Wednesday, December 30, 2015

No. 136: Ben Bernanke's Fascinating Memoir

Ben Bernanke chaired the Federal Reserve from 2006 to 2014, a period that encompassed the Great Recession of 2007-2009. He has written a fascinating book entitled The Courage to Act: A Memoir of a Crisis and Its Aftermath. The book was published October 5, 2015.

The Prologue about AIG
For persons interested in insurance, Bernanke's six-page prologue immediately grabs the reader's attention. He describes the difficult and controversial decision to rescue American International Group (AIG) from bankruptcy. He made the final decision at 9:00 p.m. on Tuesday, September 16, 2008, on the heels of his decision to rescue Bear Stearns and immediately following "Lehman Weekend," which ended with the bankruptcy filing by Lehman Brothers at 1:45 a.m. on Monday.

Maurice ("Hank") Greenberg was AIG's longtime chief executive officer. He retired in 2005 in the midst of an accounting scandal. In November 2011, he filed a pair of lawsuits against the U.S. government alleging the terms of the 2008 rescue were unfair to AIG shareholders. I wrote about the lawsuits in the April 2013 issue of The Insurance Forum and in No. 106 (posted June 24, 2015). In writing the conclusion of the April 2013 article, I considered but decided against using the word "chutzpah" to characterize the lawsuits. Instead, I expressed agreement with observers who viewed the lawsuits as an attempt to rewrite the terms of the rescue. Bernanke, however, in his chapter about AIG, calls the lawsuits "a remarkable demonstration of chutzpah."

Structure of the Book
The 579-page text of Bernanke's memoir is divided into three parts and 23 chapters. Here is the outline:
I Prelude
1 Main Street
2 In the Groves of Academe
3 Governor
4 In the Maestro's Orchestra
5 The Subprime Spark
6 Rookie Season
II The Crisis
7 First Tremors, First Response
8 One Step Forward
9 The End of the Beginning
10 Bear Stearns: Before Asia Opens
11 Fannie and Freddie: A Long, Hot Summer
12 Lehman: the Dam Breaks
13 AIG: "It Makes Me Angry"
14 We Turn to Congress
15 "Fifty Percent Hell No"
16 A Cold Wind
17 Transition
18 From Financial Crisis to Economic Crisis
III Aftermath
19 Quantitative Easing: The End of Orthodoxy
20 Building a New Financial System
21 QE2: False Dawn
22 Headwinds
23 Taper Capers
The book includes an epilogue ("Looking Back, Looking Forward"), acknowledgments, a note on sources, a selected bibliography, and an index. To save space and paper, detailed chapter and page notes are in a 56-page easy-to-read PDF that may be found at and by clicking on "Notes."

General Observations
In the opening chapters, Bernanke describes his early life in the small town of Dillon, South Carolina, and his strong academic career encompassing Harvard, Massachusetts Institute of Technology, Stanford, and Princeton. He describes his work as a member of the Federal Reserve Board, his service on the President's Council of Economic Advisers, his nomination by President George W. Bush to succeed Alan Greenspan as chairman of the Fed, and his renomination to a second four-year term as chairman by President Obama.

The remainder of the book describes the origins of the Great Recession and the actions Bernanke and others took to address the crisis. The chapters on the rescue of Bear Stearns, the failure of Lehman Brothers, the rescue of Fannie Mae and Freddie Mac, and the rescue of AIG are especially interesting.

Bernanke's writing is crisp and easy to read. The book is written to educate people who have a limited grasp of monetary policy, rather than for monetary experts and technicians. Many disagree—in some cases strongly—with Bernanke's views. In the book, however, he goes out of his way to describe in detail the arguments on all sides of the many aspects of monetary policy.

Bernanke's comments on individuals who worked hard with him and against him are fascinating. Especially interesting to me are his comments on central bank leaders around the world, his observations about individual members of Congress, and the manner in which he describes briefly the backgrounds of many of the people he mentions.

I think the Bernanke memoir is well worth reading. It is a gripping account of our nation's—and the world's—worst financial crisis since the Great Depression. I strongly recommend reading every page of the book.

Available Material
I am making available a complimentary four-page PDF containing my article entitled "Hank Greenberg Sues the U.S. Government" in the April 2013 issue of The Insurance Forum. Email and ask for the article about Greenberg's lawsuits against the U.S. government.


Monday, December 28, 2015

No. 135: The Office of Financial Research in the U.S. Department of the Treasury Issues Its First Financial Stability Report

In 2010, in response to the Great Recession of 2007-2009, Congress enacted The Dodd-Frank Wall Street Reform and Consumer Protection Act. The Dodd-Frank Act established the Office of Financial Research (OFR) as an independent bureau within the U.S. Department of the Treasury. Richard Berner is Director of the OFR. The OFR issued annual reports for 2012, 2013, and 2014, and will issue its annual report for 2015 in January 2016.

The Financial Stability Report
On December 15, 2015, the OFR issued its 142-page first Financial Stability Report, which the OFR describes as supplementing and preceding the annual report for 2015. The Financial Stability Report has an executive summary, a glossary, a bibliography, and five major sections: "Assessing and Monitoring Threats to Financial Stability," "Evaluating Financial Stability Policies," "Data Needs for Financial Stability Analysis," "Research on Financial Stability," and "Agenda Ahead."

Excerpts from the Financial Stability Report
The OFR's Financial Stability Report contains some important references to the insurance industry. Here are a few of those comments, with page numbers shown in brackets at the end of each comment:
[T]here are some indications of rising risks in the insurance sector, but progress on adopting heightened prudential standards for designated U.S. insurers remains slow. The relative lack of transparency about the process for identifying global systematically important insurers [G-SIIs] precludes public evaluation of how the risks they pose are changing over time. [Page 3]
In July 2013, the Financial Stability Board [an international coordinating body that monitors financial system developments on behalf of the G-20 nations] released an initial list of nine G-SIIs that were identified using the International Association of Insurance Supervisors (IAIS) assessment methodology. [Page 51]
The 2015 list of designated G-SIIs included three U.S. companies that FSOC [the Financial Stability Oversight Council, which was created by the Dodd-Frank Act and is chaired by the Secretary of the U.S. Department of the Treasury] has separately designated as companies whose material financial distress could pose a threat to U.S. financial stability and required additional oversight from the Federal Reserve: American International Group, Inc., MetLife Inc., and Prudential Financial Inc. The G-SII list also included six non-U.S. companies: Aegon N.V., Allianz SE, Aviva plc, AXA S.A., Ping An, and Prudential plc. [Page 51]
Broadly, the IAIS G-SII designation identifies insurance firms whose failure or distress could have adverse consequences in financial markets due to their size, market position, and global interconnectedness. At a later date, the IAIS is expected to update its assessment methodology to include reinsurance companies as well as revise its definition of nontraditional and noninsurance activities of G-SIIs. [Page 51]
[M]uch of the data for the IAIS's G-SII assessment methodology are not publicly available. The lack of disclosure of systemic importance data for G-SIIs and insurers just below the G-SII threshold precludes public evaluation of these firms' systemic footprint and how that may be changing over time. [Pages 51-52]
U.S. insurance companies currently are not subject to prudential standards on a consolidated basis to capture risks that they may be taking in noninsurance affiliates that are not subject to state-based supervision. [Page 52]
[T]he risks that some large life insurers pose to financial stability may be rising, according to certain market-based measures. [Page 53]
Financial statements filed with state regulators are the most reliable source of public information for U.S. insurance companies, but permitted deviations make it difficult to compare data across the industry. [Page 89]
Some regulators have expressed concern that too much flexibility by states in the treatment of insurance risks could encourage regulatory arbitrage by companies. [Page 89]
The lack of transparency in the activities of captive reinsurers within the U.S. life insurance industry is an area where more comprehensive access to additional data is needed. [Page 89]
Relatively little information is publicly available about captives' activities, capitalization, asset liability management, types of business reinsured, and the resulting reserve and capital benefits to the parent, or ceding, insurer. [Page 90]
There are also gaps in data available to analyze the risks insurance companies take in derivatives, variable annuities, and securities lending activities. [Page 91]
Related Recent Developments
On December 17, 2015, the FSOC approved a resolution reaffirming the G-SII designation of Prudential Financial Inc. The vote was eight to one; the independent member with insurance expertise opposed the resolution, and the Chair of the Securities and Exchange Commission recused herself.

MetLife Inc. has challenged its G-SII designation in court. The case is currently pending.

General Observations
Many observers of the Great Recession of 2007-2009 have said, based on hindsight, that the crisis took policy makers and the public by surprise. Therefore, one of the significant reforms undertaken in the wake of the crisis grew out of the perceived need for periodic reports not only for the benefit of policy makers but also for the benefit of members of the public about potential problems in our financial system. Dodd-Frank created the OFR for that purpose. The Financial Stability Report should be read not only by policy makers but also by members of the public.

Available Material
I am making available a complimentary 147-page PDF consisting of the OFR's 142-page Financial Stability Report and the FSOC's five-page resolution relating to Prudential Financial Inc. Send an e-mail to and ask for the December 2015 OFR/FSOC package.


Monday, December 21, 2015

134: Federal Criminal Charges Result in the Sentencing of an Insurance Executive to 37 Years in Prison

On December 10, 2015, U.S. District Judge William D. Quarles, Jr. sentenced Jeffrey Brian Cohen (Reisterstown, MD) to 37 years in prison on federal criminal charges. On the same day, the U.S. Attorney in Maryland issued a four-page press release entitled "Jeffrey Cohen Sentenced to 37 Years in Prison in Massive Insurance Fraud Scheme." The subtitle is "Defendant Fraudulently Obtained More Than $100 Million in Premiums from Thousands of Insureds for His Personal Benefit; Then He Planned to Kill Attorneys, Judge and Government Official." The U.S. Attorney said: "The evidence demonstrated that Jeffrey Cohen was a chronic con artist who was planning to commit murder to prevent his fraud schemes from coming to light." Assisting the U.S. Attorney in the investigation were the Federal Bureau of Investigation, Homeland Security Investigations, the Internal Revenue Service, and the Postal Inspection Service. (See U.S. v. Cohen, U.S. District Court, District of Maryland, Case No. 1:14-cr-310.)

Cohen, now aged 40, was president and chairman of the board of Indemnity Insurance Corporation RRG (Sparks, MD). He also controlled several other entities. Indemnity was domiciled in Delaware for regulatory purposes. Indemnity sold general liability insurance, liquor liability insurance, and excess liability insurance in several states. In 2012 Indemnity had more than 3,000 policyholders, especially in the entertainment industry, and collected more than $25 million in premiums.

Cohen diverted, to his own personal benefit, premiums intended for Indemnity. To conceal the missing company assets, Cohen submitted fraudulent financial statements and other fraudulent documents to insurance regulators, independent accounting firms, banks, reinsurance companies, a premium finance company, and policyholders. He also provided fraudulent documents to A. M. Best Company, which assigned an A– (Excellent) financial strength rating to Indemnity. Cohen touted Best's rating to customers and others.

Cohen threatened, attempted to intimidate, and even planned to kill attorneys involved in grand jury proceedings and Delaware government officials. He acquired powerful weapons, ammunition, and explosive materials. He created a "Target List" and assembled information about the potential victims' home addresses and family members.

Criminal Charges
On June 24, 2014, the U.S. Attorney filed a five-count indictment against Cohen. A magistrate judge issued a detention order and appointed a public defender. On September 16 the U.S. Attorney filed a 12-count superseding indictment. Cohen pleaded not guilty on all counts. On November 17, after Cohen chose to represent himself, a magistrate appointed a standby attorney for Cohen.

On November 25, 2014, the U.S. Attorney filed a 31-count second superseding indictment. On December 2 the U.S. Attorney filed a 31-count third superseding indictment. The latter included counts of wire fraud, aggravated identity theft, false statements to an insurance regulator, obstruction of justice, and money laundering. On March 30, 2015, Cohen pleaded not guilty on all counts.

Trial and Sentence
On June 1, 2015, a jury trial began before Judge Quarles. It was expected to last four weeks. However, after four days, Cohen pleaded guilty to one count each of wire fraud, aggravated identity theft, false statement to an insurance regulator, and obstruction of justice. The U.S. Attorney dropped the other 27 counts. On August 3 Cohen filed a motion to withdraw his guilty plea. On September 10 the judge denied the motion.

On December 10 Judge Quarles announced verbally in court that he was sentencing Cohen to 37 years in prison, followed by three years of supervised release. On the same day, Cohen filed what purports to be a notice that he will appeal to the U.S. Court of Appeals for the Fourth Circuit despite the fact that the plea agreement says "the defendant knowingly waives all right, pursuant to 28 U.S.C. §1291, or otherwise, to appeal the defendant's conviction and whatever sentence is imposed."

On December 14 Judge Quarles filed a judgment confirming the sentence and requiring Cohen to pay restitution of $137 million. Here are the key provisions relating to the sentence:
The defendant is hereby committed to the custody of the United States Bureau of Prisons to be imprisoned for a period of 240 months as to Count 1 [wire fraud]; 180 months as to count 24 [false statement to a regulator] to run consecutive to Count 1; 240 months as to Count 28 [obstruction of justice] to run concurrent to Counts 1 and 24; and 24 months as to Count 20 [aggravated identity theft] to run consecutive to Counts 1, 24 and 28 for a total of 444 months.
Upon release from imprisonment, the defendant shall be on supervised release for a term of 3 years as to Counts 1, 24, and 28 to run concurrent to each other; and 1 year as to Count 20 to run concurrent to Counts 1, 24, and 28 for a total term of 3 years.
General Observations
There are at least four interesting aspects of this case. First, despite the seriousness of the charges, Cohen chose to represent himself rather than retain an attorney. Initially a magistrate appointed a federal public defender. Cohen soon rejected the public defender and chose to represent himself; a magistrate then appointed a standby attorney. Still later Cohen rejected the standby attorney. Finally, when he submitted what purports to be a notice of appeal, he requested an attorney.

Second, according to the plea agreement, "Cohen re-domiciled to Delaware after difficulties in District of Columbia." I have filed public records requests with the Delaware and District of Columbia insurance departments seeking documents relating to the redomestication process.

Third, the case began with civil charges by the Delaware insurance commissioner. Later the case was referred to federal prosecutors and other federal authorities.

Fourth, the Cohen case was reported in local media outlets, but I believe that the case was not reported in major outlets such as The New York Times and The Wall Street Journal. My first knowledge of the case was a story in A. M. Best's BestDay by Washington correspondent Frank Klimko on December 11, the day after the U.S. Attorney's press release.

Available Material
I am offering a 50-page complimentary PDF consisting of four items: the four-page press release issued by the U.S. Attorney, the 25-page third superseding indictment, the 15-page plea agreement, and the six-page judgment. E-mail and ask for the December 2015 package relating to the case of U.S. v. Cohen.


Wednesday, December 16, 2015

No. 133: Unclaimed Property—The Battle Heats Up as Three Insurers File a Lawsuit against an Auditing Firm and a State Treasurer

Verus Financial LLC (Waterbury, CT) audits insurance companies on behalf of state treasurers about unclaimed property held by the companies. Michael Frerichs is the Illinois State Treasurer. United Insurance Company of America (Chicago, IL), Reserve National Insurance Company (Oklahoma City, OK), and Reliable Life Insurance Company (St. Louis, MO) are among several companies in the Kemper group and are referred to here as "Kemper."

On October 26, 2015, Kemper filed a lawsuit in an Illinois state court against Frerichs and Verus. The lawsuit is a preemptive action following an October 6 "final notice and demand" and threat of legal action by Frerichs to compel production of data.

On November 2, 2015, Frerichs issued a press release about the lawsuit. He has not yet responded to the lawsuit in court. (See United v. Frerichs, Seventh Judicial Circuit Court, Sangamon County, Illinois, Case No. 2015-MR000998.)

Kemper's Complaint
Kemper's 31-page complaint contains 11 counts. Ten are requests for declaratory judgments and one is a request for injunctive relief. Here are the counts:
  1. Kemper has no obligation arising under Illinois law to use the Social Security Death Master File (DMF) to determine whether insureds are deceased and benefits are due and payable.
  2. The dormancy period under Illinois law commences with Kemper's receipt of proof of an insured's death or attainment of the mortality limiting age (often age 100), not an insured's date of death.
  3. The Frerichs unclaimed property audit of Kemper is unlawful because he has not shown he has reason to believe that Kemper failed to report unclaimed property in Illinois.
  4. Frerichs and Verus cannot compel Kemper to provide policy records for comparison against the DMF for the purpose of seeking to create unclaimed property.
  5. Frerichs and Verus can only obtain records related to policies which were in force during the five years prior to commencement of the audit.
  6. The request by Frerichs and Verus is ultra vires [in excess of legal authority], overbroad, and unduly burdensome, and thus violates Kemper's rights under the Fourth Amendment of the U.S. Constitution.
  7. The request by Frerichs and Verus is ultra vires, overbroad, and unduly burdensome, and thus violates Kemper's rights under Article 1, Section 6 of the Illinois Constitution.
  8. The request by Frerichs and Verus violates Kemper's due process rights under the Fourteenth Amendment of the U.S. Constitution.
  9. The request by Frerichs and Verus violates Kemper's due process rights under Article 1, Section 2 of the Illinois Constitution.
  10. Frerichs failed to follow requirements of the Illinois Administrative Procedure Act in promulgating rules.
  11. Kemper needs injunctive relief barring Frerichs and Verus from requiring Kemper to produce policy records to enable DMF comparison and requiring Kemper to pay or escheat policy proceeds to the state based on the results of such a comparison.
Exhibits to Kemper's Complaint
Attached to Kemper's complaint are 161 pages showing 14 exhibits that are referred to in the complaint. Here are the exhibits:
  1. The original 2008 contract between Frerichs' predecessor and Verus.
  2. The current 2015 contract between Frerichs and Verus.
  3. A sample policy issued by United.
  4. A sample policy issued by Reserve.
  5. A sample policy issued by Reliable.
  6. The multistate settlement agreement entered into by Verus and the Pacific Life companies several years ago.
  7. An August 8, 2011 letter from the Illinois Unclaimed Property Division to Verus authorizing an audit of Kemper.
  8. An August 19, 2011 letter from Verus to Kemper notifying Kemper of the audit.
  9. A November 7, 2011 letter from Kemper to Verus containing requests relating to the audit.
  10. A March 28, 2012 letter from Kemper to Verus containing further requests relating to the audit.
  11. A June 29, 2012 letter from Kemper to Verus expressing concerns about the data requested by Verus.
  12. A May 3, 2012 memorandum from Verus to Kemper containing details of the data request from Verus. [Note that exhibits 11 and 12 are out of date sequence.]
  13. A July 17, 2012 letter from Verus to Kemper in response to the June 29, 2012 letter from Kemper.
  14. An October 6, 2015 letter from Frerichs to Kemper containing a "final notice and demand" that Kemper produce the requested data by October 16, 2015, or Frerichs "will take the necessary legal steps to compel production."
The Frerichs Press Release
The Frerichs two-page press release is entitled "Kemper Companies Sue to Block Audit to Confirm Payment of Life Insurance Policies." The subtitle is "Audits of Other Life Insurance Companies Identified More Than $195 Million Owed to Grieving Families."

My reason for mentioning the press release is that Frerichs and Verus have not yet responded to the complaint in court, and the press release provides at least an inkling of Frerichs' views. The press release says Frerichs has asked Illinois Attorney General Lisa Madigan to represent the state's interests in the lawsuit. The press release attributes this statement to Frerichs:
We made a simple request to audit these companies to determine whether they are holding onto unpaid death benefits. I can only guess as to why their lawyers responded with a lawsuit rather than work with us to help those who have suffered a death in their family.
My Articles about Unclaimed Property
I wrote articles about unclaimed property in the October 2010, November 2010, and December 2010 issues of The Insurance Forum. The first article was prompted by a story in Bloomberg Markets magazine alleging that life insurance companies were "secretly profiting from death benefits owed to the survivors of service members and other Americans" through so-called retained asset accounts. The second article reported the results of my survey of 20 large states and 20 large life insurance companies in an effort to learn the magnitude of unclaimed property turned over (escheated) to states by life insurance companies. The third article was a follow-up to my first article about retained asset accounts.

General Observations
I have three comments about unclaimed property in connection with life insurance. First, the insuring agreement in a life insurance policy usually says the company pays the death benefit when the company receives proof of the insured's death. For example, the key sentence in United's sample policy says "Payment will be made after we receive proof of the insured's death, subject to the terms of this policy." Interestingly, there is often no mention of the filing of a death claim, suggesting that the company could obtain the proof of death on its own volition. It should be recognized that it may be unrealistic to require a beneficiary, who may be unaware of the existence of the insurance, to notify the company of the insured's death. I think it is wrong to say the beneficiary's ignorance frees the company from responsibility.

Second, I have long argued that companies should be required to mail a report at least once a year to every policyholder irrespective of whether a premium payment is due. The mailing should be made in such way that the postal service will notify the company of a change of address when it forwards mail to a new address, and will return mail that was undeliverable because no forwarding address is on file. Such information would alert the company in a timely manner each year to policyholders with whom the company has lost contact. It would also alert the company to insureds who might be deceased. To my knowledge, no state insurance law or regulation has ever required life insurance companies to mail annual reports to policyholders.

Third, what brought unclaimed property held by life insurance companies to national attention was the demutualization wave beginning in the early 1990s. To complete a demutualization, a mutual company must contact its policyholders to ask for their approval of the demutualization plan, and later must send them cash and/or stock to which they are entitled. Some demutualizing companies received a deluge of undelivered mail, thus showing they had huge numbers of lost policyholders. It is ironic that the problem initially was ignored by state insurance regulators. Instead, the problem was addressed by state treasurers. They have a vested interest in obtaining unclaimed property, most of which never reaches the rightful owners and therefore remains forever with the states.

Available Material
I am making available a complimentary 206-page PDF consisting of four items: the 31-page complaint by Kemper against Frerichs and Verus, 161 pages of exhibits to the complaint, the two-page press release issued by Frerichs, and 12 pages containing the three 2010 articles in The Insurance Forum about unclaimed property. E-mail and ask for the December 2015 unclaimed property package.


Friday, December 11, 2015

No. 132: Stranger-Originated Life Insurance—More on the Wertheim Criminal Case

In No. 131 (December 9, 2015) I discussed an appellate opinion affirming the conviction and sentencing of three stranger-originated life insurance (STOLI) promoters on federal criminal charges in the Binday case. I also briefly mentioned the Wertheim case, which I discussed in detail in the October 2013 issue of The Insurance Forum, and which I discuss further here. I also discussed deterrence, an important issue in both the Binday and Wertheim cases. (See U.S. v. Wertheim, U.S. District Court, District of New Hampshire, No. 1:12-cr-136.)

Background of the Wertheim Case
On September 27, 2011, a federal investigation of Imperial Holdings Inc. (Boca Raton, FL), a firm that was in the life insurance premium financing business, became public when federal agents raided Imperial's headquarters. On April 30, 2012, Imperial and the U.S. Attorney in New Hampshire entered into a non-prosecution agreement under which Imperial terminated its life insurance premium financing business, terminated its employees involved in that business, admitted to and accepted responsibility for certain improper conduct, and paid a monetary penalty of $8 million. Also, Jonathan Neuman, Imperial's president and chief operating officer, resigned.

On October 31, 2012, the U.S. Attorney charged Robert Wertheim with one count of conspiracy to commit mail fraud and wire fraud. On February 20, 2013, the U.S. Attorney charged two brothers—Abraham Kirschenbaum (AK) and Maurice Kirschenbaum (MK)—with one count of conspiracy to commit mail fraud and wire fraud. AK and MK were tax advisers.

On February 26, 2013, Wertheim pleaded guilty and signed a plea agreement. On March 7, 2013, AK and MK pleaded guilty and signed plea agreements. Wertheim said that he had been working with Imperial, that he had recruited AK and MK to identify prospects for the STOLI scheme, and that the scheme had involved lying on life insurance applications. There were long delays in sentencing the defendants.

Recent Developments
On May 22, 2015, the U.S. Attorney, with the assent of MK, filed a motion to dismiss the conspiracy charge against MK. According to the motion, MK had been diagnosed with cancer in March 2014, by March 2015 the condition had become more serious, and currently MK was undergoing aggressive treatment. Further details about MK's medical condition were filed under seal. Attached to the motion was a deferred prosecution agreement under which the government may refile the criminal charge at its discretion within five years, at which time MK would, among other things, plead guilty and waive any defense of double jeopardy. U.S. District Court Judge Paul Barbadoro granted the motion.

On May 27, 2015, Judge Barbadoro held back-to-back sentencing hearings for Wertheim and AK. Each hearing lasted 55 minutes, including sealed discussion of the ongoing investigation in which it was anticipated that Wertheim and AK would cooperate and might even testify. The transcripts became readily available in the public court file on September 24, 2015. I obtained them on December 7, 2015.

The government sought probation and minimal financial penalties for Wertheim and AK. Home confinement was also mentioned as a possibility instead of prison time. Among the arguments for probation and minimal fines were the promptness with which they had pleaded guilty, their remorse, and their willingness to assist the government in prosecuting and testifying against other defendants who might be criminally charged in the ongoing investigation.

Judge Barbadoro, however, felt Wertheim and AK should serve at least some prison time for deterrence purposes. The judge deviated downward from the sentencing guidelines and ordered each of the two defendants to serve 18 months in a minimum-security facility, followed by two years of supervised release. They were each fined $7,500, and AK forfeited $1 million.

Judge Barbadoro agreed to defer for one year the need for Wertheim and AK to begin serving their prison time. The judge left open the possibility that the government and/or the defendants would refile within a year for a further reduction in—or even elimination of—prison time as a result of Wertheim's and AK's further cooperation in the ongoing investigation. Therefore the judge ordered Wertheim and AK to report to prison on May 27, 2016.

General Observations
The transcripts of the sentencing hearings are fascinating. They vividly illustrate how the U.S. Attorney, the defense attorneys, and Judge Barbadoro wrestled with the problem of how to arrive at appropriate sentences. Included in the discussions were references to the need for deterrence, the past and potential future cooperation of the two defendants in the ongoing investigation, and other factors that had to be considered.

As I said in No. 131, I do not understand how deterrence can be effective without broad publicity about the punishment. In that regard, I am aware of no major media coverage of the Wertheim case. Nor am I aware of any coverage of the case in the insurance press beyond my article in The Insurance Forum.

Nowhere in the documents I reviewed was there specific reference to what ongoing investigation might require further cooperation and even testimony from the two defendants. However, because Wertheim and AK had worked with Imperial, it seems likely that the ongoing investigation involves current and/or former officials of Imperial.

Available Material
I strongly urge interested persons to read the 32-page transcript of the Wertheim hearing and the 42-page transcript of the AK hearing. They are in large type, double-spaced, and easy to read. I am making them available in separate complimentary PDFs. E-mail and ask for the transcripts of the two May 2015 sentencing hearings in the Wertheim case.


Wednesday, December 9, 2015

No. 131: Stranger-Originated Life Insurance—A Federal Appellate Court Affirms the Conviction and Sentencing of Three Promoters on Criminal Charges

On October 26, 2015, a three-judge appellate court panel unanimously affirmed the criminal conviction and sentencing of Michael Binday, James Kevin Kergil, and Mark Resnick on federal criminal charges related to a fraudulent stranger-originated life insurance (STOLI) scheme. The panel consisted of Circuit Court Judges Gerard Lynch, José Cabranes, and Robert Sack. Judge Lynch wrote the 97-page opinion. (See U.S. v. Binday, U.S. Court of Appeals, Second Circuit, No. 14-2809-cr.)

In February 2012 the government filed charges and the case was assigned to District Court Judge Colleen McMahon. The government charged each defendant with mail fraud, wire fraud, and conspiracy to commit mail fraud and wire fraud. The government also charged Kergil and Resnick with conspiracy to destroy records and obstruct justice. The government initially charged Binday with obstruction of justice, but Judge McMahon later dismissed that charge. (See U.S. v. Binday, U.S. District Court, Southern District of New York, No. 1:12-cr-152.)

In September and October 2013 Judge McMahon presided over an 11-day trial. The jury found the defendants guilty on all counts.

In July 2014 Judge McMahon sentenced Binday to 12 years, Kergil to nine years, and Resnick to six years, in each instance followed by three years of supervised release. She also ordered the defendants to pay a total of $39.3 million in restitution to eight life insurance companies.

In November 2015, after the appellate ruling, Judge McMahon assigned Binday and Resnick to a minimum-security facility in Pennsylvania, and Kergil to a minimum-security facility in New York. She ordered them to report on January 5, 2016.

I wrote about the case in the May 2012 and April 2013 issues of The Insurance Forum. I also discussed the case in No. 5 (October 30, 2013) and No. 60 (August 6, 2014).

The Appellate Opinion
The introductory section of the appellate opinion includes a summary. It reads in part:
The convictions arise from an insurance fraud scheme whereby defendants, who were insurance brokers, induced insurers to issue life insurance policies that defendants sold to third-party investors, by submitting fraudulent applications indicating that the policies were for the applicants' personal estate planning. Defendants argue primarily that the government did not prove that they contemplated harm to the insurers that is cognizable under the mail and wire fraud statutes. That basic argument takes several forms, including a sufficiency of the evidence challenge, a constructive amendment claim, and a jury instruction challenge. Defendants also contend that their sentences are procedurally unreasonable because the district court used an erroneous loss amount in calculating their Guidelines sentence ranges. Additionally, Resnick and Kergil challenge their obstruction convictions on various grounds.
We conclude that there was sufficient evidence that defendants contemplated a cognizable harm under the mail and wire fraud statutes; that the indictment was not constructively amended because the allegations in the indictment and the government's proof at trial substantially correspond; and that some aspects of the defendants' challenge to the jury instruction are waived, while the remainder fail on the merits. We reject defendants' challenges to their sentences, and Kergil's and Resnick's challenges to their obstruction of justice convictions.
Accordingly, for the reasons given herein, we affirm the judgments of conviction and remand the case for the limited purpose of revising the restitution amount as agreed by the parties.
Structure of the Opinion
The background section of the opinion describes the defendants' scheme, the indictment, the trial, and the sentencing. The discussion section of the opinion examines mail and wire fraud, comments on Resnick's challenges to the obstruction of justice charges, and explores the defendants' challenges to the sentencing.

The opinion notes that, after the district court's judgment had been entered, the parties agreed the total restitution should be reduced from $39.3 million to $37.4 million. That is why the appellate court sent the case back to the district court for the limited purpose of revising the restitution order to reflect the amount agreed upon by the parties.

The Deterrence Issue
Near the end of the discussion section of the opinion is a review of the deterrence issue. Here, with citations omitted, are two paragraphs on this subject from the opinion and an important footnote:
Kergil, alone among the defendants, challenges his sentence as substantively unreasonable. He contends that his sentence is excessive because at the time of defendants' conduct fraudulent STOLI policies were "a matter for civil litigation rather than criminal indictment," and because his sentence of nine years' imprisonment far exceeds what was necessary to deter similar fraud among other brokers. We reject those arguments....
Kergil cannot meet our high bar for vacating a sentence as substantively unreasonable. He took part in a sophisticated, multi-million dollar fraud scheme. And when the FBI began investigating the scheme, he directed co-conspirators to obstruct justice by destroying incriminating documents. Notably, Kergil's sentence fell below his Guidelines range (even when adjusting the loss amount to include only commissions).* Given Kergil's culpability and the district court's reasonable determination that the sentence should serve as a deterrent to other brokers, the 108-month sentence does not shock the conscience. 
*As evidence that addressing frauds of this sort was previously left to civil litigation, Kergil cites as examples nine civil cases in which insurers sought to rescind STOLI policies based on fraudulent applications. But that STOLI frauds continued despite repeated civil enforcement supports the district court's conclusion that more significant deterrence was appropriate.
General Observations
Kergil is correct about STOLI fraud usually being handled through civil rather than criminal litigation. However, this is not the first criminal case. As examples, see the case of Robert Wertheim and two associates discussed in the October 2013 issue of The Insurance Forum, and the case of Vincent Bazemore discussed in No. 96 (April 29, 2015). There is also the case of Joseph Caramadre discussed most recently in No. 17 (January 2, 2014), although that case dealt with stranger-originated annuities rather than STOLI.

Judge McMahon and the appellate court judges are also correct about the need for strong deterrence to discourage insurance agents and brokers from fleecing insurance companies through brazen STOLI schemes. But deterrence cannot occur when there is no publicity about the criminal cases. For example, there has been no prominent media coverage of the Binday, Wertheim, and Bazemore cases. Indeed, it is inexplicable that there has been virtually nothing about those cases even in the insurance press. I would be interested in hearing from readers about the extent to which insurance companies inform their agents and brokers about STOLI criminal litigation, or even about STOLI civil litigation.

Available Material
Anyone interested in the Binday case should read the opinion from the Second Circuit. I am making it available as a complimentary 97-page PDF. E-mail and ask for the October 2015 appellate opinion in the Binday case.

Monday, December 7, 2015

No. 130: Surplus Notes—A Special Report from A. M. Best

On November 11, 2015, A. M. Best Company (Oldwick, NJ), a rating firm, issued a special report entitled "Surplus Notes Overview." Readers of The Insurance Forum over the years and readers of this blog are aware of my longtime keen interest in surplus notes. I also devoted a chapter to the subject in my new book, The Insurance Forum: A Memoir.

Contents of the Report
Best's report provides information about the aggregate amount of surplus notes outstanding in insurance companies at the end of various years from 2000 to 2014. By the end of 2014, for example, 526 insurance companies had issued 1,200 surplus notes. They totaled $47.8 billion, or 16.6 percent of the total capital (excluding asset valuation reserve) of the companies with surplus notes outstanding. The report breaks down the figures among life/annuity companies, property/casualty companies, and health companies. The report shows the rapid growth in the number of surplus notes issued in the last four years--from 59 in 2011, to 87 in 2012, to 136 in 2013, and to 160 in 2014.

Best's report also contains information about the maturity dates of surplus notes and about the interest rates on surplus notes. Also shown are the amount of surplus notes issued to affiliated companies and the amount of surplus notes issued to non-affiliated companies.

A Major Omission
Best's report does not identify insurance companies. In that respect, the report differs significantly from the type of report I showed each year in The Insurance Forum. For example, in my final tabulation, which was in the August 2013 issue, I showed data for each of the 178 insurance companies with at least $12 million of surplus notes outstanding at the end of 2012. For each company I showed the amount of surplus notes, the amount of total adjusted capital, and the ratio of surplus notes to total adjusted capital. Of the 178 companies, 42 had surplus notes equal to at least 50 percent of total adjusted capital. Of those, 19 had surplus notes equal to at least 100 percent of total adjusted capital.

Major companies have been using surplus notes extensively. For example, the tabulation in the August 2013 issue of The Insurance Forum shows 11 companies that each had more than $1 billion of surplus notes outstanding at the end of 2012. The companies, with amounts in parentheses to the nearest tenth of a billion dollars, are Ambac Assurance Corporation (1.2), AXA Equitable Life Insurance Company (1.5), Farmers Insurance Exchange (1.9), Lincoln National Life Insurance Company (1.3), Massachusetts Mutual Life Insurance Company (1.7), Metropolitan Life Insurance Company (1.7), Nationwide Mutual Insurance Company (2.1), New York Life Insurance Company (2.0), Northwestern Mutual Life Insurance Company (1.8), Pacific Life Insurance Company (1.6), and Teachers Insurance and Annuity Association of America (2.0).

Available Material
At my request, an A. M. Best Company official graciously gave me permission to offer the four-page report on surplus notes to my readers on a complimentary basis. The report is in color, which is helpful in reading the tables. I am also offering, in a separate complimentary package, the four-page relevant excerpt from the August 2013 issue of The Insurance Forum. Send an e-mail to and ask for the two packages relating to surplus notes.

My new book is available from Amazon. It is also available from us; ordering instructions are on our website at, and I will autograph it upon request.


Wednesday, December 2, 2015

No. 129: Disability Insurance—A Federal Judge Hammers Aetna

On October 30, 2015, U.S. District Court Judge Lawrence F. Stengel handed down an important ruling. The plaintiff filed the lawsuit in 2012 after Aetna Life Insurance Company denied long-term disability insurance benefits under an Employee Retirement Income Security Act (ERISA) plan. In the ruling, the judge granted the plaintiff's motion for summary judgment, denied Aetna's motion for summary judgment, and issued a judgment in favor of the plaintiff. Whether Aetna will appeal the ruling remains to be seen. (See Charles v. UPS, U.S. District Court, Eastern District of Pennsylvania, Case No. 5:12-cv-6223.)

Marvin Charles, a 57-year-old high school graduate, began working for United Parcel Service (UPS) as a pre-loader/porter in or about 1978. In 1992 he was promoted to package car driver, earning $50,000 to $60,000 per year. Before working at UPS, he was a dock worker for eight years and a self-employed farm owner for 12 years. At UPS he participated in the UPS National Long-Term Disability Benefits Plan. Aetna administered the plan.

In or about 1985, Charles was involved in a motor vehicle accident that caused brain trauma. Later he was diagnosed with a partial complex seizure disorder. He took Depakote for several months, then stopped, and remained seizure-free for many years. In 2008 he suffered a grand mal seizure. His primary care physician referred him to a neurologist, who prescribed Lamictal to control the seizures. Because he was taking anti-seizure medication, Department of Transportation regulations prevented him from driving a truck.

In June 2009 Charles stopped working at UPS. He applied for and received short-term disability (STD) benefits. In May 2010 he returned to work at UPS on a part-time basis in a different position—as a pre-loader—which did not require him to drive. He worked 20 hours a week over five days. He continued to receive STD benefits at a reduced rate while working part-time.

Aetna later began paying Charles long-term disability (LTD) benefits, from February 2010 to February 2012. The LTD plan provided benefits for two years under the "own occupation" definition of disability, and thereafter under the "reasonable occupation" definition. In 2011 Aetna began investigating the question of whether Charles qualified for LTD benefits under the tougher definition. In February 2012 Aetna terminated LTD benefits. In March 2012 Charles appealed. In September 2012 Aetna denied the appeal.

The Lawsuit
In October 2012 Charles filed a lawsuit in state court. In November 2012 Aetna removed the case to federal court. In February 2014 Charles filed a motion for summary judgment. In March 2014 Aetna filed a motion for summary judgment.

The Ruling on LTD Benefits
In October 2015 Judge Stengel issued his ruling. First, he ruled on the question of the "standard of review" applicable to the benefit denial. The "abuse of discretion" standard of review is tougher for the plaintiff than the de novo standard of review. The judge ruled the tougher "abuse of discretion" standard of review applied in this case.

Second, the judge ruled on the plaintiff's claim that Aetna's denial of LTD benefits violated the terms of the LTD plan. Aetna had argued there was no clinical evidence to show that the seizure medication required a restriction to part-time work. The judge ruled the denial based on a lack of clinical evidence was an abuse of discretion.

Third, the judge noted that Aetna "both evaluates and pays for LTD benefits under the Plan." Based in part on the U.S. Supreme Court 2008 decision in Metropolitan Life v. Glenn, the judge ruled Aetna had an inherent conflict of interest that appeared to have tainted its decision.

Fourth, the judge noted Aetna's use of outside medical consultants and a vocational analysis. He was critical of the manner in which the vocational analysis had been interpreted, and he ruled the manner in which Aetna had used the vocational analysis was an abuse of discretion.

Fifth, the judge noted Aetna did not seem to have considered additional information provided by the plaintiff in rendering its appeal decision. He ruled the manner in which Aetna handled the plaintiff's appeal was an abuse of discretion.

Sixth, the judge noted Aetna gave great weight to the opinions of its own experts and gave little or no weight to the plaintiff's physicians. He ruled Aetna's denial of LTD benefits was an abuse of discretion, and he ordered Aetna to pay LTD benefits to the plaintiff.

The ERISA Claim
The plaintiff also claimed Aetna violated a section of ERISA requiring a plan administrator to mail requested plan materials to a participant within 30 days after a request. The plaintiff sought statutory penalties for Aetna's alleged failure to mail the requested materials in a timely manner. The judge declined to rule on the plaintiff's ERISA claim without further information. On November 13 the parties agreed to dismissal of the plaintiff's ERISA claim.

Attorneys' Fees and Costs
On November 16 the plaintiff filed a motion and a supporting brief seeking attorneys' fees and costs totaling $26,678. The motion is pending.

General Observations
Although Judge Stengel applied the relatively tough "abuse of discretion" standard of review, he nonetheless granted the plaintiff's motion for summary judgment and denied Aetna's motion for summary judgment. Moreover, instead of allowing the case to proceed to trial, the judge ordered Aetna to pay LTD benefits to the plaintiff. In my view, this is a strong ruling against Aetna. At this writing, what happens next in the case remains to be seen.

Available Material
I am offering as a complimentary 43-page PDF the ruling handed down on October 30, 2015. Send an e-mail to and ask for Judge Stengel's ruling in Charles v. UPS.


Friday, November 20, 2015

No. 128: SEC Files Securities Fraud Charges Against James Torchia

On November 10, 2015, the Securities and Exchange Commission (SEC) filed a civil complaint against James A. Torchia and five entities he controls. The SEC alleges securities fraud, including the operation of a Ponzi scheme. The SEC identifies two aspects of the alleged fraud. One is the marketing of unregistered promissory notes arising from subprime automobile loans. The other is the marketing of unregistered fractional interests in viatical and life settlements. (See SEC v. Torchia, U.S. District Court, Northern District of Georgia, Case No. 1:15-cv-3904.)

The Defendants
Torchia, a Georgia resident, is the lead defendant and controls the entities that are the other defendants. Georgia-based Credit Nation Capital LLC sold promissory notes arising from subprime automobile loans. Texas-based Credit Nation Acceptance LLC sold fractional interests in viatical and life settlements. Georgia-based Credit Nation Auto Sales LLC was a used automobile dealership that is now closed. Georgia-based American Motor Credit LLC was an entity through which Credit Nation Capital made subprime automobile loans. Nevada-based Spaghetti Junction LLC was a vehicle used to funnel money to Torchia and members of his family. All the defendants are represented by James Johnson of the Atlanta law firm of Knight Johnson LLC.

The Complaint
The complaint says Torchia, through Credit Nation Capital, raised tens of millions of dollars from investors who purchased unregistered promissory notes, most of which promised a 9 percent return. The notes were described as "100% asset backed" and "backed by hard assets dollar for dollar." The notes were promoted through newspaper and radio advertisements. Here is one of the radio advertisements:
Attention investors. My name is Bob Guess. I'm with Credit Nation and I'm here to help. Don't get blindsided by the next stock market correction. Remember the correction in 2008; some investors lost 40 to 50 percent of the money that they had in brokerage and retirement accounts. Well, history tends to repeat itself. It's not too late to lock in your gains and take the stock market risk out of your portfolio. If you need income, we have a blended asset investment that'll pay you nine percent annual return. Your investment is backed dollar for dollar with hard assets and is non-correlated to the stock market. For those who don't need additional income but are looking for growth, we have investments that have historically produced double-digit returns that are also non-correlated to the stock market. Give us a call at 1-800-542-9513, that's 1-800-542-9513. Don't gamble with your financial future. Call us today for an appointment. 1-800-542-9513.
The complaint consists of eight counts. There are three counts of securities fraud, one count of offering unregistered securities, and four counts of aiding, abetting, and causing violations of securities laws. The SEC asks for a temporary restraining order, preliminary and permanent injunctions, an accounting, disgorgement of ill-gotten gains, pre-judgment interest, civil penalties, an order freezing the defendants' assets, an order preventing defendants from destroying or concealing documents, and the appointment of a receiver.

Other Filings
On the day the complaint was filed, the SEC filed an emergency motion for a temporary restraining order, an asset freeze, and the appointment of a receiver. On that day the SEC also filed an affidavit from an SEC staff accountant who had scrutinized the defendants' documents.

The next day the SEC filed an amended emergency motion for a temporary restraining order, an asset freeze, and the appointment of a receiver. The amended emergency motion was based on the findings of the staff accountant.

General Observations
The Torchia case is still in its early stages. The extent to which Torchia allegedly engaged in the extensive commingling of funds among his entities is troublesome. At one point in the complaint, the SEC alleges that Torchia "has stolen investor money." I believe that the charges are serious, and that they border on criminal activity. The SEC has demanded a jury trial. I plan to report further as the case progresses.

Available Material
I am offering as a complimentary 39-page PDF the SEC complaint against Torchia and his five entities. E-mail and ask for the complaint in the case of SEC v. Torchia.


Monday, November 16, 2015

No. 127: Tontines Are Not Likely to Stage a Comeback

A recent article about tontines and an intriguing new book on which the article is based are not likely to revive the ancient scheme. However, they provide an opportunity to revisit an interesting but almost forgotten piece of insurance history.

The Article and Book
The recent article about tontines, written by Jeff Guo of The Washington Post, is entitled "It's sleazy, it's totally illegal, and yet it could become the future of retirement." The article was posted on September 28, 2015, as a "Wonkblog" of the "Wonkbook Newsletter." I believe that the article did not appear in the newspaper. Here is the lead sentence: "Over 100 years ago in America—before Social Security, before IRAs, corporate pensions and 401(k)s—there was a ludicrously popular (and somewhat sleazy) retirement scheme called the tontine."

Guo's article was based on a 2015 book entitled King William's Tontine. The author of the book is Moshe Milevsky, a professor at the Schulich School of Business and a member of the Graduate Faculty in the Department of Mathematics and Statistics at York University in Toronto. I read the book with great interest.

The Word "Tontine"
The 11th (2003) edition of Merriam-Webster's Collegiate Dictionary defines "tontine" as "a joint financial arrangement whereby the participants usually contribute equally to a prize that is awarded entirely to the participant who survives all the others." That definition does not do justice to the complexity of tontines.

Tontines are named after Lorenzo A. Tonti, an Italian banker who has received credit for inventing the scheme. Tonti suggested the idea to the government of King Louis XIV of France as a method by which the government could raise money. As Milevsky points out, tontines were used primarily to help governments raise money to wage wars.

A tontine investor enrolled in the scheme by buying a share for a lump sum, and in exchange received interest payments. No return of principal was involved. The investor designated himself or herself as the "nominee," on whose life the tontine was based, or the investor designated another person, perhaps a grandchild, as the nominee.

The nominees were divided into age classes. Initially the interest on a class's share of the tontine fund was divided among all the nominees in the class. As nominees died, the interest on the class's share of the fund was divided among fewer and fewer surviving nominees in the class, thus generating larger and larger interest payments to the survivors. The last several surviving nominees in the class received very large interest payments, and the interest payment to the last surviving nominee in the class amounted to a bonanza. (Milevsky points out that tontines often were modified to prevent large benefits to the last surviving nominees in a class.) When the last survivor in the class died, interest payments to the class stopped and the government did not have to repay the principal of the class's share of the tontine fund.

Relationship to Life Annuities
The expression "life annuity," as used here, refers to what is sometimes called a "pure life annuity" or "straight life annuity." The annuitant receives payments as long as he or she lives, and no payments are made after the annuitant dies. Milevsky points out that there is a close relationship between tontines and life annuities. However, life annuities involve payments that are partly interest and partly a return of principal, whereas tontine payments are entirely interest.

Furthermore, as Milevsky emphasizes, the issuer of a life annuity (normally an insurance company or a pension fund) assumes longevity risk, or the risk that annuitants will live longer than was anticipated in the original pricing of the annuity. Indeed, Milevsky believes that issuers have been underpricing life annuities significantly. His favorable view of tontines is based to a large extent on the fact that the tontine issuer does not assume longevity risk, because the tontine issuer never has to repay the principal of the tontine fund.

Full-Tontine Policies
In the U.S. in the middle of the 19th century, participating (dividend paying) "full-tontine" life insurance policies paid the death benefit on the death of the insured, but provided no surrender values. Insureds were divided into age classes. Dividends were not paid each year to the insureds, but instead were deferred and ultimately were distributed to the remaining survivors at the end of a tontine period such as 20 years. Thus the remaining insureds profited directly from the deaths of other insureds and from lapses by other insureds. Although glowing sales illustrations showed large amounts to be paid to surviving and persisting insureds, full-tontine policies did not gain significant traction with the public.

Deferred-Dividend Policies
A later and much more widely sold version of the tontine policy was the "deferred-dividend" policy, which was also called the "semi-tontine" policy. Deferred-dividend policies included surrender values. Insureds who survived and persisted to the end of a tontine period such as 20 years benefited from the forfeiture of deferred dividends by insureds who lapsed their policies during the tontine period. However, because of the surrender values, the losses suffered by insureds whose policies lapsed during the tontine period were not as large as in the case of full-tontine policies. Glowing sales illustrations appealed to the gambling instincts of the public, and deferred-dividend policies were heavily sold during the final quarter of the 19th century.

It is important to point out that insurance companies were not required to establish reserve liabilities for the deferred dividends. Thus companies selling deferred-dividend policies accumulated large surpluses that were used in part to pay agents large commissions for selling the policies and in part to create a slush fund that could be dissipated by insurance company executives.

The glowing sales illustrations did not work out, not only because the assumptions were unrealistic, but also because the large surpluses were squandered. The result was policyholder disappointment and anger, and deferred-dividend policies became fodder for the muckrakers of the day. Some insurance companies, most notably Equitable Life Assurance Society of the United States, vigorously promoted deferred-dividend policies. Some companies, notably Connecticut Mutual Life Insurance Company, strongly opposed the sale of deferred-dividend policies.

Henry Hyde was the founder of Equitable. Later, in a classic example of nepotism, his son James Hyde became a vice president of Equitable. On January 31, 1905, James Hyde sponsored, at company expense, a "Parisian Ball" at a swanky New York City restaurant. The ball was said to have cost a fortune. James Hyde had spent several years in France and had become addicted to Parisian styles. He did not realize or did not care that his ostentatious behavior would generate massive negative publicity. Nor did he understand how his squandering of company funds would be viewed by the public.

In September 1905, the famous Hughes-Armstrong investigation began in New York. There were several components to the scandal that led to the investigation, and the deferred-dividend policy was one of them. Some historians believe that, if there had been no Parisian ball, there would have been no investigation.

One of the statutory requirements that grew out of the investigation was that dividends had to be distributed annually. Thus deferred-dividend policies became illegal in New York, and several other states followed New York's lead. Thus the death of tontines was not caused by the deferred-dividend policies themselves, but rather by the marketing, accounting, and executive abuses associated with those policies.

The Milevsky Book
Milevsky has a knack for presenting complex mathematical material in an amusing and readable manner. The thrust of his book is his belief that tontines have gotten a bad rap, and that they should become the basis for retirement systems that would have significant advantages over existing retirement systems. In the end he says it is time to embrace tontines, and he assures us he would be among the first to sign up.

General Observations
I disagree with Milevsky because I have two fundamental problems with tontines. First, I think it is inappropriate and distasteful for people to profit directly from the deaths of others. Milevsky may be correct when he says there is no evidence in the history of tontines that foul play occurred in the late years of a tontine scheme, notwithstanding several novels about fictional tontines involving all manner of skullduggery. Nonetheless, I am uncomfortable with the idea of gambling on human life, and the idea of people profiting directly from the deaths of other people.

Second, tontines make no provision for family members who survive the death of a tontine nominee. Milevsky and others may believe that retirement funds should be used to care only for retirees, and that the next generation should fend for themselves. However, I think many retirees want to leave some of their retirement assets for the next generation.

It is fun to read and think about tontines. In my view, however, it is preferable to leave them on the scrap heap of history.

Finally, readers of The Insurance Forum over the years, and readers of chapter 19 (especially pages 189-191) of my new book entitled The Insurance Forum: A Memoir, know I have two fundamental problems even with life annuities. First, it is difficult if not impossible to determine the price of the protection provided by a life annuity; that is, the price of the protection against living too long. Second, as in tontines, there is no provision for those who survive the death of the annuitant, except to the extent that extra costs are incurred for temporary "certain" periods following the death of the annuitant.

I prefer systematic monthly withdrawals equal to minimum distributions required by the Internal Revenue Code, even for nonqualified retirement funds. After the death of the annuitant, such an approach is likely to leave substantial funds for the next generation. However, I recognize that, for persons without substantial retirement accumulations, the minimum distribution may not be enough to live on. Thus a life annuity, which involves invasion of principal, may be needed to provide more generous retirement benefits.

Available Material
The Milevsky book entitled King William's Tontine and my book entitled The Insurance Forum: A Memoir are available from Amazon. My book is also available from us; ordering instructions are on our website,, and I will autograph it upon request.


Thursday, November 12, 2015

No. 126: Life Partners—Recent Adversary Proceedings in the Bankruptcy Case

Life Partners Holdings, Inc. (LPHI) and its operating subsidiaries were participants in the secondary market for life insurance for many years. Now they are involved in bankruptcy proceedings. The trustee in the bankruptcy case is H. Thomas Moran II. (See In re LPHI, U.S. Bankruptcy Court, Northern District of Texas, Case No. 15-40289.)

An "adversary proceeding" is a lawsuit filed within a bankruptcy case and assigned its own case number. In September and October 2015 Trustee Moran filed two adversary proceedings in the LPHI bankruptcy case. One is a complaint against Brian Pardo, the former chief executive officer of Life Partners. That complaint was later amended and nine plaintiffs were added. The other was a complaint against 30 licensees of Life Partners. The complaints are discussed here.

The Complaint against Pardo
On September 11, 2015, Trustee Moran filed a complaint against Pardo seeking $41 million for the benefit of the bankruptcy estate and investors allegedly victimized by actions of LPHI and its subsidiaries. The amount sought represents salaries, bonuses, dividends, and other personal remuneration received by Pardo. In No. 117 (September 21, 2015), I wrote about the complaint. (See Moran v. Pardo, U.S. Bankruptcy Court, Northern District of Texas, Case No. 15-04079.)

The Amended Complaint against Pardo and Others
On October 5, 2015, Trustee Moran filed an amended complaint. The amount sought for the benefit of the bankruptcy estate is increased to $75 million, and the allegations are expanded. Nine defendants are added: Deborah Carr, daughter of Brian Pardo and former vice president of administration of Life Partners; Kurt Carr, husband of Deborah Carr and former vice president over policy acquisition of Life Partners; R. Scott Peden, former president, general counsel, and secretary of Life Partners; Linda Robinson, also known as Linda Robinson-Pardo; Pardo Family Holdings Ltd., a Gibraltar corporation; Pardo Family Trust, a trust domiciled in Gibraltar; Pardo Family Holdings US LLC, a Delaware limited liability company; Paget Holdings Inc., a Texas corporation; and Paget Holdings Ltd., a St. Vincent partnership.

The introductory section of the amended complaint contains a paragraph describing the allegedly "fraudulently inflated arbitrage." The paragraph reads:
It was a further part of the scheme to defraud the investors that, in or about January 1999, Pardo and the Defendant Executives hired a medical doctor, Donald Cassidy ("Cassidy"), with no actuarial experience or training, and no experience in rendering life expectancies, to prepare a life expectancy ("LE"), which Pardo and his team used to market the fractional interests to investors. Life Partners typically purchased those policies on which a significant discrepancy existed between the independent LE and the Cassidy LE, so that it could create a fraudulently inflated arbitrage between the low price (based on the longer LE) it paid for the policy and the higher price (based on the shorter Cassidy LE) at which it sold investment contracts to investors.
The factual background section of the amended complaint mentions an article that appeared in The Wall Street Journal on December 21, 2010 about the activities of Life Partners. Exhibits to the amended complaint show e-mail correspondence between Pardo and Journal reporters Mark Maremont and Leslie Scism that preceded publication of the article.

The amended complaint has 12 counts. There are two counts of actual fraudulent transfer, two counts of constructive fraudulent transfer, one count of preferences, one count of fraud, one count of breach of fiduciary duty, one count of alter ego and/or sham to perpetrate a fraud, one count of unjust enrichment and constructive trust, one count of RICO [Racketeer Influenced and Corrupt Organizations Act], one count of disallowance of defendants' claims, and one count of equitable subordination.

Trustee Moran seeks return of funds from the defendants, actual damages, consequential damages, exemplary damages, pre-judgment interest, and post-judgment interest. He also seeks attorneys' fees and costs.

The Complaint against Licensees
On October 28, 2015, Trustee Moran filed a complaint against 30 licensees. He seeks recovery of what he alleges were excessive fees and commissions received from Life Partners. (See Moran v. Sundelius, U.S. Bankruptcy Court, Northern District of Texas, Case No. 15-04087.)

The introductory section of the complaint against the licensees describes the alleged scheme to defraud investors. Here is the final paragraph of that section:
Life Partners and its Licensees perpetrated the fraud on the Investors by (1) accepting fees and commissions well in excess of industry norms and often exceeding the true value of the underlying life settlement policy; (2) misrepresenting the nature and accuracy of the life expectancy of the insured, including concealing the existence of longer estimated life expectancies; and (3) misrepresenting the likely returns on investments, among other things.
The "factual background" section of the complaint describes, among other things, the procedural history of the bankruptcy case, how Life Partners acquired policies, contractual arrangements with investors, the network of licensees, and the undisclosed and allegedly exorbitant fees and commissions received by licensees. The complaint also alleges wrongful conduct by the licensees.

The licensee defendants, mostly from Texas, are the individuals and firms that received the largest amount of fees and commissions from 2008 through February 2015. The total of the fees and commissions received by the licensee defendants is $91.7 million, which is 56 percent of all the fees and commissions received during that period by the entire network of Life Partners licensees. Trustee Moran seeks to recover the $91.7 million for the benefit of the investors, as well as attorneys' fees and costs. Here is the list of licensee defendants, with amounts shown in millions of dollars:
James Sundelius (TX) 13.1
B G & S Management Consultants (TX) 10.4
Life Insurance Settlements Inc (FL) 7.8
Life Settlement Exchange LLC (TX) 7.8
American Safe Retirements LLC (TX) 6.8
Advanced Settlements LLC (FL) 6.0
Tolleson Investments LLC (TX) 4.3
Fred A. Cowley (TX) 4.2
Security Reserve Financial Inc (TX) 3.0
Gallagher Financial Group (TX) 2.3
ASR Alternative Investments LP (TX) 2.2
JL Providers Inc (NY) 2.1
New Asset Advisors LLC (TX) 1.9
Frank W. Bice (TX) 1.9
Edward G. Burford Corp (TX) 1.9
Trinity Financial Services LLC (FL) 1.7
Sun Safety Inc (TX) 1.6
Abundant Income LLC (TX) 1.6
Life Distributors of America LLC (CA) 1.5
Faye Bagby (TX) 1.5
Ella Oliver (TX) 1.4
Lakeside Equity Partners Inc (TX) 1.3
Wealthstone Financial (TX) 1.1
Falco Group LLC (TX) 1.0
Alpha & Omega Global Risk Management LP (NV) 1.0
Rangetree Strategies LLC (CA) 0.9
Mark McKay (TX) 0.8
Kainos Asset Management (TX) 0.3
Life Strategies LLC (TX) 0.2
H. Peyton Inge (TX) 0.1
The complaint has five counts. There are two counts of actual fraudulent transfer, two counts of constructive fraudulent transfer, and one count of claim for contribution from the licensee defendants for their participation in and facilitation in the scheme to defraud Investors.

General Observations
The trials in the two adversary proceedings are tentatively scheduled for March and April 2016, respectively, before the bankruptcy court judge. From what I have heard about the trials in adversary proceedings in bankruptcy cases, they are relatively brief and disposed of fairly quickly. Whether that will happen here remains to be seen.

Available Material
I am offering a complimentary 78-page PDF consisting of the 62-page text of Trustee Moran's amended complaint against Pardo and others, 14 pages of exhibits showing correspondence in 2010 between Pardo and two reporters for The Wall Street Journal, and a 2-page cover sheet. Send an e-mail to and ask for the amended complaint in Moran v. Pardo.

I am also offering a complimentary 51-page PDF consisting of the 37-page text of Trustee Moran's complaint against the licensees, a 1-page exhibit showing the payments to the licensee defendants, and 13 pages of exhibits showing samples of licensee agreements. Send an e-mail to and ask for the complaint in Moran v. Sundelius.


Friday, November 6, 2015

No. 125: Backdated Capital Contributions—the NAIC Response to Questions

In No. 123 (October 27, 2015), I discussed a capital contribution shown in the statutory statement of Senior Health Insurance Company of Pennsylvania (SHIP) as of December 31, 2014. The contribution was in the form of a $50 million surplus note issued February 19, 2015. Thus the issue date of the note was 50 days after the "as of" date of the statement. SHIP filed the statement with the Pennsylvania Insurance Department in a timely manner on March 2, 2015, or 11 days after the note was issued.

I said I would send No. 123 to the National Association of Insurance Commissioners (NAIC), I showed four questions about backdated capital contributions, and said I would report the responses. The communications department of the NAIC responded one week later.

The First Question
First, I asked whether the NAIC agrees with me that a backdated capital contribution falsely portrays the financial condition of a company as of the statement date. I also asked for an explanation if the NAIC does not agree with me. The NAIC did not answer yes or no to the basic question, but provided this explanation:
The statutory financial statements are the reporting mechanism in which state insurance regulators assess the financial condition of the insurance entities subject to their regulation. Pursuant to the Preamble of the NAIC Accounting Practices and Procedures manual, the primary responsibility of each state insurance department is to regulate insurance companies in accordance with state laws with an emphasis on solvency for the protection of policyholders.
The NAIC went on to explain surplus notes, although I had not asked for an explanation of surplus notes. Next, referring to Statutory Accounting Principles (SAP) and Statements of Statutory Accounting Principles (SSAPs), the NAIC said:
Ensuring timely receipt of funds, prior to the issuance of the statutory financial statements, which are first committed to policyholders and other claimants, should likely be perceived as an appropriate regulatory action consistent with the responsibility to provide protection to policyholders.

For SAP purposes, this approach is consistent with a Type 1 subsequent event under SSAP No. 9, as the conditions warranting the need for a surplus note existed as of the financial statement date. Furthermore, actions are perceived to be in place prior to the statement date to develop the note, obtain commissioner approval, and obtain funds from the actual issuance of the note timely to receive the funds prior to the issuance date of the statutory financial statement.
The Second Question
Second, I said SSAP No. 9 and SSAP No. 72 were effective January 1, 2001, and asked when the NAIC began to allow backdated capital contributions. In response, the NAIC mentioned Financial Accounting Standards (FAS), the Financial Accounting Standards Board (FASB), the FASB Emerging Issues Task Force (EITF), the American Institute of Certified Public Accountants (AICPA), and Generally Accepted Accounting Principles (GAAP). The NAIC said:
The guidance reflected in SSAP No. 9 is adopted from FASB. The Statutory Accounting Principles (E) Working Group [of the NAIC] adopted SSAP No. 9 to be effective January 1, 2001, as part of the original codification of SAP. The original guidance was adopted to be consistent with the AICPA Statement on Auditing Standards No. 1, Section 560—Subsequent Events. In 2009, FASB issued FAS 165, Subsequent Events, and revisions were reflected in SSAP No. 9 to reflect the adoption of this guidance. The adoption of FAS 165 should not have resulted in significant changes in the subsequent events that an entity reports, through either recognition or disclosure in the financial statements. The revisions adopted from FAS 165 included guidance to ensure assessment of subsequent events through the date the financial statements are issued, or when financial statements are available to be issued.

The Statutory Accounting Principles (E) Working Group [of the NAIC] adopted the guidance in SSAP No. 72 to be effective January 1, 2001, as part of the original codification of SAP. The referenced paragraph for capital contributions was included in the original adoption after considering GAAP guidance.

Although the SAP guidance in SSAP No. 72 provides an explicit direction regarding these notes or other receivables as Type 1 subsequent events, the guidance was developed after considering EITF 85-1 (currently reflected in 505-10-45 of the FASB Codification). The EITF 85-1 GAAP guidance is technically rejected in SSAP No. 72, but in Issue Paper No. 72, this rejection is noted as EITF 85-1 generally requires these contributions to be recorded as a debit to equity instead of an asset, but could allow for such notes to be recorded as assets if collected in cash before the financial statements are issued.

For SAP purposes, and the consistency concept, the statutory accounting guidance is explicit that such notes are admitted assets if they are satisfied by receipt of cash or readily marketable securities prior to the filing of the statement. If the notes or other receivables are not satisfied, they are nonadmitted. Furthermore, the domiciliary commissioner must approve the capital contribution under SSAP No. 72 and the cash or securities must be infused prior to the filing of the statutory annual financial statements.
The Third Question
Third, I asked why the NAIC allows backdated capital contributions. The NAIC said:
The NAIC does not establish statutory accounting provisions. The guidance reflects the decisions of the Statutory Accounting Principles (E) Working Group [of the NAIC]. See questions 1 and 2 regarding the ultimate objective of the regulators in providing protections to policyholders, the background for the guidance, and related FASB guidance.
The Fourth Question
Fourth, I asked whether banks and other regulated financial institutions are allowed to accept backdated capital contributions. The NAIC said it "cannot advise on specific rules regarding these institutions."

The 1988 Executive Life Incident
Chapter 7 of my new book, The Insurance Forum: A Memoir, is entitled "The Collapse of Executive Life." On page 84 in that chapter, I discussed a backdated capital contribution to Executive Life Insurance Company (ELIC) from ELIC's parent company. The transaction was in the form of a $170 million surplus note that was reflected in ELIC's statutory statement as of December 31, 1987. However, the note was not executed until March 7, 1988. In response to my inquiry to ELIC, the company's general counsel said the
subject transactions were given effect for accounting purposes at year end 1987. They were given such effect because under the circumstances present, applicable statutory accounting principles so permit.
Back in 1988 I called that explanation nonsense. I said the company officers who sign the statutory annual statement swear the statement is "a full and true statement of all the assets and liabilities and of the condition and affairs of the said insurer as of the thirty-first day of December last." The backdated capital contribution was one of the factors that caused me to view ELIC as insolvent three years before the company failed.

The 2008 IndyMac Incident
On May 21, 2009, the Office of Inspector General (OIG) of the U.S. Department of the Treasury issued an "Audit Report" entitled "Safety and Soundness: OTS [Office of Thrift Supervision] Involvement with Backdated Capital Contributions by Thrifts." The report grew out of a May 2008 capital contribution from IndyMac's parent company backdated to March 31, 2008. The effect of the transaction "was that IndyMac was able to maintain its well capitalized status, and avoid the requirement in law to obtain a waiver from FDIC [Federal Deposit Insurance Corporation] to accept brokered deposits." In the report, OIG "reviewed the backdating of capital contributions at IndyMac and five other thrifts and concluded that "the backdating of these transactions was inappropriate under GAAP for all six thrifts."

Years before the financial crash of 2008, American International Group selected OTS to be its regulator. Today, as a result of investigations conducted in the wake of the crash, OTS no longer exists.

Evolution of the Jurat
At the bottom of the first page of the statutory annual statement form promulgated each year by the NAIC is a sworn, notarized statement called a "jurat." As a result of No. 123 and the NAIC's responses to my questions, I became interested in the evolution of the jurat. First, I looked at the 1960 statutory statement. Here is the language of the jurat:
[The officers of this company, with their names and titles shown in the jurat itself], being duly sworn, each for himself deposes and says that they are the above described officers of the said insurer, and that on the thirty-first day of December last, all of the herein described assets were the absolute property of the said insurer free and clear from any liens or claims thereon, except as herein stated, and that this annual statement, together with related exhibits, schedules and explanations therein contained, annexed or referred to are a full and true statement of all the assets and liabilities and of the condition and affairs of the said insurer as of the thirty-first day of December last, and of its income and deductions therefrom for the year ended on that date, according to the best of their information, knowledge and belief, respectively.
Second, I looked at the jurat in the statutory statement for 1999. By that time, the jurat had been modified. Near the end, this language was inserted beginning with the words "on that date" and ending with the words "according to":
on that date, and have been completed in accordance with the NAIC annual statement instructions and accounting practices and procedures manuals except to the extent that: (1) state law may differ; or, (2) that state rules or regulations require differences in reporting not related to accounting practices and procedures, according to
By 2014, the jurat had been modified to incorporate the names of the NAIC Annual Statement Instructions and Accounting Practices and Procedures manual. Also, two sentences had been added at the end of the jurat relating to electronic filing of the annual statement.

General Observations
The NAIC did not use the word "backdated" in its responses. Perhaps the NAIC views the word as pejorative.

It is interesting that the "NAIC does not establish statutory accounting provisions" even though "guidance reflects the decisions of" an NAIC working group. I do not know whether the NAIC membership as a whole, or the NAIC Executive Committee, or any other NAIC body signs off on the work of the Statutory Accounting Principles (E) Working Group of the NAIC.

I reviewed several FASB documents mentioned in the NAIC's responses. I believe that backdated capital contributions were not among the items FASB had in mind when it talked about "subsequent events." There were many examples of subsequent events, but backdated capital contributions were not among them.

In No. 123, I expressed dislike for backdating because it falsely portrays a company's year-end financial condition. I still believe that backdated capital contributions are contrary to accounting principles, and that insurance companies should not be permitted to use them.

Available Material
I am offering a complimentary 34-page PDF of the 2009 Treasury OIG Audit Report on Backdated Capital Contributions. Send an e-mail to and ask for the 2009 Treasury OIG Audit Report.

Monday, November 2, 2015

No. 124: Annuity Sales Incentives—Results of the Investigation by U.S. Senator Elizabeth Warren

On April 28, 2015, U.S. Senator Elizabeth Warren (D-MA), the Ranking Member of the Subcommittee on Economic Policy of the Committee on Banking, Housing, and Urban Affairs, sent letters to 15 major issuers of annuities seeking "information on rewards and incentives offered by your company to brokers and dealers who sell annuities to families and small investors." The companies were AIG, Allianz, American Equity, Athene, AXA, Jackson National Life, Lincoln Financial, MetLife, Nationwide, New York Life, Pacific Life, Prudential, RiverSource, TIAA-CREF, and Transamerica. In No. 97, posted May 4, I wrote about Senator Warren's investigation.

Results of the Investigation
On October 27, Senator Warren released a report indicating that all 15 companies responded at least in part and describing the results of the investigation. The report is entitled "Villas, Castles, and Vacations: How Perks and Giveaways Create Conflicts of Interest in the Annuity Industry." Here are some "key findings" mentioned in the executive summary:
  • The majority of companies admitted to providing rewards and inducements, such as expensive vacations and other prizes, to annuity agents in exchange for sales.
  • Companies also create conflicts of interest by offering perks and inducements to annuity sales agents through third party marketing organizations.
  • Current disclosure rules are inadequate to ensure that customers are informed about the incentives agents receive for selling them specific financial products.
  • Existing rules and regulations to deter conflicts of interest are completely inadequate.
The report includes an introduction, findings, and policy options to address conflicts of interest in the sale of annuities. The report mentions the draft of a rule proposed by the U.S. Department of Labor (DOL). Here is the conclusion in the report:
This investigation reveals that companies representing tens of billions of dollars in annuity sales are allowed to offer and do offer a variety of kickbacks, from lavish vacations to golf outings to gift cards to iPads, either directly to sales agents or indirectly to these agents via third-party marketing organizations, in exchange for selling a specific company's products. Disclosure of these perks and payments to consumers is inadequate, and even with regulations designed to curb these kinds of payments, some companies have identified and taken advantage of numerous loopholes in those rules so they can continue to offer these kickbacks.
The perks offered by companies to agents create a conflict of interest that result in consumers—many of whom are at or near retirement age—receiving advice about investments in annuities that may not match their needs. The annuity industry is not the only industry affected by these conflicts. Across the financial industry, conflicts cost American investors an estimated $17 billion in retirement savings every year. New regulations are needed to protect consumers and end this financial conflict of interest.
My Public Records Requests
In May 2015, I learned that the New York Department of Financial Services (DFS) had asked the 15 companies for copies of their responses to Senator Warren's letters. On May 29, I filed with DFS, pursuant to the New York Freedom of Information Law, a request for copies of the responses. On June 25, DFS said it needed additional time to respond to my request because the documents "require specialized review." In response to my inquiries, DFS said all 15 companies had filed copies of their responses, and DFS intended to respond to my request by August 25. On October 28, having heard nothing further, I contacted DFS again. I have not yet received a response.

When this item is posted, I will send it to Senator Warren's office. At the same time, pursuant to the federal Freedom of Information Act, I will file with her office a request for copies of the 15 companies' responses.

General Observations
In No. 97, I expressed the opinion that the widespread use of annuity sales incentives is a serious problem. I also expressed disappointment at the comments made in April by the American Council of Life Insurers (ACLI) and the National Association of Insurance Commissioners (NAIC) suggesting that existing laws and regulations are adequate. According to the recent Warren report, at least two of the companies made similar comments in their responses. The report does not identify those companies.

Available Material
I am offering a complimentary 12-page PDF containing the October 2015 report on Senator Warren's investigation. Also, the complimentary 19-page PDF offered in No. 97 is still available; the package includes a sample of Senator Warren's letters to the 15 companies, examples of annuity sales incentives, a press release about the Warren investigation, the ACLI and NAIC comments about the investigation, and information about the DOL proposed rule. Send an e-mail to and ask for the October 2015 Warren report, the May 2015 package about the Warren investigation, or both.