Friday, October 7, 2016

No. 182: Long-Term Care Insurance Liabilities Return to the Forefront at CNO Financial (Formerly Conseco)

On September 29, 2016, two developments brought long-term care insurance reserve liabilities back to the forefront at CNO Financial Group, Inc. (CNO), which formerly was Conseco, Inc. First, CNO filed an 8-K (significant event) report with the Securities and Exchange Commission. Second, two CNO subsidiaries, New York-domiciled Bankers Conseco Life Insurance Company and Indiana-domiciled Washington National Insurance Company, filed a federal court lawsuit (referred to here as "CNO's complaint") against three individuals associated with Beechwood Re, a Cayman Islands-based reinsurance company, and Platinum Partners, a New York-based hedge fund. On the same day, Reuters posted an article by reporter Lawrence Delevingne about CNO's 8-K report and CNO's complaint.

In No. 180 (posted September 19, 2016), I described how CNO (then Conseco) separated itself in 2008 from a financially troubled long-term care insurance subsidiary that was in runoff. With the approval of the Pennsylvania insurance commissioner, CNO transferred the subsidiary, Pennsylvania-domiciled Conseco Senior Health Insurance Company, to an independent trust and renamed it Senior Health Insurance Company of Pennsylvania (SHIP).

In the same post I explained how SHIP enhanced its surplus by borrowing money, through a surplus note, from Beechwood, which has close ties to Platinum. I indicated that SHIP invested a significant amount of assets in Platinum offerings, but was trying to divest itself of those investments. I also described SHIP's fragile financial condition, with total adjusted capital at the end of 2015 (including the surplus infusion from Beechwood) below company action level risk-based capital.

CNO's 8-K Report
Bankers Conseco Life and Washington National transferred their long-term care insurance reserve liabilities to Beechwood through reinsurance agreements that required Beechwood to maintain quality assets in trust to meet its obligations under those agreements. CNO's 8-K report explains how CNO and its regulators, through examinations, learned that Beechwood and Platinum were tied closely together, that Beechwood had invested its reinsurance trust assets in Platinum's offerings, that those offerings were not in compliance with state laws and regulations governing reinsurance trust assets, and that the transfers of liabilities from the CNO subsidiaries to Beechwood therefore were not valid.

The text of CNO's 8-K report describes the problems. The report also contains three exhibits: a regulatory demand letter from the New York Department of Financial Services to Bankers Conseco Life, a regulatory demand letter from the Indiana Department of Insurance to Washington National, and a CNO press release. The demand letters assert that the assets held in trust by Beechwood under the reinsurance agreements do not comply with state laws and regulations, and threaten disciplinary action unless the problems are resolved promptly.

CNO's Complaint
CNO's complaint describes the close ties between Beechwood and Platinum. It alleges, for example, that Beechwood officials are also Platinum officials. The defendants are Moshe Feuer, Scott Taylor, and David Levy. (See Bankers Conseco Life v. Feuer, U.S. District Court, Southern District of New York, Case No. 16-cv-7646.)

The complaint describes how the reinsurance agreements came about, and how the defendants allegedly misled the plaintiffs into entering into the agreements. The complaint mentions SHIP's investments in Platinum's offerings, but does not mention SHIP's surplus note relationship with Beechwood. I discuss that relationship below. The complaint lists 12 counts of alleged wrongdoing, including three counts of violations of the federal Racketeer Influenced and Corrupt Organizations (RICO) Act:
  1. Breach of Fiduciary Duty
  2. Aiding and Abetting a Breach of Fiduciary Duty
  3. Fraudulent Misrepresentation/Fraudulent Concealment
  4. Aiding and Abetting a Fraud
  5. Violation of RICO—18 U.S.C. §1962(c)
  6. Violation of RICO—18 U.S.C. §1962(a)
  7. RICO Conspiracy—18 U.S.C. §1962(d)
  8. Civil Conspiracy to Commit Fraud
  9. In the Alternative, Negligent Misrepresentation
  10. In the Alternative, Negligence
  11. In the Alternative, Gross Negligence
  12. In the Alternative, Unjust Enrichment
CNO's complaint was assigned to U.S. District Court Judge Edgardo Ramos, a 2011 Obama nominee. U.S. Magistrate Judge Barbara C. Moses was also assigned to the case.

The SHIP/Beechwood Surplus Note
A surplus note is a debt instrument that increases the surplus of the borrowing company because the company is not required to establish a liability for the amount borrowed. A surplus note is subordinate to the borrowing company's other obligations, and can be issued only with the insurance commissioner's prior approval. Also, interest and principal payments can be made only with the commissioner's prior approval.

On February 19, 2015, SHIP borrowed $50 million from Beechwood by issuing a five-year surplus note with the permission of the Pennsylvania insurance commissioner. The interest rate is 6 percent. The surplus infusion was reflected in SHIP's December 31, 2014 financial statement, which was filed March 1, 2015.

Questions for SHIP
After the September 29 developments described above, I wrote to Brian Wegner, president and chief executive officer of SHIP. I asked:
  1. Have you paid any interest on the surplus note? If your answer is yes, please indicate dates and amounts, and please send me the letter(s) you received from the Pennsylvania commissioner approving the payment(s). If your answer is no, please explain whether this means the surplus note is in default.

  2. Did Beechwood agree to lend you the $50 million in exchange for your investment in Platinum's offerings? If your answer is yes, please indicate the date on which you began investing in Platinum's offerings. If your answer is no, please explain what prompted you to borrow from Beechwood (rather than someone else) and what prompted you to invest in Platinum's offerings.
I asked for answers "on the record" and indicated a response date. I did not receive a response directly from SHIP. Instead I received a telephone call on behalf of SHIP from a media relations person in New York. He said he would try to obtain detailed answers to my questions by the response date, but he was not able to do so. I plan to prepare a follow-up post when and if SHIP provides detailed answers.

General Observations
As mentioned in No. 180, exhibits of "other long-term invested assets" in recent SHIP statements show that the company had significant investments in Platinum's offerings. On September 15, 2016, Reuters posted an article entitled "Long-term care insurer SHIP works to dump Platinum cargo." According to the article, SHIP, as of June 30, 2016, had at least $100 million of Platinum's offerings (3.6 percent of SHIP's assets). The article quoted SHIP's Brian Wegner as saying that "the company is in the process of reviewing and shedding all Platinum-related investments—now down to about $50 million—and would be done by the end of 2016," and that "SHIP has experienced no losses and fully anticipates that will be the case as the remainder is divested."

Normally interest on surplus notes is payable semiannually. With regard to the 6 percent surplus note through which SHIP borrowed $50 million from Beechwood to increase SHIP's surplus, I think SHIP has missed three semiannual interest payments of $1.5 million each, for a total of $4.5 million. Therefore, I think SHIP is in default on the surplus note. However, I am not aware of any action taken against SHIP by Beechwood or by the Pennsylvania insurance commissioner.

I think the SHIP/Beechwood surplus note was not an arm's-length transaction, because an interest rate of 6 percent does not compensate Beechwood for the risk involved in lending money to SHIP, which was in fragile financial condition at the time of the loan, and still is. I believe that the $50 million was a gift from Beechwood to SHIP in exchange for SHIP making investments in Platinum's offerings.

Available Material
I am offering a 71-page complimentary PDF consisting of CNO's 14-page 8-K report (including the three exhibits) and CNO's 57-page complaint against three individuals associated with Beechwood and Platinum. Email and ask for the October 2016 CNO/Beechwood package.