promoters of IUL want to base sales illustrations on historical (referred to in the current debate as "look-back") interest rates rather than the currently low interest rates. The Life Actuarial Task Force (LATF) of the National Association of Insurance Commissioners (NAIC) is trying to develop rules regarding the preparation of sales illustrations for IUL policies.

ACLI and Three Dissident Companies
On May 14, 2014, the American Council of Life Insurers (ACLI), a major association of life insurance companies, sent LATF a four-page "Proposed Actuarial Guideline for Indexed Universal Life Illustrations." Because ACLI is dominated by companies anxious to sell IUL, it comes as no surprise the ACLI proposed that "IUL illustrations have a maximum illustrated rate of the disciplined current scale based on a standardized look-back period of 25 years."

On August 12, three life insurance companies—Metropolitan Life, New York Life, and Northwestern Mutual Life—sent LATF a three-page letter expressing concern over the ACLI proposal. The three companies do not sell IUL, but explained their concern that IUL illustrations as contemplated in the ACLI proposal "could ultimately negatively impact the reputation of the entire life insurance industry." The three companies said they were developing a more detailed proposal.

On September 5, the three companies sent LATF an eight-page proposal. Attached was a two-page proposed actuarial guideline. The three companies said their proposal "provides the appropriate level of transparency, consistency, and consumer protection." They also said the proposal "is based on a sound theoretical framework and is supported by our robust analysis." (The proposal implied, but did not state, that American United Life supported the work of the three companies.)

On September 9, ACLI sent LATF a three-page letter responding to the August 12 letter from the three companies. ACLI expressed the belief that the August 12 letter "is not consistent with the Model Regulation and ASOP (Actuarial Standards of Practice), and is also inconsistent with the way that other general account products are illustrated."

The New York Department
On September 10, the New York Department of Financial Services (NYDFS) sent a three-page "Section 308 letter" to all life insurance companies authorized to do business in New York. The letter asked a series of five questions about whether the company sells indexed universal life or any other indexed life insurance products. If so, the letter asked for certain information about the products, for sales illustrations, and for the amount of business by face amount and by premiums for the past three years (separately for New York sales and national sales). The companies were required to respond to the letter by October 1, 2014. The letter was signed by Michael Maffei, assistant deputy superintendent and chief of the life bureau, and responses to the letter were to be sent to William B. Carmello, chief life actuary in the Albany office of NYDFS.

Supporters of the ACLI Proposal
At least nine life insurance companies wrote LATF in support of the ACLI proposal. Listed in chronological order, with the dates of their letters indicated in parentheses, the companies are:
Minnesota Life (August 25)
Penn Mutual Life (September 2)
Midland National Life (September 4)
National Life (VT) (September 4)
AXA Equitable Life (September 5)
Lincoln Financial (September 5)
Pacific Life (September 5)
Transamerica Life (September 5)
John Hancock Life (September 15)
Also, on September 5, M Financial Group sent a letter in support of the ACLI proposal. To my knowledge, it is the only agents' group that has entered the debate.

The Shadowy ALIA
Affordable Life Insurance Alliance (ALIA) is a shadowy organization with no website, and its letterhead shows no address or other contact information. On September 5, ALIA sent a five-page letter to LATF in support of the ACLI proposal.

The ALIA letter was signed by Scott R. Harrison, its executive director. He is an attorney in private practice. I asked him for a mission statement and the identity of member companies, officers, and directors. In response, he said the mission—as stated by Dennis Glass of Jefferson-Pilot Life (now part of Lincoln Financial) when ALIA was organized in March 2005—is "to ensure that American consumers have access to safe and affordable life insurance." Harrison did not identify the member companies, officers, and directors, so I asked again. He did not respond.

When I wrote about ALIA in the February 2012 issue of The Insurance Forum, in the context of ALIA's support for so-called principles based reserves, I said the member companies at the time were Aviva, John Hancock Life, Lincoln Financial, and Pacific Life. I think ALIA is incorrectly named. It should be named Alliance for Elimination of Redundant Reserves (AERR) or Alliance for Weakening Life Insurance Reserves (AWLIR).

General Observations
LATF and NAIC face a serious challenge in developing rules to curb the use of deceptive sales illustrations for IUL policies. Not the least of their challenges is to develop a disclosure mechanism that would be meaningful to the average consumer. Consider these nuggets from the ACLI proposal and from the dissidents' proposal, and try to imagine the effect they would have on the average consumer:
ACLI: "For illustrations on a policy form for which credited rates can be based on an index, actual index performance in conjunction with the illustrated index crediting parameters should be displayed. That display should show index performance that begins on January 1 and should include at least 20 years of performance ending in the previous calendar year."
Dissidents: "The Indexed Derivative Return required to achieve the illustrated crediting rate must be clearly disclosed to consumers for all illustrations other than the required minimum guaranteed illustration."
ACLI, the supporters of its proposal, and the dissident companies all claim IUL is a general account product, is not a security, and is not subject to the many requirements that would be imposed if IUL were deemed to be a security. I disagree. I think any product whose performance is based in part on the performance of a market index is a security.

For readers interested in seeing some of the documents referred to in this post, I am offering a complimentary 23-page PDF consisting of the May 14 proposal from ACLI, the August 12 letter from the three companies, the September 5 proposal from the three companies, the September 9 letter from ACLI, and the September 10 "Section 308" letter from NYDFS. Send an e-mail to jmbelth@gmail.com and ask for the IUL package.


Monday, September 22, 2014

No. 68: TIAA, Moody's, and Surplus Notes

Teachers Insurance and Annuity Association of America (TIAA), its affiliated and unrated College Retirement Equities Fund (CREF), and its subsidiary TIAA-CREF Life Insurance Company are referred to in this discussion as "TIAA-CREF." TIAA-CREF, which has more than $600 billion in assets under management, has long specialized in serving faculty members and administrators of colleges and universities. In recent years, however, TIAA-CREF has expanded its activities to other constituencies. TIAA and TIAA-CREF Life have long held top ratings from the major rating firms.

TIAA-CREF's Announcement
On April 14, 2014, TIAA-CREF issued a press release announcing its agreement to acquire Nuveen Investments, Inc., a diversified investment management company, for $6.25 billion. Nuveen has more than $200 billion in assets under management, and will operate as a separate subsidiary within TIAA-CREF's asset management business. The transaction is expected to close by the end of 2014.

Moody's Reaction
On April 14, Moody's Investors Service issued a press release announcing it had placed its Aaa ratings of TIAA and TIAA-CREF Life on review for downgrade. Here is the first paragraph of Moody's ratings rationale:
Moody's said that the review for downgrade of TIAA's ratings is driven by the size and scope of the announced acquisition. The acquisition of the much lower-rated asset manager Nuveen, given the substantial size of the transaction, combined with the likelihood of accompanying leverage (either operating or financial), places downward pressure on TIAA's credit profile. Although asset management is a complementary business, the rating agency said the planned acquisition of Nuveen is outside of the core higher-education pension business of TIAA, which is the foundation of its Aaa rating. Such a large acquisition outside of its core business, if completed, may not be consistent with Moody's expectations for TIAA's Aaa rating. If and when the acquisition closes, Moody's will likely downgrade TIAA's IFS [insurance financial strength] rating [one notch] to Aa1 from Aaa, and its affiliated ratings by one notch.
On August 19, Moody's issued a press release reiterating its concerns about the transaction. Moody's also indicated it had placed its B3 rating of Nuveen on review for upgrade.

Other Rating Firms' Reactions
On April 14, Standard & Poor's (S&P) issued a press release indicating that its AA+ ratings of TIAA and TIAA-CREF Life were not affected by the transaction. In August 2011, S&P had lowered its rating of U.S. debt one notch from AAA to AA+ and consequently had lowered the ratings of all its top-rated insurance companies from AAA to AA+.

On April 14, Fitch Ratings issued a press release indicating that its AAA ratings of TIAA and TIAA-CREF Life were not affected by the transaction. On April 15, A. M. Beat issued a press release indicating that its A++ ratings of the two companies were not affected.

TIAA's Surplus Notes
In the lead article in the August 2010 issue of The Insurance Forum, I deplored the issuance of surplus notes by TIAA and The Northwestern Mutual Life Insurance Company. They were the last two holdouts against the tidal wave of surplus notes issued by financially strong life insurance companies following what I called the "revolution of 1993" prompted by The Prudential Insurance Company of America.

In December 2009, TIAA issued $2 billion of 30-year surplus notes at an annual interest rate of 6.85 percent. Moody's, in accordance with its practice of rating surplus notes two notches below the financial strength ratings of highly-rated issuers, rated the surplus notes Aa2.

On September 15, 2014, TIAA issued another $2 billion of surplus notes—$1.65 billion of 30-year surplus notes at an annual interest rate of 4.90 percent and $350 million of 40-year surplus notes at an annual fixed-to-floating interest rate of 4.375 percent. The net proceeds of the new surplus notes are intended to fund a portion of the cost of the acquisition of Nuveen and for general corporate purposes.

On September 15, Moody's issued a press release saying that it had rated the new surplus notes Aa2, and that the 2014 surplus notes and the 2010 surplus notes are on review for downgrade along with the Aaa ratings of TIAA and TIAA-CREF Life. Moody's indicated the 2014 surplus notes and the 2010 surplus notes, in terms of subordination, rank the same.

General Observations
Moody's said its Aaa ratings of TIAA and TIAA-CREF Life, and its Aa2 ratings of the surplus notes could be affirmed if the Nuveen acquisition is not completed, but likely will be lowered one notch if the transaction is completed. I have no recollection of ever seeing such a threat by a rating firm. Also, it appears there is a difference of opinion among the rating firms about the implications of the transaction, although S&P had already downgraded its ratings of the two TIAA companies by one notch in the wake of its 2011 downgrade of U.S. debt. After the transaction is completed, which seems likely, it will be interesting to see the effect Nuveen has on the operations of TIAA-CREF.

Although TIAA now has far more surplus notes outstanding than any other insurance company, the rating firms do not seem concerned. Perhaps their reasoning is that TIAA's surplus notes still represent only a small proportion of the company's capital. Nonetheless, I am uncomfortable that TIAA now has $4 billion of surplus notes outstanding.

I am offering a complimentary seven-page PDF consisting of my three-page August 2010 article about surplus notes and Moody's four-page September 15 press release. Send an e-mail to jmbelth@gmail.com and ask for the TIAA package.


Tuesday, September 16, 2014

No. 67: AIG Declares War against Coventry and the Buergers

On September 5, 2014, Lavastone Capital, a unit of American International Group (AIG), filed a complaint in federal court against Coventry First, an intermediary in the secondary market for life insurance. Later that day, Coventry filed a complaint in state court against Lavastone.

The Lavastone Complaint
The text of the Lavastone complaint is 151 pages long. There is an 89-page appendix showing "selected predicate acts" relating to 80 "fraudulently marked-up policies."

The plaintiff is Lavastone Capital LLC, an indirect subsidiary of AIG. The nine defendants are: Coventry First LLC (Fort Washington, PA), a wholly owned subsidiary of Montgomery Capital; LST I LLC and LST II LLC (Fort Washington, PA), wholly owned subsidiaries of Montgomery Capital; LST Holdings Ltd. (Dublin, Ireland), a wholly owned subsidiary of Montgomery Capital; Montgomery Capital Inc. (Fort Washington, PA), which is wholly owned by Alan Buerger, Constance Buerger, Reid Buerger, and/or other members of their families or trusts of which they are beneficiaries; Alan Buerger; Reid Buerger, son of Alan Buerger; Constance Buerger, wife of Alan Buerger; and Krista Lake, wife of Reid Buerger.

Lavastone makes 13 claims for relief. The first two claims, against all defendants, are for violations of the Racketeer Influenced and Corrupt Organizations (RICO) Act and for conspiracy to violate RICO. Three other claims, against all defendants, are for fraud, fraudulent inducement, and unjust enrichment. Six other claims, against Coventry, are for breach of contract, breach of the implied covenant of good faith and fair dealing, indemnity, negligent misrepresentation, faithless servant doctrine, and breach of fiduciary duty. Two other claims, against all defendants except Coventry, are for aiding and abetting breach of fiduciary duty and tortious interference with contract.

Lavastone seeks general and compensatory damages; treble damages in accordance with statute; injunctive relief, including an order permitting Lavastone to unwind its relationship with Coventry in an orderly fashion at Lavastone's direction; and a series of declaratory judgments. Lavastone also seeks disgorgement of compensation and other payments to Coventry; disgorgement of moneys received by the defendants as a result of their misconduct toward Lavastone; Lavastone's attorneys' fees and costs; punitive damages; and prejudgment interest. (Lavastone v. Coventry, U.S. District Court, Southern District of New York, Case No. 1:14-cv-7139.)

An Excerpt from the Lavastone Complaint
In the text of the Lavastone complaint, the description of the "Nature of the Case" consists of 14 paragraphs. Here is the first paragraph:
Lavastone brings this action to seek redress for Defendants' egregious criminal scheme to defraud Lavastone out of hundreds of millions of dollars. Lavastone enlisted Defendant Coventry First LLC ("Coventry") with the responsibility of finding attractive life insurance policies ("life settlements" or "Life Policies") for Lavastone to purchase from policyholders on the open market, and paid Coventry more than a billion dollars in fees to do so. In return, Coventry was obligated to convey to Lavastoneat cost, meaning exactly what Coventry paidthe Life Policies that it procured for Lavastone. Instead of fulfilling that obligation, Coventry formed an illegal enterprise with its co-conspirators, including the other Defendants here, in which they abused Lavastone's confidences, bought Life Policies at prices below what it knew in confidence Lavastone would pay to purchase them, "laundered" the Life Policies' titles and purchase prices through affiliated shell companies, and then induced Lavastone to purchase those Life Policies at inflated prices, marked up to approach or reach Lavastone's ceiling, unbeknownst to Lavastone. Defendants' fraudulent conduct breaches not only the Racketeer Influenced and Corrupt Organizations ("RICO") Act, 18 U.S.C. §§ 1961-1968, but also Coventry's contracts and fiduciary duties owed to Lavastone. Moreover, it has resulted in Defendants being unjustly enriched at Lavastone's expense. In sum, Defendants are scam artists whose criminal scheme to defraud Lavastone falls squarely within the very racketeering conduct that the RICO statute was intended to redress.
A Possibly Related Pending Lawsuit
In 2009, Ritchie Risk-Linked Strategies Trading (Ireland) filed a complaint in federal court against Coventry. The Ritchie complaint differs from the Lavastone complaint; however, Ritchie alleges that it suffered significant losses when it was forced into bankruptcy, and that Coventry is responsible for the losses. In November 2013, U.S. District Court Judge Jed Rakoff of the Southern District of New York presided over a ten-day bench trial in the Ritchie case. In December 2013, each party filed proposed post-trial findings of fact, and they also filed a joint stipulated list of admitted trial exhibits. Judge Rakoff has not yet handed down his decision in the Ritchie case. (Ritchie v. Coventry, U.S. District Court, Southern District of New York, Case No. 1:09-cv-1086.)

Lavastone, on the day it filed its complaint against Coventry, filed a "statement of relatedness" that the case is related to the Ritchie case. The Lavastone case has not yet been assigned to a judge, but it was referred to Judge Rakoff as a case that is possibly related to the Ritchie case.

In the Ritchie case, the plaintiff's proposed post-trial findings of fact include an incredibly detailed description of the events that led up to the filing of then New York Attorney General Eliot Spitzer's 2006 civil lawsuit in state court against Coventry. That case was settled in 2009 by then New York Attorney General Andrew Cuomo. (See the January/February 2007, December 2007, and December 2009 issues of The Insurance Forum.)

The Coventry Complaint
The text of the Coventry complaint is 20 pages long. There are five appendixes: a 28-page appendix showing a 2011 arbitration award in a dispute between an AIG subsidiary and a premium finance company, a 245-page appendix showing a 2010 registration statement filed with the Securities and Exchange Commission by Imperial Holdings, Inc., and three "Origination Agreements" between Lavastone and Coventry that Coventry says it will seek to file under seal.

The plaintiff is Coventry, and the defendant is Lavastone. Coventry makes two claims; one is for breach of contract, and the other is for a declaratory judgment. Coventry seeks monetary damages it suffered as a result of Lavastone's breach of the exclusivity provision of the Origination Agreements. Coventry also seeks a series of declaratory judgments. (Coventry v. Lavastone, Supreme Court of the State of New York, County of New York, Index No. 652712/2014.)

An Excerpt from the Coventry Complaint
Coventry's opening description of the "Nature of the Case" consists of eight paragraphs. Here is the first paragraph:
For more than a decade, Coventry First and Lavastone, along with their respective predecessors and affiliates, have been parties to a series of agreements ("Origination Agreements") by which Coventry First acquired life insurance policies on the secondary market and sold them to Lavastone. Lavastone, formerly known as AIG Life Settlements LLC, is an affiliate of American International Group, Inc. ("AIG") and acquired these life insurance policies for the asset portfolio of the AIG family of companies. Lavastone not only has breached the Origination Agreements, but also wants to change the terms of the deal it made. Thus, after many years of amicable and cooperative dealings under the Origination Agreements, Lavastone's new business team now refuses to honor its obligations. But instead of bargaining for its desired changesand in an effort to escape contractual provisions that affect Lavastone's ability to resell the policies (such as privacy restrictions to protect insureds)Lavastone now accuses Coventry First of breaches. The contractual provisions Lavastone seeks to escape have an estimated value to the portfolio, and to Coventry First, of $700 million. To date, to Coventry First's knowledge, AIG has not revealed these restrictions in its annual securities filings.
"Hank" Greenberg Got It Right in 2001
In May 2005, then Attorney General Spitzer and then New York Superintendent of Insurance Howard Mills filed a civil complaint in state court against AIG, then AIG chairman and chief executive officer Maurice "Hank" Greenberg, and another AIG senior officer. One section of the complaint dealt with "life settlements." The complaint said AIG entered the business with Coventry in 2001, and included the allegation that AIG was falsely reporting income from life settlements as underwriting income. The complaint said: "AIG and Greenberg decided as a public relations matter that it was best not to use the AIG name to handle its life settlements business...." The complaint said Greenberg had expressed this comment in April 2001 to the AIG executive heading up the life settlements initiative: "It seems to me that anybody doing anything in the field stands the risk of adverse PR.... I am uneasy about this." I think Greenberg was right to be "uneasy" about the life settlements business. (See the August 2005 issue of The Insurance Forum.)

General Observations
I believe that the Coventry lawsuit is not a response to the Lavastone lawsuit. Rather, I believe that Coventry knew Lavastone was preparing to file a lawsuit, and that Coventry prepared a lawsuit in advance in order to be able to file it immediately after the filing of the Lavastone lawsuit. Indeed, in news stories published electronically on September 5, after the filing of the Lavastone lawsuit, Alan Buerger, the chief executive officer of Coventry, was quoted as saying he had not yet seen the Lavastone lawsuit. Although I was able to obtain the Coventry lawsuit from the state court late on September 5, I was not able to obtain the Lavastone lawsuit from the federal court until late on September 9.

The Lavastone lawsuit is a sweeping attack not only on Coventry, but also on the Coventry group of companies and the Buerger family. The allegations are so extensive and so detailed that I think the Lavastone lawsuit is an effort to destroy Coventry and the Buerger family. In my opinion, the Lavastone lawsuit is the beginning of an outright war.

I am offering two complimentary PDFs. One is the 151-page text of the Lavastone complaint and the other is the 20-page text of the Coventry complaint. Send an e-mail to jmbelth@gmail.com and ask for the two Lavastone-Coventry documents.