Monday, November 28, 2016

No. 190: Annuity Factoring—A Follow-Up on a Lawsuit Against Two Companies and Three Individuals

In the August 2011 and October 2011 issues of The Insurance Forum, I wrote major articles about the practices of factoring companies that pay cash to annuitants and in exchange receive the annuitants' annuity payments. In No. 115 (September 11, 2015), I said the federal Consumer Financial Protection Bureau (CFPB) and the New York State Department of Financial Services (DFS) filed a lawsuit against two annuity factoring companies and three individuals associated with those companies.

The CFPB/DFS Complaint
On August 20, 2015, CFPB and DFS filed their complaint. The company defendants were Pension Funding LLC and Pension Income LLC, both based in Huntington Beach, California. They were related companies that extended consumer credit, serviced consumer loans, and transmitted money in connection with their loan business. The individual defendants were Steven Covey, Edwin Lichtig, and Rex Hofelter, who were senior officials of the two companies. The case was assigned to U.S. District Judge Josephine L. Staton. President Obama nominated her in February 2010, and the Senate confirmed her in June 2010.

The plaintiffs alleged that the defendants denied their product was a loan, failed to disclose fees or interest rates, and claimed the cost could be as little as 13 percent. The plaintiffs also alleged that the transactions had an average interest rate of 28.56 percent, in excess of the New York State civil usury and criminal usury rates. Further details about the allegations are in No. 115 and in the complaint I offered to readers.

The complaint included seven counts. The first three related to New York State's Consumer Financial Protection Act of 2010 (CFPA), and were asserted by CFPB and DFS. The other four were asserted by DFS. The seven counts were (1) unfair acts or practices in violation of CFPA, (2) deceptive acts or practices in violation of CFPA, (3) abusive acts or practices in violation of CFPA, (4) usury, (5) false and misleading advertising of loans, (6) intentional misrepresentation of a material fact regarding a financial product, and (7) unlicensed money transmitting. The plaintiffs sought injunctive relief, damages, redress to harmed consumers, disgorgement of ill-gotten revenues, civil money penalties, and plaintiffs' costs in bringing the action. (See CFPB v. Pension Funding, U.S. District Court, Central District of California, Case No. 8:15-cv-1329.)

Subsequent Developments
On October 7, 2015, the plaintiffs applied for a preliminary injunction and the appointment of a receiver. On October 23 Lichtig, Hofelter, and the two company defendants answered the complaint. Covey ignored the complaint. On October 30 the four defendants other than Covey opposed the application for a preliminary injunction. On December 23 the clerk entered a notice of default relating to Covey.

On January 22, 2016, the plaintiffs and the four defendants other than Covey filed a joint application for a stipulated final judgment and order. On the same day the plaintiffs applied for a default judgment relating to Covey.

On February 10 Judge Staton issued a stipulated final judgment and order relating to the four defendants other than Covey. Among other things, she permanently enjoined Lichtig and Hofelter from engaging directly or indirectly in any "pension-advance" products or services; permanently enjoined Lichtig, Hofelter, and the two company defendants from engaging directly or indirectly in servicing or providing any financial products or services in New York State without the requisite license; appointed Krista Freitag of E3 Advisors as the permanent receiver of the two company defendants; ordered Lichtig and Hofelter to pay $282,000 and $40,000, respectively, to the receivership estate; and ordered Lichtig and Hofelter to cooperate with the receiver.

On July 11 Judge Staton issued a default judgment and order relating to Covey. Among other things, she permanently enjoined Covey from engaging directly or indirectly in any pension-advance products or services, permanently enjoined him from engaging directly or indirectly in servicing or providing any financial products or services in New York State, ordered him to disgorge $578,182 representing profits from the conduct alleged in the complaint, ordered him to cooperate with the receiver, and ordered him to meet certain reporting requirements.

The Receivership
On July 11, according to the docket, the case was terminated. The only documents filed since then have been reports filed by the receiver, bills for her time and expenses, and other items related to the receivership.

As mentioned, the receiver was appointed on February 10. Thus far she has issued three interim reports—on April 29, July 28, and November 11. In each report she summarizes the case, shows amounts recovered for the receivership estate, and describes other activities. The November 11 report, for example, shows cash of $689,737 as of January 7, 2016, cash of $2,500,797 as of September 30, 2016, and the collections and disbursements during that period.

General Observations
For many years I have been convinced that the business of buying streams of annuity payments from annuitants by paying cash to the annuitants is fraught with potential problems. Two major problems are the refusal of factoring companies to acknowledge that the arrangements are loans, and the failure to disclose the interest rates imposed on annuitants who accept cash in exchange for annuity streams. The CFPB/DFS case illustrates these and other problems in the so-called pension-advance business. I think the case should be studied closely by persons interested in protecting the financial interests of annuitants.

Available Material
In No. 115, I offered a complimentary 29-page PDF consisting of the August 2015 CFPB/DFS complaint and the two 2011 articles in the Forum about annuity factoring companies; that package is still available. Now I offer a complimentary 37-page PDF consisting of Judge Staton's 15-page February 10 stipulated final judgment and order relating to the four defendants other than Covey, her 12-page July 11 default judgment relating to Covey, and the receiver's 10-page November 11 third interim report. E-mail and ask for the December 2016 package about the CFPB/DFS lawsuit against two annuity factoring companies and three individuals.


Monday, November 21, 2016

No. 189: Life Settlement Promotion Based on a Lawsuit That Went Nowhere

On November 10, 2016, I received an email from a marketing organization on the subject of "Fiduciary notice for life agents." Here is the full text of the email:
Recently, a family filed a class action lawsuit in a California U.S. District Court against their life insurance provider. They sought punitive damages, treble damages, restitution and an injunction because their agent failed to inform them of their options on the life settlement market.
This is not a fluke occurrence.
Uphold your fiduciary responsibility, save yourself from litigation and help seniors save the 100B worth of lapsed policies that could be used, for example, to fund long-term care.
Simply read a new white paper that provides a simple overview of life settlements in a fiduciary context, plus life and annuity options to help you uphold your responsibility and make additional sales. [Emphasis in original.]
The email identified the lawsuit as Grill v. Lincoln National Life. I had looked at the case in February 2016, but did not report on it at the time because it had gone nowhere. Now that the case is being used to support the argument that a life insurance agent has a "fiduciary responsibility" to mention life settlements as "options," I felt it would be appropriate to report on the case.

The Grill Lawsuit
On January 9, 2014, three members of the Grill family filed a class action lawsuit against Lincoln National Life Insurance Company. The case was assigned to U.S. District Judge Jesus G. Bernal. President Obama nominated him in April 2012, and the Senate confirmed him in December 2012. His career is an immigrant success story. Born in Mexico, he received his undergraduate degree cum laude from Yale University and his law degree from the Stanford Law School. (See Grill v. Lincoln National, U.S. District Court, Central District of California, Case No. 5:14-cv-51.)

The plaintiffs filed four complaints. The discussion here is based on the fourth (third amended) complaint, which was filed September 29, 2014.

In 2004 the plaintiffs purchased a second-to-die policy with a death benefit of $7.2 million. The insureds were aged 68 and 65. The third plaintiff was trustee of the trust that was owner and beneficiary of the policy. The policy type is not stated, but it was probably universal life because the complaint said the "premium payments were designed to generate investment returns that would cover the cost of insurance." Although the complaint did not say so, the policy probably was being paid for with minimum premiums so as to generate no account value.

By 2008 the investment returns became insufficient to cover the cost of insurance. The plaintiffs consulted their agent, who allegedly said "they had two options: (1) pay new premiums into the Policy to extend it, or (2) surrender the Policy, in whole or in part, to reduce the cost of insurance." The plaintiffs surrendered part of the policy, decreasing the death benefit to $5.4 million. By 2009 the investment returns again became insufficient, and the plaintiffs again surrendered part of the policy to reduce the death benefit to $2 million. The plaintiffs alleged that they had twice surrendered parts of the policy "for no consideration" and that their agent did not tell them about life settlements. Further, they alleged:
Defendant's failure to inform and/or concealment of the option of a life settlement is part of a common and systematic practice by Defendant to hide this option from its insureds. The reason for this failure to inform and/or concealment is clear: Defendant stands to profit significantly if Plaintiffs and similarly situated Class members pay new premiums into their policies or surrender their policies for little or no value. Conversely, if Plaintiffs and similarly situated Class members sell their policies in a life settlement, Defendant would have to pay the death benefit without receiving higher premiums and/or without a surrender.
The complaints survived Lincoln's motions to dismiss. On October 6, 2014, one of the insureds died. On May 29, 2015, Judge Bernal ordered the plaintiffs to file a motion for class certification by June 15. On that date the plaintiffs instead filed a notice of settlement. On August 24 the parties filed a joint stipulation to dismiss the case based on the fact that one of the lead plaintiffs had died and the survivors had not substituted another lead plaintiff. On August 25 Judge Bernal granted the stipulation to dismiss with prejudice (permanently) all claims asserted by the plaintiffs.

The Final Stipulation
On September 21, 2015, the parties filed a joint stipulation of dismissal. Here is the full text of the stipulation:
WHEREAS, Plaintiffs' investigation and analysis to date did not support the allegation that Defendant had a common and systematic practice of concealing life settlement options from its insureds;
WHEREAS, the parties have elected to settle each and every claim asserted in the above-captioned matter with no admission of wrongdoing, impropriety or liability on the part of any party;
NOW, THEREFORE, IT IS HEREBY STIPULATED AND AGREED by and between the parties through their respective counsel of record pursuant to that settlement agreement, and pursuant to Rule 41(a)(1) of the Federal Rules of Civil Procedure, the individual claims of the named plaintiffs in the above-entitled action be dismissed with prejudice, and the claims of the putative class be dismissed without prejudice, with each party to bear its own costs.
General Observation No. 1
Citing a case that went nowhere to support the notion that the agent has a fiduciary obligation to disclose life settlement "options" is not the only phony tactic used by life settlement promoters. The requirement of insurable interest has caused a huge amount of litigation in the secondary market for life insurance. In the June 2009 issue of The Insurance Forum, in a discussion of an agent's lawsuit against Phoenix Life Insurance Company, I said the plaintiff had cited a 2007 article in a prestigious law journal condemning the insurable interest doctrine. The author argued that "the doctrine creates perverse incentives that encourage the very practices the doctrine seeks to deter," that "the doctrine also invites unfairness and inefficiency in the insurance market," and that the doctrine should be abolished. The article was written by a law student on the editorial staff of the law journal. In a note the author acknowledged the help of a fellow student on the editorial staff of the law journal, and the help of a member of the faculty of the law school.

I was certain that the article had been planted by promoters of the secondary market for life insurance. I wrote to the author and his fellow student, both of whom by then were associated with major law firms. I also wrote to the faculty member. I asked who had suggested the idea for the article. I also asked whether anyone at the law school had received compensation. In the December 2013 issue of the Forum, in an article entitled "Why the Secondary Market for Life Insurance Will Never Win Full Public Acceptance," I said I had received no reply.

General Observation No. 2
The plaintiffs in the Grill case, in their reasoning about why Lincoln allegedly concealed the life settlement option, are incorrect. As a general rule, life insurance companies want their policies to remain in force. That is why companies often reward agents for strong persistency. Exceptions to the general rule are so-called "lapse-supported" policies that are priced so as to depend on high lapse rates for profitability. The policy in this case does not fit into the "lapse-supported" category. Furthermore, in their reasoning, the plaintiffs neglected to point out that the speculator in human life who would have acquired the policy in the secondary market would have had to continue paying premiums to keep the policy in force until the death of the second insured, and that the need to pay those premiums would have been a factor in determining the price paid in a life settlement.

General Observation No. 3
A matter somewhat related to the second observation above is the question of how much a company would pay on surrender of a policy whose insured is in poor health. At least two observers—an actuary and I—have suggested the idea of "health-related" or "health-adjusted" cash values. If an insured is in poor health, it would seem reasonable for a company to pay an enhanced cash value upon surrender of the policy. In the March 1999 issue of the Forum, which was a special 12-page issue, I mentioned health-related cash values as one of eleven suggested methods of dealing with "The Growth of the Frightening Secondary Market for Life Insurance Policies." The February 2001 issue of the Forum included an article by Albert E. Easton, FSA, MAAA. He had written a technical article on the subject in an actuarial journal, and I had invited him to write a nontechnical article for the Forum.

Available Material
I am offering a complimentary 21-page PDF containing the four Forum articles mentioned in the general observations above. Email and ask for the November 2016 package of Forum articles about the secondary market for life insurance.


Tuesday, November 15, 2016

No. 188: The U.S. Department of Labor Wins One of the Lawsuits Challenging Its New Fiduciary Rule

On April 8, 2016, the U.S. Department of Labor (DOL) promulgated its long-awaited "fiduciary rule" addressing conflicts of interest in the marketing of commission-driven retirement advice given to consumers. In the months that followed, the industry's opposition to the rule took the form of several lawsuits seeking to prevent or at least delay implementation of the rule. The rule is to go into effect on April 10, 2017, with full implementation of certain aspects of the rule on January 1, 2018.

The NAFA Lawsuit
On June 2, 2016, the National Association for Fixed Annuities (NAFA) filed a complaint seeking to delay implementation of the new DOL rule, a motion for a preliminary injunction, and a memorandum in support of the motion. The defendants are the DOL and Secretary of Labor Thomas E. Perez. The case was assigned to U.S. District Judge Randolph D. Moss. President Obama nominated him in April 2014, and the Senate confirmed him in November 2014. (See NAFA v. DOL and Perez, U.S. District Court, District of Columbia, Case No. 1:16-cv-1035.)

On June 7 Judge Moss said NAFA's motion will be treated as a motion for a preliminary injunction and for summary judgment. On July 8 the defendants filed an opposition to NAFA's motion and a cross-motion for summary judgment. On August 30 Judge Moss held a hearing on NAFA's motion and the defendants' cross-motion.

The Opinion
On November 4 Judge Moss issued a 92-page opinion and a one-page order. They constitute a win for the defendants. Here, without citations, are the first and last paragraphs of the five-page introductory section of the opinion:
  • Plaintiff the National Association for Fixed Annuities ("NAFA") brings this action under the Administrative Procedure Act and the Regulatory Flexibility Act, challenging three final rules promulgated by the Department of Labor on April 8, 2016. Taken together, the three rules substantially modify the regulation of conflicts of interest in the market for retirement investment advice under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. NAFA focuses its challenge on how the new rules will affect the market for the fixed annuities its members sell.
  • Based on these arguments, and its further contention that the new rules will have catastrophic consequences for the fixed indexed annuities industry, NAFA seeks both a preliminary injunction and summary judgment. The Department opposes both motions and has cross-moved for summary judgment. For the reasons explained below, the Court will deny NAFA's motions for a preliminary injunction and summary judgment and will grant the Department's cross-motion for summary judgment.
The Outline
Below is an outline of the opinion. In parentheses is the page number on which the discussion of each item begins. "ERISA" is "Employee Retirement Income Security Act of 1974," "PTE" is "Prohibited Transaction Exemption," and "BIC" is "Best Interest Contract."

Memorandum Opinion (1)
I. Background (5)
A. Annuities (5)
B. Statutory and Regulatory Background (7)
1. ERISA (7)
a. Title I of ERISA (8)
b. Title II of ERISA (10)
2. The 1975 Definition of "Fiduciary" and PTE 84-24 (11)
3. The Current Rulemaking (14)
a. The 2010 Proposed Rule (14)
b. The 2015 Proposed Rules (15)
c. The Final Rule (21)
C. Procedural Background (27)
II. Analysis (29)
A. Revised Definition of "Rendering Investment Advice" (30)
1. Chevron Step One (30)
2. Chevron Step Two (40)
B. Imposition of Fiduciary Duties as Condition of PTE 84-24 and the BIC Exemption (45)
C. Written Contract Requirement of the BIC Exemption (55)
D. Reasonable Compensation Requirement and Due Process (61)
E. Placement of Fixed Indexed Annuities in the BIC Exemption (71) 
1. Treatment of Fixed Income [sic] Annuities as "Securities" (72)
2. Notice and Opportunity to Comment (73)
3. Reasoned Explanation (76)
4. Workability and Rationality (79)
5. Cost/Benefit Analysis (85)
F. Regulatory Flexibility Act (88)
Conclusion (92)

The Parties' Statements
After Judge Moss's ruling, Secretary Perez issued a brief statement. NAFA sent its members a relatively lengthy statement entitled "NAFA to Appeal Court Decision on DOL Fiduciary Rule" and subtitled "NAFA Will Seek Expedited Review." Here are the statements:
Perez: The conflicts of interest rule was developed after substantial input from a variety of stakeholders, including the industry, and it will make sure that retirement savers receive advice that puts their interests first. I'm pleased that the court recognized the comprehensive and thoughtful process we used in crafting this rule—this ruling is a win for working Americans who simply want a secure retirement.
NAFA: The National Association for Fixed Annuities ("NAFA") announced today, following a federal district court decision upholding the Department of Labor's fiduciary rule, that it will appeal to the D.C. Circuit Court of Appeals. "We are obviously disappointed by the court's decision, but we have always assumed this case would get decided by a higher court and we are pleased the issues will get de novo review by the Circuit Court," said Chip Anderson, Executive Director of NAFA. De novo review means the appellate court will consider the case without being bound or influenced by the lower court's decision. NAFA filed its lawsuit last June seeking a preliminary injunction to stay implementation of the rule, which is scheduled to go into effect in April 2017. Judge Randall [sic] Moss denied the preliminary injunction and at the same time ruled in favor of the DOL on the merits upholding the rule. NAFA's lawsuit, one of four lawsuits against the rule, challenges the DOL's authority to issue the rule, asserts the rule creates an impermissible private right of action, contends the rule contains unconstitutionally vague requirements that compensation be reasonable, and alleges the manner of adoption of the rule by DOL was arbitrary and capricious. Anderson stressed that NAFA would move quickly to get the case up to the appellate court and would continue to seek a preliminary injunction. Anderson said NAFA remains optimistic that the courts will ultimately find the rule to be an overreach by the Department of Labor that is inconsistent with existing tax and financial services laws. "NAFA believes the fiduciary rule will disrupt the distribution and availability of fixed annuities and have a particularly adverse impact on the low and middle income consumers who have come to rely on these valuable retirement savings products," said Anderson. Fixed annuities provide consumers with a guaranty of principal and minimum accumulation and provide a guaranteed lifetime income stream consumers cannot outlive. NAFA consists of insurance companies, agencies, and agents and affiliated persons who provide fixed annuities.
Other Lawsuits
As mentioned in NAFA's statement, several lawsuits have been filed seeking to delay implementation of the DOL rule. Some of the lawsuits have been consolidated. It is beyond the scope of this post to discuss the status of the other cases. However, to appreciate the significance of the DOL rule, it is instructive to identify some (but by no means all) of the parties involved as plaintiffs, as filers of amicus curiae (friend of the court) briefs, and as participants in other capacities, on both sides of the cases.

Some of those opposing the DOL, in addition to NAFA, are American Council of Life Insurers, American Equity Investment Life Insurance Company, Chamber of Commerce of the U.S., Life Insurance Company of the Southwest, Midland National Life Insurance Company, National Association of Insurance and Financial Advisors, North American Company for Life and Health Insurance, and Thrivent Financial for Lutherans. Some of those supporting the DOL are AARP, Americans for Financial Reform, Better Markets, Inc., Consumer Federation of America, and Public Citizen, Inc.

General Observations
Judge Moss's opinion is an extraordinary document. The five-page introductory section is an excellent summary of the DOL rule and the arguments for and against its implementation.

The terminology is interesting. In the first paragraph of the introductory section of the opinion, the expression "fixed annuities" appears. In the fifth paragraph, the expression "fixed index annuities" appears. Including NAFA's name, the statement to its members contains four references to "fixed annuities" and no mention of "fixed index annuities." It is my understanding that "fixed annuities" have no special upside potential based on a stock index, and that they are deemed to be insurance products. "Index annuities," on the other hand, have some upside potential based on a stock index, and therefore should be deemed securities. However, those arguing against their being deemed securities changed the name in a confusing and even contradictory manner to "fixed index annuities" in an effort to strengthen their argument.

Although many readers have asked me to write in detail about index annuities or fixed index annuities, I have not done so. The reason is that I do not understand the instruments well enough to feel comfortable writing about them. Some promoters have said I am too stupid to know a good thing when I see it, but I think the instruments are being sold by agents who do not understand them to buyers who do not understand them.

I have long believed that those selling insurance instruments, whether or not the instruments are deemed securities, should be required to operate under the fiduciary standard of care rather than the much weaker suitability standard of care. I think the new DOL rule, provided it survives the efforts of the industry to delay its implementation, will be an important step in that direction. In the long run, I think such a result would benefit not only insurance consumers but also the insurance industry.

Blogger's Note
In view of the results of the November 8 election, it is likely that the Trump-appointed Secretary of Labor—whoever he or she may be—will withdraw the DOL rule in view of the campaign promises that have been made to cut back on government regulations. Thus the efforts of all the parties—including the industry and the Department of Labor—in developing the rule and preparing for its implementation, as well as all the efforts of the parties and the courts in fighting over the rule, are likely to have been wasted.

More importantly, withdrawal of the rule will have a severe, adverse effect on retirement savers and other consumers. They will continue to be victimized by purchasing so-called fixed index annuities that benefit primarily commission-driven agents and others who sell them.

Available Material
I am offering a complimentary 92-page PDF containing the opinion Judge Moss issued on November 4, 2016. Email and ask for the Moss ruling in the NAFA/DOL case.


Thursday, November 10, 2016

No. 187: Genworth Financial, Long-Term Care Insurance, and Clarification of a Comment in No. 185

The purpose of this post is to clarify a comment I made in No. 185, in which I discussed, among other things, regulatory supervision. I discussed the October 23 surprise announcement by Genworth Financial, Inc. that it had entered into a definitive merger agreement. If the agreement is consummated, Genworth would be an indirect, wholly owned subsidiary of China Oceanwide Holdings Group Co., Ltd., a privately held international financial holding company group headquartered in Beijing.

I said Genworth has long been in the long-term care (LTC) insurance business, it is one of the few major companies still in the business, its subsidiaries have suffered significant declines in their financial strength ratings, primarily as a result of their LTC insurance business, and the company is trying to reorganize in order to "isolate" its LTC insurance business. I also said that, because of Genworth's financial problems and its effort to reorganize, one or more of its subsidiaries may be operating under a supervision order, but that I was not aware of the existence of such an order.

When No. 185 was posted on Friday morning, November 4, I forwarded it as a courtesy to a Genworth spokeswoman. She promptly said Genworth is not operating under a supervision order. She also said she is happy to fact check anything I am uncertain about before posting an item on my blog. I explained that I made a decision not to ask Genworth about supervision because I felt that the very act of asking such a question would be unfair. On Monday afternoon, November 7, she said:
Our corporate counsel wanted to make sure you understood the implications of your suggestion that one or more of Genworth's companies are operating under a supervision order. He told me there is virtually no circumstance under which a publicly traded company could keep from disclosing such an order and by suggesting that one or more of our companies are operating under a supervision order that has not been disclosed in our SEC [Securities and Exchange Commission] report is, in essence, suggesting that we are committing securities fraud. Although we know this was not your intent, the statement does establish a cloud of uncertainty that is unwarranted. We respectfully ask that you correct the statement and let your readers know definitively that Genworth is not operating under a supervision order.

The 1999 Incident
In No. 185 I also discussed the 1999 case of General American Life Insurance Company. Also involved in the case were ARM Financial, Inc., which is a publicly traded company, and Integrity Life Insurance Company, an ARM subsidiary that is domiciled in Ohio. I said ARM had disclosed in a public filing with the SEC that Integrity Life was operating under a confidential supervision order issued by the Ohio Department of Insurance. Thus ARM's attorney and Genworth's attorney apparently agree that a public company must disclose in its SEC filings the existence of a supervision order.

Blogger's Note
I finished writing this item on November 8 and planned to schedule it on November 9 for posting early in the morning on November 10. I sent an email on the morning of November 9 to Genworth's spokeswoman asking for a brief company statement about the impact of the election results on the pending merger agreement with China Oceanwide. She responded that afternoon as follows:
We will have no comment on the impact of the election results on the China Oceanwide transaction. Thank you.

Tuesday, November 8, 2016

No. 186: Chernow's Superb Biography of Alexander Hamilton—An Election Day Special

Ron Chernow's Alexander Hamilton, a superb biography of our first Secretary of the Treasury, inspired the smash Broadway hit, Hamilton: An American Musical. The 818-page book, published in 2004, provides fascinating details about many of the founders of our great nation. For example, the book delves into Hamilton's abolitionist views as well as the views of other founders on the subject of slavery.

Chernow describes Hamilton's birthplace on the Caribbean island of Nevis, and his early life on other islands there. His apparent illegitimate birth plagued his entire life. When he immigrated (yes, he was an immigrant) to New York City as a young man, he became a prodigious student, reader, and writer, and he built an amazing life as an attorney and political leader.

George Washington was Hamilton's greatest supporter. Hamilton was Washington's top assistant during most of the Revolutionary War. Toward the end of the war Hamilton achieved the military rank of general and became a battlefield hero. He later ran the Treasury Department, which was the dominant cabinet department during Washington's administration. The Treasury Department dwarfed the State Department, which at the time was headed by Thomas Jefferson.

Chernow examines in detail Aaron Burr's career, which in many ways was parallel to Hamilton's career. Burr was Jefferson's vice president at the time of the fateful duel that ended Hamilton's life. The duelists and their seconds crossed the Hudson River in separate boats to meet at Weehawken, New Jersey, because dueling was illegal in New York State at the time. As is common in such incidents, there are conflicting views about precisely what happened. Chernow believes that Hamilton purposely fired the first shot into the trees high above Burr.

Chernow devotes considerable space to Hamilton's beloved wife Eliza, who survived him by about half a century. They had eight children. One thing I never knew before was that Philip, their eldest and a handsome young man in the prime of his life, died in a duel about two years before Hamilton's death. Hamilton never fully recovered from the shock of that loss. They named their youngest child Philip (nicknamed Little Phil), who was born after his eldest brother's death.

Chernow provides detail about Hamilton's philandering, especially an affair that resulted in his paying blackmail in what turned out to be an unsuccessful attempt to keep the matter secret. Apparently the affair was a major obstacle that prevented Hamilton from occupying a prominent position in the government after he left Washington's cabinet.

Throughout the book are descriptions of the prickly (to put it mildly) relationship between Hamilton and Jefferson. Hamilton was an admirer of Great Britain and its form of government. Jefferson had spent a substantial amount of time in France and was an admirer of the French, even after the nasty developments that occurred during the French revolution.

Chernow describes in detail Hamilton's strained relationships with other founding fathers, including not only Jefferson, but also John Adams, James Madison, James Monroe, and others. Hamilton's friendship with Madison, for example, was on and off. In the early days of their close relationship, they worked together on The Federalist Papers, although Hamilton wrote most of the pieces in that famous series. Hamilton and Madison later had a falling out.

Chernow describes how Hamilton became the leader of the Federalists in the original two-party system and served as a member of the Constitutional Convention. Hamilton laid the groundwork for what became the New York Stock Exchange, and he developed our tax system. He created our first central bank, the Coast Guard, and the Customs Service. Early in 1795, at age 40, he resigned as Secretary of the Treasury. Here are two sentences (buried on page 481) that summarize Chernow's views on Hamilton's contributions to his adopted country:
Hamilton's achievements were never matched because he was present at the government's inception, when he could draw freely on a blank slate. If Washington was the father of the country and Madison the father of the Constitution, then Alexander Hamilton was surely the father of the American government.
General Observations
Chernow's book is so well written that it is a delight to read. I strongly recommend it to anyone interested in learning about the beginnings of the United States. Readers will recognize the relevance of many parts of the book to happenings in our country today, even including the presidential election campaign of 2016.

This is the first Chernow book I have read. It is so superb that I am determined to read his two other major books—about John D. Rockefeller (Titan) and about John Pierpont "J.P." Morgan (The House of Morgan).

An Interesting Coincidence
When I acquired Chernow's book about Hamilton, I was startled by the back cover of the dust jacket. Two of the three testimonials were written by two of my favorite authors—Robert Caro and David McCullough. I have read all their books. Caro has written about Robert Moses (The Power Broker) and about Lyndon Johnson. The biography of Johnson now consists of four major volumes; Caro's faithful readers anxiously await the fifth and presumably final volume. McCullough has written about Harry Truman, John Adams, the early life of Theodore Roosevelt, the Wright Brothers, the Johnstown Flood, the building of the Brooklyn Bridge, and the building of the Panama Canal, among other persons and events.


Friday, November 4, 2016

No. 185: Long-Term Care Insurance—Regulatory Supervision, Rehabilitation, and Liquidation of Financially Troubled Companies

For 25 years I have been saying that the problem of financing long-term care (LTC) cannot be solved through private insurance because the LTC exposure violates important principles necessary for the proper functioning of private insurance. Thus I am not surprised that most companies in the LTC insurance business have left the business, and that some of the few remaining are in fragile financial condition. Here I discuss and provide examples of three processes that state insurance regulators use to deal with financially troubled insurance companies.

Supervision is a process that state insurance regulators use to deal with financially troubled companies. Regulators normally have the authority to place a company under supervision without obtaining court approval. In some instances, the regulator issues a supervision order openly, by making public the existence of the order and the order itself. In other instances, the regulator makes public the existence of the order but keeps the order itself confidential. In still other instances, the regulator keeps the existence of the order and the order itself confidential.

Rehabilitation and Liquidation
Rehabilitation and liquidation are two other processes that state insurance regulators use to deal with financially troubled companies. In contrast to supervision, court approval is required for rehabilitation or liquidation. The regulator files a petition in state court. If the court approves the petition, the court would appoint the regulator as rehabilitator or liquidator, and full details would be available to the public. The objective of a rehabilitation is to preserve the company so as to allow it to emerge from rehabilitation. To accomplish that objective, the rehabilitator may take such actions as modifying the company's operations, selling the company in whole or in part, merging the company into another company, or changing provisions of the company's existing policies.

Liquidation is a last resort when the regulator and the court agree that rehabilitation is futile. State guaranty associations become involved, and drastic actions may have to be taken. For example, the company may have to be wound down, and policyholders may suffer significant losses.

General American, ARM Financial, and Integrity Life
The 1999 case of Missouri-domiciled General American Life Insurance Company illustrates the use of supervision, although the incident did not involve LTC insurance. At the company's request, the Missouri department of insurance placed the company under supervision to stop a devastating run. The existence of the order became known to the public, but the department kept the order itself confidential.

My first article about supervision, which discussed the General American case, was in the October 1999 issue of The Insurance Forum. While working on the article, I learned that ARM Financial Group, Inc. and a subsidiary, Ohio-domiciled Integrity Life Insurance Company, had extensive dealings with General American. The Ohio department of insurance placed Integrity Life under a confidential supervision order, but word of the existence of the order leaked out. Pursuant to the Ohio public records law, I asked the Ohio department for a copy of the order. The department denied the request, saying the order was confidential. However, ARM Financial, a shareholder-owned company, included the order in a public filing with the Securities and Exchange Commission. I showed the order in the article about the General American case.

Ability Insurance Company
A few companies that abandoned the LTC insurance business transferred their existing policies to Nebraska-domiciled Ability Insurance Company, which is running off the policies. In December 2012 the Nebraska department of insurance placed Ability under a supervision order. The existence of the order was publicly known, and the order itself was available to the public. Here is the third of the department's seven findings of fact in the supervision order:
Based upon examination of financial statements filed by [Ability], including those filed with the Department dated September 30, 2011 and September 30, 2012, the Director has reasonable cause to believe that [Ability] is in such a condition as to render the continuance of its business hazardous to its policyholders and the general public as defined in the Nebraska Insurance Regulations, specifically, 210 Neb. Admin. Code 55 §§ 004.05 and 004.06.
In January 2013 the Nebraska department approved the acquisition of Ability by Advantage Capital Holdings, LLC, an investment company based in Wilmington, Delaware. In July 2014 the department issued an order removing Ability from under supervision. I wrote about the Ability case in the May 2013 issue of the Forum.

Two examples of liquidation, neither of which involved LTC insurance, are the International Workers Order (IWO) and Executive Life Insurance Company of New York (ELNY). IWO was liquidated during the "Red Scare" in the 1950s. ELNY was placed in rehabilitation in 1991 and remained there for 21 years until it was liquidated in 2012. I wrote about the IWO and ELNY liquidations in the August 2012 issue of the Forum.

Penn Treaty
In 2009 the Pennsylvania insurance department petitioned the court to place Pennsylvania-domiciled Penn Treaty Network America Insurance Company, an LTC insurance company, in rehabilitation. Six months later the department petitioned the court to convert the rehabilitation to a liquidation. In 2012, after lengthy proceedings including a 30-day bench trial, the judge, in a 162-page opinion and order, denied the liquidation petition and ordered the department to develop a rehabilitation plan. Later the department and the court revised the rehabilitation plan. In July 2016 the department again petitioned the court to liquidate the company. In October 2016 the judge scheduled a November 9 hearing on the liquidation petition. If the judge approves the petition, the case might have a profound impact on the U.S. system of state guaranty associations. That subject, however, is beyond the scope of this discussion. I wrote about the Penn Treaty case in the August 2012 issue of the Forum, and I plan to write again irrespective of what happens during and after the hearing.

CNO Financial Group
In 2008 CNO Financial Group, Inc. (then Conseco, Inc.) separated itself from Pennsylvania-domiciled Conseco Senior Health Insurance Company (CSHI), a financially troubled LTC insurance subsidiary. With the approval of the Pennsylvania insurance department, Conseco transferred CSHI to an independent trust and renamed the company Senior Health Insurance Company of Pennsylvania (SHIP). I have written about the separation, most recently in No. 182 (October 7, 2016).

In that post I also wrote about a CNO effort to separate itself from a total of about 10,000 LTC insurance policies written by two other CNO subsidiaries, which are domiciled in Indiana and New York. That effort was through reinsurance with Cayman Islands-based Beechwood Re. The Indiana and New York departments required the CNO companies to recapture the reinsurance. Also, CNO filed a lawsuit against three individuals who allegedly misled CNO by failing to disclose Beechwood's close ties to Platinum Partners, a troubled hedge fund. Although CNO's problems with Beechwood and Platinum are significant, I think the problems do not warrant supervision of the CNO companies.

SHIP, the former Conseco subsidiary, is in fragile financial condition. It has suffered operating losses, its total adjusted capital at the end of 2015 was below company action level risk-based capital, and it too is entangled with Beechwood and Platinum. Because of its financial condition, SHIP may be operating under a supervision order, but I am not aware of the existence of such an order. I have written about SHIP, most recently in No. 183 (October 19, 2016).

Genworth Financial, Inc. has long been in the LTC insurance business, and is one of the few major companies that are still in the business. Genworth has suffered significant declines in its financial strength ratings, primarily as the result of its LTC insurance business. Genworth's subsidiaries, other than those in the mortgage insurance business, are domiciled in Delaware, New York, and Virginia. Genworth is trying to reorganize in order to "isolate" its LTC insurance business. I have written about that effort, most recently in Nos. 154 and 155 (April 7 and 13, 2016). Because of its financial problems and its effort to reorganize, one or more of Genworth's companies may be operating under a supervision order, but I am not aware of the existence of such an order.

On October 23, 2016, Genworth surprised insurance observers by announcing its entry into a definitive merger agreement. If the agreement is consummated, Genworth would be an indirect, wholly owned subsidiary of China Oceanwide Holdings Group Co., Ltd., a privately held international financial holding company group headquartered in Beijing. The agreement provides for Genworth's headquarters to remain in Virginia under the current senior management. The agreement is subject to the approval of Genworth's shareholders, state insurance regulators, federal agencies in the U.S., and governmental authorities in Australia, Canada, China, and Mexico. Genworth hopes to close on the agreement by the middle of 2017.

The agreement consists of 129 single-spaced pages and additional exhibits and schedules that Genworth will make available upon request. An overview of the agreement is in a five-page, single-spaced, October 23 joint press release from China Oceanwide and Genworth. Here are the first two paragraphs of the press release:
China Oceanwide Holdings Group Co., Ltd. ("China Oceanwide") and Genworth Financial, Inc. (NYSE:GNW) ("Genworth") today announced that they have entered into a definitive agreement under which China Oceanwide has agreed to acquire all of the outstanding shares of Genworth for a total transaction value of approximately $2.7 billion, or $5.43 per share in cash. The acquisition will be completed through Asia Pacific Global Capital Co. Ltd., one of China Oceanwide's investment platforms. The transaction is subject to approval by Genworth's stockholders as well as other closing conditions, including the receipt of required regulatory approvals.
As part of the transaction, China Oceanwide has additionally committed to contribute to Genworth $600 million of cash to address the debt maturing in 2018, on or before its maturity, as well as $525 million of cash to the U.S. life insurance businesses. This contribution is in addition to $175 million of cash previously committed by Genworth Holdings, Inc. to the U.S. life insurance businesses. Separately, Genworth also announced today preliminary charges unrelated to this transaction of $535 to $625 million after-tax associated with long term care insurance (LTC) claim reserves and taxes. Those items are detailed in a separate press release. The China Oceanwide transaction is expected to mitigate the negative impact of these charges on Genworth's financial flexibility and facilitate its ability to complete its previously announced U.S. life insurance restructuring plan. Genworth believes this transaction is the best strategic alternative to maximize stockholder value.
The "separate press release" referred to in the second paragraph quoted above is a three-page, single-spaced, October 23 press release from Genworth. It is entitled "Genworth Financial Announces Preliminary Charges For The Third Quarter."

General Observations
Unlike in the case of a rehabilitation or a liquidation, state insurance regulators normally have the authority to place an insurance company under supervision without court approval. The supervision may be carried out in secret, or it may be carried out publicly. Where secrecy is used, the reason is to avoid exacerbating the company's fragile financial condition. Nonetheless I question the wisdom of secret supervision because I think policyholders, shareholders, creditors, employees, agents, and other interested parties are entitled to the truth about the company's financial problems.

It is my understanding that similar secret proceedings are used in the banking business, arguably to prevent runs. Here again, however, I think a bank's customers, shareholders, creditors, employees, and other interested parties are entitled to the truth about the bank's financial problems.

Available Material
I am offering a complimentary 22-page PDF. It consists of articles from the October 1999, August 2012, and May 2013 issues of The Insurance Forum (a total of 14 pages), the five-page October 23 joint press release from China Oceanwide and Genworth, and the three-page October 23 press release from Genworth. Email and ask for the November 2016 package about LTC insurance and supervision.