Thursday, December 21, 2017

No. 245: Shadow Insurance and Cost-of-Insurance Increases—Recent Lawsuits Involving the Confluence of Those Topics

"Shadow insurance" (also called "captive reinsurance") and "cost-of-insurance (COI) increases" are topics on which I have blogged extensively. Recently I learned of five lawsuits—four in federal courts and one in a state court—involving the confluence of those two topics. Here I identify the cases, describe their general thrust, and quote from one of them.

The General Thrust of the Cases
For several years some life insurance companies have been engaging in transfers—through captive reinsurance subsidiaries—of large amounts of liabilities on universal life insurance policies. Some of the captive reinsurance subsidiaries are based offshore and some are based in states that have enacted laws and adopted regulations allowing the creation and operation of limited purpose subsidiaries (LPSs). To offset the liabilities that the LPSs acquire, the LPSs often use as assets items such as parental guarantees, letters of credit, credit-linked notes, and other phony assets that are permitted by the regulators in the domiciliary states of the LPSs but are not permitted under generally accepted accounting principles or under statutory accounting principles promulgated by the National Association of Insurance Commissioners. After unloading their liabilities, the parent insurance companies of the LPSs are able to pay large dividends to their ultimate parent companies, and the ultimate parent companies are able to pay large dividends to their shareholders. In that fashion the ultimate shareholders receive large dividends long before earnings materialize to justify those dividends. When the problem emerges, as it invariably does, the parent insurance companies try to survive by imposing large COI increases on their policyholders with the argument that future expectations are far below what had been anticipated.

The First Banner Case
In January 2016 Richard Dickman and one other individual filed a 79-page, four-count complaint against Banner Life Insurance Company and two Banner affiliates. Here, with italics as in the original and without citations, is the nine-paragraph introduction to the complaint:
  1. Banner Life Insurance Company ("Banner") is a for-profit life insurer organized under Maryland law. Legal and General America, Inc. ("LGA"), Banner's immediate parent, owns all of Banner's Class A common stock, Class B common stock, and preferred stock. Full control of LGA ultimately resides with Legal and General Group Plc ("L&G"), a United Kingdom company.
  2. Banner, LGA, and L&G, working in concert with each other, embarked upon a scheme to take funds, which were designated as support for reserves [liabilities] and set aside to pay American policyholders' death claims, and convert them to L&G's investors' and executives' benefit.
  3. For more than a decade, Banner, under the direction of its ultimate parent, L&G, put investors and executives ahead of their own policyholders. In doing so, Banner pretended to offload billions of dollars of liabilities, a la Enron, from Banner's balance sheet to its wholly-owned "captives" and other affiliates. As false "surplus" was created by this scheme, L&G caused Banner to pay more than $800 million in "extraordinary stockholder dividends."
  4. Importantly, L&G executives have stated, in press releases to its United Kingdom investor audience, that it was repatriating capital and profits from Banner, its American insurer, through an "internal reinsurance arrangement."
  5. This "internal reinsurance arrangement" has been called "financial alchemy" by New York's former Superintendent of Financial Services, Benjamin M. Lawsky. In reality, Banner merely dumped approximately $4 billion worth of liabilities into wholly-owned captive reinsurance companies that are incapable of satisfying their assumed obligations, thereby freeing up hundreds of millions of dollars Banner would otherwise be legally required to hold as reserves.
  6. Banner's captive reinsurance companies are strategically domiciled in jurisdictions that, amazingly, allowed the "reinsurers" not to file any public financials, hiding the true nature and details of these transactions.
  7. After engaging in this financial alchemy for a decade, Banner decided to embark upon a new scheme to take U.S. policyholder funds and send them to L&G, ultimately to benefit shareholders. In September 2015, Banner suddenly increased the Cost of Insurance ("COI") charged to certain universal life insurance policyholders; in some cases, by as much as 620 percent.
  8. Through mailers, press releases, and myriad other mediums, Banner has told policyholders that dramatic COI increases are necessary because "the company did not adequately account for future experience." Banner and LGA define "experience" as "the number and timing of death claims; how long people would keep their policies; how well the company's investments would perform; and the cost to administer policies." Apparently suffering from corporate amnesia, Banner, LGA, and L&G forgot that they told insurance examiners, policyholders, rating agencies, and shareholders the exact opposite for more than a decade to justify paying extraordinary dividends and encourage investment by both policyholders and shareholders.
  9. Since September 2015, Banner has systematically raided policyholder accounts, arguing that its action is permitted by the policies' terms. In reality, the justifications offered by Banner are false, and merely a guise to accomplish two objectives: (1) find new cash with which to fund future dividends, and (2) rid itself of near-term liabilities, and delay inevitable financial disaster.
In December 2016 the two affiliates were dropped from the case. The case is progressing. (See Dickman v. Banner, U.S. District Court, District of Maryland, Case No. 1:16-cv-192.)

The Transamerica Case
In November 2016 Tommy Hill filed an 86-page, nine-count complaint against Transamerica Life Insurance Company and three Transamerica affiliates. In January 2017 the three affiliates were dropped from the case. The case is progressing. (See Hill v. Transamerica, Circuit Court of Jefferson County, State of Alabama, Case No. 2016-6000401.)

The Voya/Lincoln Case
In February 2017 Monte Swenson and five other individuals filed a class action complaint against Voya Financial Inc. and one Voya affiliate, and against Lincoln National Corp. and two Lincoln affiliates. The case was filed initially in federal court in Washington State. In June the judge granted a motion by the defendants to transfer the case to New York. The number of plaintiffs expanded to 15 individuals. In August the plaintiffs filed a first amended complaint. In October the plaintiffs filed a 98-page, 14-count second amended complaint that included two RICO (Racketeer Influenced and Corruption Organizations Act) counts. In November the plaintiffs filed a notice of voluntary dismissal "without prejudice to Plaintiffs' right to refile." (See Swenson v. Voya, U.S. District Court, Eastern District of Washington, Case No. 2:17-cv-48, and Southern District of New York, Case No. 1:17-cv-4843.)

The Second Banner Case
In March 2017 irrevocable insurance trusts of Robert Appel and one other individual filed a 32-page, one-count class action complaint against Banner. In June the plaintiffs stipulated that the case was stayed until final resolution of the first Banner case. (See Appel v. Banner, U.S. District Court, District of Maryland, Case No. 1:17-cv-759.)

The William Penn Life Case
In July 2017 Lesley Rich filed a complaint against William Penn Life Insurance Company of New York. In October the plaintiff filed an 83-page, two-count amended complaint. The case is progressing. (See Rich v. William Penn Life, U.S. District Court, District of Maryland, Case No. 1:17-cv-2026.)

The Book about Enron
The third paragraph quoted above from the introduction to the complaint filed in the first Banner case refers to Enron. In 2003, two years after Enron filed for bankruptcy, a 435-page book about the Enron case was published. The book is entitled The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron. The authors are Bethany McLean and Peter Elkind. A tenth anniversary edition was published in 2013; it includes a foreword by Joe Nocera and an afterword by the authors. Many view the book as the definitive account of the Enron scandal, and I strongly recommend the book.

General Observations
I refer to the use of shadow insurance as a shell game often used to impose large COI increases on the owners of universal life insurance policies. It is a shell game because the details of the phony assets are shielded from public scrutiny. I have tried to see those details, but have been rebuffed. In Iowa, where Transamerica Life is domiciled, I tried to examine the phony assets used by the company's Iowa LPSs. After the Iowa insurance division denied my requests under the Iowa open records law, I filed a lawsuit against the division seeking access to the documents. I lost the case on the grounds that Iowa laws and regulations (drafted by insurance company attorneys) render the documents confidential.

I do not know when or how, but there is no doubt that the shell game will collapse. When it does, I fear that the primary victims will be life insurance policyholders who placed their faith in the companies.

Available Material
I am offering a complimentary 103-page PDF consisting of the complaint in the first Banner case (79 pages) and the Lawsky report alluded to in the fifth paragraph of the complaint in that case. (24 pages). Email and ask for the December 2017 package about shadow insurance and COI increases.


Monday, December 11, 2017

No. 244: Long-Term Care Insurance and Philip A. Falcone

In No. 242 (posted November 20, 2017), I discussed the sale of a closed block of long-term care (LTC) insurance policies to a subsidiary of HC2 Holdings, Inc., a public company controlled by Philip A. Falcone. He is the founder of Harbinger Capital Partners LLC, a New York hedge fund. I expressed deep concern about the fate of the 30,000 LTC insurance policyholders remaining in the closed block. The reason for my concern is that in 2013 Falcone entered into a settlement with the Securities and Exchange Commission (SEC) under which he paid a large fine, admitted wrongdoing, and agreed to be barred from the securities industry for at least five years. Here I provide further details about the Falcone case.

SEC Complaints Against Falcone
On June 27, 2012, the SEC filed two related complaints. One was against Falcone and two units of Harbinger Capital. The other was against Falcone, Harbinger Capital, and Peter A. Jenson. The first paragraph of the first complaint summarized the allegations:
This case stems from an illegal "short squeeze"—a form of market manipulation that occurs when a trader constricts the available supply of a security with the intention of forcing settlement from short sellers at the trader's arbitrary and inflated prices. Falcone engineered and carried out a squeeze in a series of distressed high-yield bonds issued by MAAX Holdings, Inc., through two unregistered investment managers he controls [two units of Harbinger Capital].
The second complaint contained other allegations. The first two paragraphs of the second complaint summarized the allegations:
First, Falcone and Harbinger, aided and abetted by Jenson, engaged in a fraudulent scheme to misappropriate $113.2 million from a Harbinger fund in order to pay a personal tax obligation owed by Falcone. Instead of paying his personal taxes with his own assets, which may have required Falcone to curtail his lifestyle and personal expenditures, Falcone obtained $113.2 million from a hedge fund that Falcone and Harbinger managed during a period when Harbinger had precluded investors in the fund from redeeming their interests. The Defendants neither sought nor obtained investor approval for the related party transaction. Having structured the transfer of fund assets to Falcone as a loan with a highly favorable interest rate, Falcone and Harbinger, aided by Jenson, concealed the related party transaction from fund investors for approximately five months. To give the appearance of legality, the Defendants engaged a law firm to advise them; however, the Defendants failed to disclose all material information to the law firm. In addition, the Defendants did not act in accordance with the advice that they did receive from the law firm.
Second, in order to obtain investor approval to impose more stringent redemption restrictions on investors in a second Harbinger fund, Falcone and Harbinger engaged in a scheme to grant certain large investors favorable redemption and liquidity terms in return for their vote to approve the restrictions. Falcone and Harbinger concealed this scheme from the fund's board of directors and the other investors, even though Falcone and Harbinger knew, or should have known, that only the board, and not Falcone or Harbinger, had the authority to grant such preferential rights.
The complaints alleged violations of federal securities laws and rules. The first complaint included two claims for relief, and the second complaint included five claims for relief. In the first complaint, the SEC sought a permanent injunction against future violations, disgorgement of ill-gotten gains, and civil monetary penalties, and, in the second complaint, a permanent prohibition against Falcone serving as an officer or director of a public company. (See SEC v. Falcone, U.S. District Court, Southern District of New York, Case Nos. 1:12-cv-5027 and 5028.)

Settlement with the SEC
On August 16, 2013, Falcone and the Harbinger units settled with the SEC on both complaints through a consent agreement and an attachment. They admitted the facts in the attachment, agreed to issuance of a final consent judgment, and agreed to appointment of an independent monitor for two years. Falcone and the Harbinger units agreed to payment of civil penalties of more than $18 million.  Falcone also agreed to be barred from the securities industry for at least five years, but he was not barred from serving as an officer or director of a public company. On October 1, 2014, Jenson agreed to pay a civil penalty of $200,000.

Admission of Wrongdoing
In No. 242 I said that the defendants' admission of wrongdoing was important, and that the case was one of the first SEC settlements requiring such an admission. In a January 2014 speech, then SEC Chair Mary Jo White discussed the subject. Here are excerpts from her speech:
As you know, for many years, the SEC, like virtually every other civil law enforcement agency, typically did not require entities or individuals to admit wrongdoing in order to enter into a settlement. This no admit/no deny settlement protocol makes a great deal of sense and has served the public interest very well. More and quicker settlements generally mean that investors receive as much (and sometimes more) compensation than they would after a successful trial—and without the litigation risk or the inevitable delay that comes with every trial. Settlements also can achieve more certain and swifter civil penalties, and bars of wrongdoers from the [securities] industry or from serving as officers or directors of public companies—all very important remedies for deterrence and the public interest.
So, why modify the no admit/no deny protocol at all?... Because admissions can achieve a greater measure of public accountability, which can be important to the public's confidence in the strength and credibility of law enforcement and the safety of our markets. It is not surprising that there has also been renewed public and media focus on the accountability that comes with admissions following the financial crisis, where so many lost so much....
As United States Attorney, I made the decision that companies should, in certain circumstances, admit their wrongdoing, even if they were not criminally charged, but where there was a special need for public accountability and acceptance of responsibility. That is why, when I negotiated the first deferred prosecution for a company, back in 1994, I required an admission of wrongdoing, and I brought that mindset to the SEC when I became Chair last April [2013]....
To be sure there was no ambiguity about the misconduct of a defendant who was continuing to deal with investors, we required a hedge fund adviser [Falcone] to not only agree to a bar from the securities industry for five years, but to also admit to misuse of more than one hundred million dollars of fund assets in order to pay his personal taxes through a personal loan that was not timely disclosed to investors....
HC2 Filings with the SEC
As mentioned in No. 242, Falcone is now chairman, president, and chief executive officer of HC2 Holdings. I searched through many of its filings with the SEC, including the 10-K annual reports filed after the settlement with the SEC. Falcone's positions with HC2 are shown, but I found no disclosure of the SEC settlement. However, the HC2 10-K report for the year ended December 31, 2016 contains a three-sentence paragraph on page 36 about an arrangement between Falcone and the New York Department of Financial Services (NYDFS). The arrangement grew out of the 2013 settlement with the SEC. Here is the paragraph:
On October 7, 2013, the New York State Department of Financial Services announced that Philip A. Falcone, now our Chairman, President and Chief Executive Officer, had committed not to exercise control, within the meaning of New York insurance law, of a New York-licensed insurer for seven years (the "NYDFS Commitment"). Mr. Falcone, who at the time of the NYDFS Commitment was the Chief Executive Officer and Chairman of the Board of HRG Group Inc. ("HGI"), also committed not to serve as an officer or director of certain insurance company subsidiaries and related subsidiaries of HGI or to be involved in any investment decisions made by such subsidiaries, and agreed to recuse himself from participating in any vote of the board of HGI relating to the election or appointment of officers or directors of such companies. However, it was also noted that in the event compliance with the NYDFS Commitment proves impracticable, including in the context of merger, acquisition or similar transactions, then the terms of the NYDFS Commitment may be reconsidered and modified or withdrawn to the extent determined to be appropriate by the NYDFS Insurance regulatory authorities may [sic] consider the NYDFS Commitment in the course of a review of any prospective acquisition of an insurance company or block of insurance business by us or our insurance segment, increasing the risk that any such transaction may be disapproved, or that regulatory conditions will be applied to the consummation of such an acquisition which may adversely affect the economic benefits anticipated to be derived by us and/or our Insurance segment from such transaction.
It is ironic that HC2 disclosed the NYDFS Commitment, but apparently failed to disclose the SEC settlement agreement that prompted the NYDFS Commitment. With regard to Falcone's disclosure practices, see White's comments in the final paragraph of what I quoted above from her January 2014 speech.

NYDFS Press Release
On October 7, 2013, NYDFS issued a press release describing the NYDFS Commitment. I am including the press release in the complimentary package offered at the end of this post. The press release includes a link to the SEC settlement but does not include a link to the NYDFS Commitment. Therefore, pursuant to the New York Freedom of Information Law (FOIL), I asked NYDFS for the NYDFS Commitment. NYDFS denied my request on the grounds that the document is confidential under the New York Insurance Holding Company Law. I have not yet decided whether to appeal the denial.

Continental General's Statutory Filings
In the statutory financial statements filed by Continental General Insurance Company, a subsidiary of HC2, I found no disclosure of Falcone's settlement agreement with the SEC or the NYDFS Commitment. I reviewed Continental's statutory annual statements for 2015 and 2016, and its statutory statement for the quarter ended September 30, 2017. The latter financial statement, under "subsequent events," includes a note about the acquisition of the closed block of LTC insurance policies and the need for various regulatory approvals, such as from the South Carolina and Texas insurance departments.

The three statutory statements did not mention Falcone, despite his positions with Continental's parent company. Also, Falcone was not mentioned as a member of Continental's board of directors. The only familiar name I saw among the directors, in all three of the statutory statements, was James P. Corcoran. He served as New York State's superintendent of insurance from 1983 to 1990.

Biographical Affidavits
When an individual or entity seeks to acquire an insurance company, the relevant state insurance regulator must approve the acquisition. To obtain approval, the acquirer must submit information to allow the regulator to determine that the acquisition does not present a danger to the public. The required information includes biographical affidavits of the principals involved in the acquisition. State statutes relating to the information that must be provided to regulators refer to those affidavits, which include these two sentences:
No such person has been convicted in a criminal proceeding (excluding minor traffic violations) during the past ten years. No such person has been the subject of any disciplinary proceedings with respect to a license or registration with any federal, state or municipal government agency, during the past ten years.
The second sentence above seems highly relevant to Falcone, who must have been required to describe his settlement with the SEC and the NYDFS Commitment. However, the biographical affidavits invariably are deemed confidential. Presumably the reason for confidentiality is that a biographical affidavit includes information of a personal nature. In No. 139 (January 19, 2016), I described my inability to obtain copies of biographical affidavits in an Indiana situation.

General Observations
I am disturbed that the public is not entitled to relevant information about the principals in acquisitions. It would be appropriate to redact from the biographical affidavits the private information and leave unredacted the information that should be in the public domain.

With regard to the closed block of LTC policies referred to in this post and in No. 242, insurance regulators in South Carolina and Texas probably are aware of Falcone's settlement with the SEC, but nonetheless have approved or will approve the acquisitions relating to the closed block. I hope the regulators have imposed or will impose safeguards to protect the interests of the policyholders in the closed block.

Available Material
I am offering a complimentary 60-page PDF consisting of the first SEC complaint (27 pages), the second SEC complaint (28 pages), the consent order relating to both complaints (3 pages), the NYDFS press release (1 page), and the note in the Continental General statutory statement (1 page). Email and ask for the December 2017 package about Falcone.


Friday, December 1, 2017

No. 243: Guardian Life's Problematic Dividend Announcement

On November 16, 2017, Guardian Life Insurance Company of America issued a press release entitled "Guardian Announces Largest Policyholder Dividend in Company's History." It is subtitled "Board of Directors Approves $911 Million Dividend Allocation to Participating Individual Life Policyholders." The press release quotes Deanna M. Mulligan, Guardian's president and chief executive officer, as referring to "our 5.85% dividend rate." A small-type footnote at the bottom of the press release, below the section entitled "About Guardian," reads:
Dividends are not guaranteed. They are declared annually by Guardian's Board of Directors. The total dividend calculation includes mortality experience and expense management as well as investment results.
I immediately emailed Guardian's media contact person. I forwarded my blog post No. 10 (November 25, 2013) entitled "The Danger of Announcing Dividend Interest Rates," which relates to a November 2013 dividend announcement by Massachusetts Mutual Life Insurance Company. I asked that the email be forwarded to Ms. Mulligan. I received neither an acknowledgment nor a reply to my email.

The Problem
I have long expressed the opinion that announcing dividend interest rates associated with traditional participating life insurance policies is a deceptive sales practice. The footnote in Guardian's press release fails to disclose the seriousness of the problem. As indicated in the footnote, dividend calculations generally include interest, mortality, and expense components. For as long as I can remember, life insurance companies have maintained total secrecy about the calculation of dividends on their participating life insurance policies.

In recent years, during a period of low interest rates on new investments, some life insurance companies have begun to relax the secrecy on the calculation of the interest component of the dividend while continuing to maintain secrecy on the calculation of the mortality and expense components of the dividend. The problem is that there can be no assurance that the disclosed dividend interest rate is in fact the dividend interest rate. For example, it would be possible for a company to decrease the expense component of the dividend and thereby seemingly increase the interest component of the dividend. Moreover, there is no limit to the possible extent of such a practice, because it would be possible to decrease the expense component of the dividend all the way into negative territory.

The Regulators
It is natural to wonder what state insurance regulators are doing about the problem. In that regard, most states do not have the resources to address the problem. The last time I checked, most state insurance departments did not have a full-time actuary on staff. I believe that only the New York State Department of Financial Services pays attention to dividend matters.

A Solution to the Problem
A solution to the problem is to require all companies that issue or have issued participating life insurance policies to disclose fully the details of their dividend calculations. I do not suggest that disclosure of such complex information should be made directly to policyholders. Rather, I suggest that the companies should be required to file such information every year with state insurance regulators, and that such information should be made available to interested members of the public through state open records laws.

It is my understanding that some years ago Northwestern Mutual seriously considered the idea of voluntarily providing such disclosure to state regulators. In the end, however, the company decided such unilateral disclosure would place the company at a disadvantage, because competitors would be able to criticize the company's methods without themselves being subjected to scrutiny. In other words, a solution to the problem is to require that all companies file the information publicly.

Another Solution to the Problem
Another solution to the problem is for regulators and legislators to require life insurance companies to provide rigorous point-of-sale and post-sale disclosure to life insurance consumers. I have long suggested imposing such a requirement, but have met with no success. My most complete description of a rigorous disclosure system is in an article published in the December 1975 issue of the Drake Law Review. The system includes disclosure of, among other things, point-of-sale and post-sale year-by-year disclosure of the yearly price per $1,000 of the protection component of life insurance policies, and point-of-sale and post-sale year-by-year disclosure of the yearly rate of return on the savings component of cash-value life insurance policies.

General Observations
I do not intend to suggest that any of our few remaining great mutual life insurance companies—Guardian Life, Massachusetts Mutual, New York Life, Northwestern Mutual, and Penn Mutual—would engage in the kind of manipulation discussed in "The Problem" above. However, many stock life insurance companies (some of them former mutual companies) have issued and may still be issuing participating policies, and some stock life insurance companies that have never been mutual companies have issued and may still be issuing participating policies.

Available Material
I am offering a complimentary 27-page PDF consisting of the recent Guardian Life press release (1 page) and my 1975 article in the Drake Law Review (26 pages). Email and ask for the November 2017 package relating to dividend interest rates.


Monday, November 20, 2017

No. 242: Long-Term Care Insurance—The Closed Block at Kanawha Hits the News

KMG America Corporation is a holding company formed in 2004, incorporated in Virginia, and based in Minnesota. In 2004 KMG acquired Kanawha Insurance Company, which is domiciled in South Carolina. Kanawha, which began business in 1958, had been selling, among other things, long-term care (LTC) insurance. Kanawha stopped selling LTC insurance in 2005, and continued to administer the policies in runoff as a closed block. In 2007 Humana Inc. (NYSE:HUM), a large health insurance company, acquired KMG, including Kanawha's LTC block.

On November 6, 2017, Humana announced it had entered into a definitive agreement to sell KMG, including Kanawha and its LTC block, to Continental General Insurance Company, a Texas company owned by HC2 Holdings, Inc. (NYSE:HCHC). The parties anticipate the transaction will close in the third quarter of 2018, subject to various approvals, including approval by the South Carolina Department of Insurance. Here I discuss the transaction and its implications for those in the LTC block.

The Acquirer
Philip Alan Falcone (CRD#1442413) is chairman, president, and chief executive officer of HC2 Holdings. On November 6, 2017, HC2 issued a press release about the agreement with Humana. The press release quotes Falcone as saying:
We closed our initial acquisitions of American Financial Group's long-term care insurance businesses almost two years ago as the first step towards building a platform focused on acquiring LTC businesses. Since then, we've steadily built our insurance platform infrastructure in Austin, Texas and looked at numerous potential acquisitions in the space. We are extremely pleased to have reached this mutually beneficial agreement with Humana as it represents another key stepping stone for our platform. In addition, we believe this transaction is further validation of our platform and our strategy and represents industry recognition as the counterparty of choice for future LTC transactions. We look forward to leveraging this platform to generate meaningful growth.
Falcone is the founder of Harbinger Capital Partners, a New York hedge fund. On August 19, 2013, the Securities and Exchange Commission (SEC) issued a press release entitled "Philip Falcone and Harbinger Capital Agree to Settlement." The press release provides a link to a June 2012 SEC press release that in turn provides links to four other SEC documents. The first paragraph of the August 2013 press release reads:
The Securities and Exchange Commission today announced that New York-based hedge fund adviser Philip A. Falcone and his advisory firm Harbinger Capital Partners have agreed to a settlement in which they must pay more than $18 million and admit wrongdoing. Falcone also agreed to be barred from the securities industry for at least five years. [Blogger's note: The words "and admit wrongdoing" are important. This was one of the first SEC settlements requiring an admission of wrongdoing. Also, although the agreement barred Falcone from the securities industry for at least five years, he was not barred from serving as an officer of a publicly-owned company.]
Rating Actions
Kanawha has financial strength ratings issued by Standard & Poor's (S&P) and A. M. Best. Both issued announcements about their financial strength ratings of Kanawha promptly after Humana and HC2 announced the tentative agreement. Continental General is not rated by any of the major rating firms, and HC2 has an S&P debt rating of B– (Weak).

On November 8, 2017, S&P said it has placed its BB+ (Marginal) rating of Kanawha on CreditWatch with negative implications. BB+ is the highest rating in S&P's below-investment-grade (junk) range. Upon closing of the sale, S&P said it could lower the rating to HC2's rating of B– (Weak), which would place Kanawha's rating deep in the junk range.

On November 9, 2017, Best said it has placed its B++ (Good) rating of Kanawha under review with negative implications. B++ is low in Best's investment-grade range, and a downgrade of two or more levels would place Kanawha's rating in Best's junk range. Best said that a downgrade could occur on closing of the sale, but that Best would need discussions with Continental General and HC2.

Humana's Public Filings
To get a feel for Humana's experience with Kanawha's LTC closed block, I reviewed Humana's public filings with the SEC from the 2007 acquisition of KMG to the present. On November 30, 2007, Humana announced its purchase of KMG in an 8-K (significant event) report and a press release. The announcements did not mention the LTC block. In its 10-K report for the year ended December 31, 2007, Humana mentioned its acquisition of KMG but did not mention the LTC block. In its 10-K report for 2008, Humana mentioned the LTC block and said:
Long-term care policies provide for long-term duration coverage and, therefore, our actual claims experience will emerge many years after assumptions have been established. The risk of a deviation of the actual morbidity and mortality rates from those assumed in our reserves are particularly significant to our closed block of long-term care policies. We monitor the loss experience of these long-term care policies, and, when necessary, apply for premium rate increases through a regulatory filing and approval process in the jurisdictions in which such products were sold. We expect to file premium rate increases in 2009. To the extent premium rate increases or loss experience vary from our acquisition date assumptions, future adjustments to reserves could be required. Failure to adequately price our products or estimate sufficient benefits payable or future policy benefits payable may result in a material adverse effect on our results of operations, financial position, and cash flows.
In its 10-K report for 2008, Humana also said there were about 37,000 policyholders in the LTC block. In subsequent reports, the company provided figures that show the pace at which the number of policyholders in the LTC block has been declining:
12/31/08       37,000
12/31/09       36,000
12/31/10       36,000
12/31/11       Not shown
12/31/12       34,000
12/31/13       33,300
12/31/14       32,700
12/31/15       31,800
12/31/16       30,800
9/30/17         30,100
In its reports for 2009 and thereafter, Humana mentioned increases in reserves, increases in future benefits, and premium increase requests. The company also mentioned capital contributions it made to KMG to support the LTC block.

General Observations
Readers of this blog and The Insurance Forum are aware I have written extensively about transfers of blocks of policies from one insurance company to another. For example, see No. 220 (posted June 1, 2017). I wrote numerous articles on the subject in the Forum beginning in 1989, and I devoted a chapter to the subject in my 2015 book entitled The Insurance Forum: A Memoir.

I have said a transfer of a block of policies from one insurance company to another requires the consent of each affected policyholder. However, no such requirement applies when an entire insurance company is acquired by another insurance company, as is the case with Kanawha's LTC block.

I did not learn of the transfer of Kanawha's LTC block to Humana in 2007. If I had, I would not have been particularly concerned because Humana was (and is) a major company with fairly high financial strength ratings. Now, however, I am deeply concerned about the fate of the 30,000 policyholders remaining in the LTC block. The parties plan to move the LTC block to an unrated insurance company whose parent has a junk debt rating. Moreover, the acquiring insurance company and its parent are controlled by an individual now barred from the securities industry.

I hope the South Carolina Department will take a close look at the situation before approving the transfer of the LTC block from Humana to Continental General and HC2. I asked the Department what documents will be provided, which will be public and which will be confidential, whether there will be a hearing, and, if so, whether the hearing will be public or closed. A Department spokeswoman replied promptly. She said the matter will be handled in accordance with South Carolina statutes (Sections 38-21-60 and 38-21-70) and a regulation (69-14). My impression is that the process will generate little public information, but I plan to follow developments as closely as possible.

Available Material
I am offering a complimentary 11-page PDF consisting of Humana's November 2007 press release (2 pages), Humana's November 2017 press release (4 pages), HC2's November 2017 press release (3 pages), and the SEC's August 2013 press release (2 pages). Email and ask for the November 2017 package about Kanawha's closed block of LTC insurance policies.


Friday, November 17, 2017

No. 241: The Age 100 Problem—An Update

In No. 141 (posted February 1, 2016), I wrote about what I call the "age 100 problem in cash-value life insurance," a topic on which I had written two articles in The Insurance Forum in 2001. In No. 226 (July 20, 2017), I discussed an elderly insured's lawsuit against Transamerica Life Insurance Company relating to the problem. In this update I discuss two recent developments.

The Lebbin Case
Gary Lebbin was born in September 1917 in Germany, came to the United States in 1938 to escape Nazi persecution, and married in 1944. His wife died in 2015 at age 97. He has two children, four grandchildren, and seven great-grandchildren. In 1990 he created a trust that purchased two universal life policies from Transamerica with a total face amount of $3.2 million. His two children are the trustees of the trust.

In July 2017 Lebbin and the trust filed a lawsuit against Transamerica. They alleged that Transamerica had falsely represented the policies as "permanent insurance" for his "whole life," that the company had refused his request to extend the policies beyond their terminal age of 100, and that he was facing a potentially serious income tax problem. In September 2017 Lebbin reached the policies' terminal age of 100.

On October 2, 2017, Transamerica filed a motion to transfer the case from the federal court in Maryland (where the trust and one of the trustees are located) to the federal court in the southern district of Florida (where the policies were originally sold, where one of the trustees is located, and where other potential witnesses are located). On October 16 Lebbin and the trust filed an opposition to the motion. On October 30 Transamerica filed a reply to the opposition. On November 3 Transamerica filed a record of the exhibits supporting the motion. The judge has not yet acted on the motion.

Lincoln's Extension Offer
On October 30, 2017, Lincoln National Life Insurance Company sent a newsletter to its field force. The first two pages contain an article entitled "Extension of Maturity Offer—Beginning October 30, 2017." The first paragraph of the article reads:
In response to agent and policyowner requests and to better align with industry practices, beginning October 30, 2017 Lincoln is offering to extend the maturity date on certain permanent life insurance policies in order to preserve the death benefit within the contract and help avoid a taxable event. These older products typically have maturity dates ranging from age 95-100, and due to the age of this business, policies are beginning to approach these dates. Newer products often contain a maturity extension feature as part of the base product.
Lincoln said it will write to each policyholder eight to twelve months before the original maturity date, and the first mailing will occur on November 13, 2017. Each mailing will include an offer letter, the policy amendment, and an acceptance form the policyholder must sign and return to the company at least 30 days prior to the policy's original maturity date.

The policy amendment has been approved in all jurisdictions except Florida, Louisiana, Massachusetts, Missouri, New Hampshire, New York, Pennsylvania, Puerto Rico, Virgin Islands, and Virginia. Pursuant to the Indiana Public Records Act (Lincoln is domiciled in Indiana), I obtained the approval file from the Indiana Department of Insurance. The policy amendment was submitted for approval on December 29, 2016, and the Department approved it on January 24, 2017.

Included in the approval file is a sample of the offer letter, which will be over the signature of Lincoln's president, Dennis R. Glass. The final paragraph of the offer letter reads:
There may be tax consequences to either surrendering the Policy on or after the maturity age or continuing the Policy past the maturity age of the applicable Insured(s). A tax advisor should be consulted to determine which choice best meets Your needs.
I believe that Transamerica's motion to transfer the Lebbin case from Maryland to Florida is a delaying tactic. I hold that belief because, even if the case survives the inevitable motion to dismiss, I think the case will never go to trial. I believe that the case will be settled quietly, and that we will never learn the terms of the settlement because it is an individual case rather than a class action. Moreover, even if it were a class action and the settlement terms were made public, I think the age 100 problem would remain unresolved.

As I discussed in No. 141, there appears to be no guidance on how an insured who reaches the terminal age of 96 (in whole life policies based on the American Experience mortality table) or the terminal age of 100 (in whole life policies based on the 1941 CSO, 1958 CSO, or 1980 CSO mortality tables) can avoid a potentially serious income tax situation. The problem is that the insured who accepts an offer to postpone receipt of the death benefit beyond the terminal age could be viewed as having constructive receipt of the death benefit at the terminal age.

All types of firms invariably refuse to provide tax advice to customers. In the case of life insurance, in the absence of guidance, I do not see how a tax advisor can provide sound advice to a client.

Available Material
I am offering a complimentary 16-page PDF consisting of the article in Lincoln's newsletter (2 pages) and Indiana's approval file for Lincoln's new rider (14 pages). Email and ask for the November 2017 package about the age 100 problem.

In my two previous posts on the subject, I offered complimentary packages that are still available. In No. 141, I offered a 37-page package consisting of the two 2001 Forum articles, an excerpt from a variable universal life prospectus, a 2009 request for comments from the Internal Revenue Service (IRS), a 2009 comment letter from the American Council of Life Insurers, and a 2010 revenue procedure promulgated by the IRS; ask for the February 2016 package about the age 100 problem. In No. 226, I offered a 54-page package consisting of Lebbin's complaint and an exhibit showing one of Lebbin's policies; ask for the July 2017 package about the age 100 problem.


Thursday, November 9, 2017

No. 240: TIAA-CREF Under the Microscope

On October 22, 2017, The New York Times carried a long article about Teachers Insurance and Annuity Association of America (TIAA) and its affiliates, including College Retirement Equities Fund (CREF). Gretchen Morgenson, who received a Pulitzer Prize in 2002 for "trenchant and incisive coverage of Wall Street," wrote the article. It is entitled "Finger-Pointing at TIAA," and examines TIAA's reputation as a "selfless steward of its clients' assets for almost a century." Here I discuss some matters Morgenson mentioned in her excellent article, and some matters she did not mention.

TIAA long specialized in serving faculty members and senior administrators of colleges and universities, as well as officials of other nonprofit organizations. Indiana University, where I was an active faculty member for 31 years, was and remains a TIAA client. I have a CREF retirement account with the organization.

The Hiring of Allison
Morgenson pointed out in her article that in 1997 Congress revoked TIAA's nonprofit status because that status supposedly gave TIAA an unfair advantage over other companies. What she did not mention in her article was that TIAA had a long tradition of promoting from within its ranks. Thus new chief executive officers always had been deeply immersed in the organization's nonprofit and client-oriented culture.

The tradition ended in 2002, when the board of directors hired Herbert M. Allison, a former Merrill Lynch executive, as chief executive officer. Allison served until 2008, when he retired. Roger W. Ferguson, Jr., who also had not been associated with TIAA, succeeded Allison.

The Accounting Fiasco
Allison decided to revamp the accounting system, which inside staff had developed and maintained over many years. He fired all the TIAA employees connected with the existing system and hired an outside consulting firm to set up the new system. The result was a disaster. Among other problems were widespread reports of clients having to endure long delays in completing transactions.

I was affected, although I never engaged in anything other than simple and routine transactions. I have been taking systematic monthly withdrawals to meet the minimum distribution requirements imposed by the Internal Revenue Service. One month I received two payments instead of one. In another instance, every dollar figure in my quarterly financial statement had all the decimal points off by one place.

The accounting problems prompted a long front-page article in The Wall Street Journal on April 24, 2006. Tom Lauricella wrote the article, which was entitled "College Try: A Wall Streeter Aims to Revive Handler of University Pensions." Participants filed at least two lawsuits after publication of Lauricella's article.

The Rink Case
In October 2007 Richard Donald Rink filed in state court a class action lawsuit against CREF. A CREF account's value derives from the CREF-managed common stock of prominent public companies. Rink alleged that, when a CREF client requested a withdrawal or transfer of funds, CREF would assign an effective date but often would delay completing the transaction. To the extent the account value increased during the delay, CREF rather than the client received the benefit of the increased value.

In December 2010 the judge certified a class and scheduled trial for December 2012. The class consisted of:
All persons who at any time during the class period (October 1, 2005 to March 1, 2008) had one or more contracts with CREF and experienced a delay of more than seven days in the processing of a distribution or transfer request related to a fund governed by a CREF contract.
In May 2012, after extensive negotiations, the parties agreed to settle the case. The judge preliminarily approved the settlement and later granted final approval.

Under the settlement, 26,188 class members were entitled to about $18 million plus $4.4 million of interest at 4 percent per annum. The judge awarded the plaintiffs' attorneys $7.5 million of fees and up to $150,000 for expenses, both of which were on top of the amounts paid to class members, as well as up to $20,000 for Rink as class representative. (See Rink v. CREF, Circuit Court, Jefferson County, Kentucky, Division Six, Case No. 07-CI-10761.)

The Bauer-Ramazani Case
In August 2009 Norman Walker, Christine Bauer-Ramazani, and Carolyn Duffy filed in federal court a class action lawsuit against TIAA-CREF. They were faculty members with TIAA-CREF accounts subject to the Employee Retirement Income Security Act (ERISA). They endured long delays in completing transaction requests. Walker later dropped out and the case was continued by the other two plaintiffs, who filed a fourth amended complaint in October 2012. They alleged three counts: (1) ERISA breach of fiduciary duty of loyalty, (2) ERISA breach of fiduciary duty of impartiality, and (3) ERISA prohibited transactions. In May 2013 the judge certified the following class:
All persons who, between August 17, 2003 and May 9, 2013, requested a transfer or distribution of funds invested in a CREF or TIAA variable annuity account covered by ERISA whose funds were not transferred or distributed within seven days of the date the account was valued and who were not paid the investment gains, if any, during the delay period.
In October 2013 the judge set the trial for January 2014. In November 2013 he dismissed the second and third counts of the complaint. In December 2013 the parties reached a settlement. In February 2014 the judge preliminarily approved the settlement, and in September 2014 he granted final approval.

Under the settlement, TIAA-CREF created an interest-bearing $19.5 million fund for the benefit of class members. Out of the fund, TIAA-CREF agreed to pay $7,500 to each of the two class representatives. In addition to the fund, TIAA-CREF agreed to pay $3.3 million of plaintiff attorney fees and expenses. (See Bauer-Ramazani v. TIAA-CREF, U.S. District Court, District of Vermont, Case No. 1:09-cv-190.)

The Long-Term Care Fiasco
In 2003 TIAA abandoned the long-term care (LTC) insurance line of business it had been offering for more than a decade. It sent a letter to its 46,000 LTC insurance policyholders saying it was transferring them to Metropolitan Life Insurance Company. The letter prompted a furious response from educators who had selected TIAA for LTC insurance because of the firm's stellar reputation for fair treatment of its policyholders. I wrote about the incident in the March/April 2004, December 2005, and June 2007 issues of The Insurance Forum.

The Life Annuity Fiasco
One of the first anti-TIAA lawsuits with which I had become familiar involved a college professor who retired at a time when she was suffering from advanced emphysema. She had a $1 million retirement account (virtually all of her estate) with TIAA. She exchanged the entire account for an immediate life annuity with no death benefit. TIAA allowed her to make that horrible choice. She died six months later. In 2003 her estate filed a lawsuit against TIAA, which fought the case bitterly. After ten years of legal wrangling in a federal district court and a federal appellate court, the lawsuit finally ended in a confidential settlement. I wrote about the case in the January 2010 issue of the Forum.

The Surplus Notes
A surplus note is a bizarre debt instrument. When an insurance company borrows by issuing a surplus note, the money the company receives increases its surplus. That happens because state surplus note laws say the company issuing the note does not have to establish a liability. A surplus note is subordinate to all the company's other obligations. A surplus note can be issued only with the prior approval of the insurance commissioner in the issuing company's state of domicile. Interest and principal payments on a surplus note can be made only with the commissioner's prior approval.

State surplus note laws date back more than a century. Their purpose was to provide a mechanism allowing mutual insurance companies in financial trouble to increase surplus. When a surplus note appeared in a company's financial statement, it was a sure sign the company was in financial trouble. All that changed in "the revolution of 1993," when Prudential Insurance Company of America, a financially strong company, issued $300 million of surplus notes to investors through a private offering. The offering was made for tax reasons because courts had ruled that interest payments on surplus notes are deductible for income tax purposes. Within a few years, most major insurance companies had issued large amounts of surplus notes.

TIAA was one of the few holdouts, but in 2009 it issued $2 billion of surplus notes to help finance the acquisition of Nuveen, a for-profit investment firm. I wrote about that event in the August 2010 issue of the Forum. Later TIAA issued more surplus notes to help finance the acquisition of EverBank, yet another for-profit investment firm. TIAA now has $5.05 billion of surplus notes outstanding, according to its latest (June 30, 2017) financial statement. I have not been tracking surplus note data in recent years, but TIAA's surplus notes may now exceed those of any other insurance company. TIAA's surplus notes are described in detail on two pages in the above mentioned financial statement.

General Observations
The Carnegie Foundation for the Advancement of Teaching created TIAA through a grant in 1918. The purpose was to make it possible for college and university professors to retire in dignity with adequate financial resources. TIAA created CREF in 1952 so that the organization could offer variable annuities supplementing TIAA's fixed annuities.

Morgenson questions the objectivity of the investment advice being given by TIAA's advisers, with compensation that includes bonuses for steering clients into more expensive TIAA products and services. I am saddened that, during the past 15 years, TIAA seems to have been moving in the direction of for-profit investment firms, and that there seems to be little or no chance of reversing the trend.

Available Material
I am offering an 86-page complimentary PDF consisting of the Rink settlement agreement (30 pages), the Bauer-Ramazani settlement agreement (27 pages), selected articles from the March/April 2004, December 2005, June 2007, January 2010, and August 2010 issues of The Insurance Forum (27 pages), and an excerpt from the latest TIAA financial statement (2 pages). Email and ask for the November 2017 package about TIAA-CREF.


Monday, October 23, 2017

No. 239: Transamerica's Cost-of-Insurance Increases and an Important Class Action Lawsuit

In 1989 Gordon Feller, a California resident, purchased a $500,000 universal life policy from a California-based predecessor of Transamerica Life Insurance Company that later redomesticated to Iowa. In February 2016 Feller and several others filed a class action lawsuit against Transamerica in a federal court in California. The case relates to large cost-of-insurance (COI) increases Transamerica imposed recently on owners of universal life policies. The plaintiffs filed an amended complaint in June 2016 and a second amended complaint in August 2017. Here I report on the progress of the case. (See Feller v. Transamerica, U.S. District Court, Central District of California, Case No. 2:16-cv-1378.)

Senior U.S. District Judge Christina A. Snyder is handling the case. President Clinton nominated her in January 1997, the Senate confirmed her in November 1997, and she took senior status in November 2016.

The Plaintiffs' Views
The plaintiffs include several individuals, some of whom are named in their capacities as trustees of trusts. The opening four-paragraph "Nature of the Action" section of the second amended complaint describes the plaintiffs' views. Here is that section, with my light editing:
  1. In the late 1980s and early 1990s, Transamerica sold hundreds of millions of dollars in universal life insurance policies under which it agreed to credit interest on policyholders' accounts at guaranteed annual rates generally ranging between 4.0 and 5.5 percent. Plaintiffs and the class members bought these policies so that they and their families would be protected as they entered their senior years. Beginning in August 2015 Transamerica suddenly, unilaterally, and massively began increasing the monthly deductions withdrawn from the policies' account values by as much as 100 percent, falsely stating that the increase was permitted by the terms of the policies. Transamerica's true reasons for imposing the drastic increase, however, were to (a) subsidize its cost of meeting its interest rate guarantees under the policies, (b) recoup past losses in violation of the terms of the policies, and (c) induce policy terminations by elderly policyholders.
  2. To maximize the number of elderly policyholders who would surrender their policies and lose their insurance coverage, Transamerica sent letters to policyholders directing them to contact a designated Transamerica hotline with any questions about the increase, rather than the agents they had dealt with for many years. Transamerica has also begun refusing to provide policyholders with illustrations showing how their policies will perform as a result of the increase. Instead, Transamerica will now only provide policy illustrations depicting how the policies would perform if the monthly COIs were raised to a level even higher than the rates imposed by the increase. Transamerica hopes that by showing elderly policyholders the most pessimistic policy performance possible, they will surrender their policies. As a result of Transamerica's actions, thousands of class members are faced with the imminent harm of either paying the exorbitant and unjustified new charges, or forever losing the benefits for which they have dutifully paid premiums for many years.
  3. Plaintiffs in this action seek injunctive and equitable relief, and ancillary damages, to halt and reverse Transamerica's massive increase in the monthly deduction withdrawn from their accounts each month. This increase has already injured plaintiffs and, if allowed to proceed, will continue to cause irreparable injury to plaintiffs and other class members.
  4. As further described below, Transamerica's sudden and unilateral increase in the monthly charges constitutes a breach of its express and implied obligations under each and every policy, a violation of the unlawful and unfair prongs of California's Unfair Competition Law, and a violation of California's Elder Abuse Law.
Transamerica's Views
Later I discuss Judge Snyder's denial of Transamerica's motion to dismiss the case. Here are a few of Transamerica's views as mentioned there, with my editing:
  1. Transamerica says a prior class action settlement bars all of plaintiffs' claims based on policies issued before June 30, 1996. The prior case is Natal v. Transamerica, where a California state court approved a settlement in 1997. The company says the Natal settlement bars all future claims based on COI rate changes, whether the changes occurred before or after the Natal settlement.
  2. Transamerica says the policies give it discretion to set COI rates anywhere below the maximum rates guaranteed in the policies.
  3. Transamerica says the policies permit the company to set COI rates based upon any factors it chooses so long as it does not do so to recoup past losses.
  4. Transamerica says the plaintiffs' claim that the company breached their policies by raising COI rates to recoup past losses is insufficiently plausible.
  5. Transamerica says its COI rate changes were to mitigate future losses from persistently low interest rates rather than to recoup past losses.
  6. The plaintiffs claim that Transamerica violated the implied covenant of good faith and fair dealing through the COI rate increases. The company says the claim is duplicative of the breach of contract claim, and that the implied covenant does not prohibit a party from doing what a contract expressly permits.
  7. Transamerica says plaintiffs' claim for declaratory relief should be dismissed as duplicative of plaintiffs' other claims.
  8. Transamerica says the plaintiffs have failed to state a claim for relief under any prong of California's Unfair Competition Law.
  9. Regarding plaintiffs' elder abuse claim, Transamerica says plaintiffs must allege specific targeting of elders rather than unfair practices directed at elders and non-elders.
The Motion to Transfer the Case to Iowa
In July 2016 Transamerica filed a motion to transfer the case to Iowa, where the company is now based. In August 2016 Judge Snyder denied the motion to transfer the case to Iowa.

The Motion to Dismiss the Case
In August 2016 Transamerica filed a motion to dismiss the case. In November 2016, after a conference, Judge Snyder denied Transamerica's motion to dismiss. Here in brief is what she said about some of the plaintiffs' claims for relief, according to the minutes of the conference:
  1. Plaintiffs allege Transamerica attempted to use COI increases to offset its guaranteed interest obligations. Transamerica's motion to dismiss plaintiffs' breach of contract claim is denied.
  2. Plaintiffs allege Transamerica increased COIs to recoup past losses. Transamerica's motion to dismiss plaintiffs' breach of contract claim is denied.
  3. Plaintiffs allege Transamerica violated California's Unfair Competition Law (UCL) by systematically and excessively increasing COIs to induce forfeiture of elderly policyholders' benefits or compel payment of higher premiums. Transamerica's motion to dismiss the plaintiffs' UCL claim is denied.
  4. Plaintiffs allege Transamerica violated California's Elder Abuse Law by increasing COIs on policies held by the elderly, thus appropriating property from elderly plaintiffs in bad faith and with intent to defraud them. Transamerica's motion to dismiss the plaintiffs' elder abuse claim is denied.
The Motion for a Preliminary Injunction
In May 2016 the plaintiffs filed a motion for a preliminary injunction. They consider an injunction essential to prevent Transamerica from sharply increasing COI rates during the litigation and thereby forcing policyholders to lapse their policies. The motion is on the agenda of a hearing currently scheduled for November 13, 2017.

The Motion for Class Certification
In May 2016 the plaintiffs filed a motion for class certification, appointment of a class representative, appointment of class counsel, and issuance of a class notice. In February 2017 they filed a corrected motion. The motion is on the agenda of the November 13 hearing. The class would consist of:
All persons who own an in-force Policy for which the Monthly Deduction Rate increases imposed by Transamerica beginning August 1, 2015, have resulted or will result in higher Monthly Deduction charges than those applicable under the rate schedule in effect before that date.
The Redactions
In June 2016 Transamerica filed the first of many documents that relate to protective orders. Many documents are sealed, and some of them are designated "Highly Confidential—Attorneys' Eyes Only." Some documents are so heavily redacted that they are meaningless to the reader.

General Observations
This is an important case. It survived Transamerica's motion to dismiss, but it still has a long way to go. Judge Snyder's rulings at or soon after the hearing scheduled for November 13, 2017 may indicate the future timetable for the case.

Meanwhile, Feller and other COI cases with which I am familiar have led me to believe that universal life policies are fundamentally defective unless they are managed with extreme care. In other words, the planned premium should be reviewed at least once a year for adequacy. Moreover, the annual reports that companies send to policyholders are so complex that the average policyholder—or even a sophisticated policyholder—will have difficulty performing the management function. A skilled and highly professional agent may be able to perform that function, but many policyholders do not have access to the services of such agents. I plan to write further on this subject in the near future.

Available Material
I am offering a complimentary 70-page PDF consisting of the minutes of the conference in which Judge Snyder denied Transamerica's motion to dismiss the case (27 pages) and the text (without exhibits) of the second amended complaint (43 pages). Email and ask for the October 2017 package relating to the case of Feller v. Transamerica.


Monday, October 16, 2017

No. 238: Lincoln National Life's Cost-of-Insurance Increases—An Important Recent Development in an Ongoing Lawsuit

In No. 212 (posted April 7, 2017), I discussed four class action lawsuits filed in the federal court in Philadelphia against Lincoln National Life Insurance Company (Fort Wayne, IN) relating to cost-of-insurance (COI) increases imposed on owners of certain universal life insurance policies. In No. 215 (April 28, 2017), I discussed the consolidation of the four cases. Here I report on developments relating to a similar case that has been transferred to the same court and the same judge.

In September 2016 Lincoln notified the owners of certain universal life insurance policies that the company was implementing COI increases effective in October 2016. In the next several weeks, affected policyholders filed four class action lawsuits against Lincoln in the federal court in Philadelphia, where Lincoln's parent is based. In March 2017 U.S. District Judge Gerald J. Pappert issued an order consolidating the four cases.

The EFG Bank Lawsuit
In February 2017 EFG Bank AG (Cayman Branch) and six other entities filed a lawsuit against Lincoln in the federal court in Los Angeles relating to the same COI increases. The other six entities are DLP Master Trust, DLP Master Trust II, DLP Master Trust III, GWG DLP Master Trust, Greenwich Settlements Master Trust, and Palm Beach Settlement Company. In March 2017 the plaintiffs filed a first amended complaint. (See EFG Bank v. Lincoln, U.S. District Court, Central District of California, Case No. 2:17-cv-817.)

In May 2017 Lincoln filed a motion to dismiss the case and a motion to transfer the case to the federal court in Philadelphia. In June 2017 the federal judge in California denied the motion to dismiss and granted the motion to transfer the case, which was then assigned to Judge Pappert. In July 2017 the plaintiffs filed a second amended complaint that included four counts:
  1. Breach of Contract, relating to all policies.
  2. Implied Covenant of Good Faith and Fair Dealing (Contractual Breach), relating to policies issued in Arizona, California, Florida, Georgia, Massachusetts, New Jersey, North Carolina, and Wisconsin.
  3. Implied Covenant of Good Faith and Fair Dealing (Tortious Breach), relating to policies issued in California.
  4. Declaratory Relief, relating to all policies.
The plaintiffs sought compensatory damages, punitive damages, pre- and post-judgment interest, attorney fees, and costs. On August 9, 2017, Lincoln filed a motion to dismiss the case.

The September 2017 Order
On September 22, 2017, Judge Pappert issued a memorandum and an order. He denied Lincoln's motion to dismiss the first three counts of the second amended complaint and granted Lincoln's motion to dismiss the fourth count. Here are excerpts (citations omitted) from the memorandum relating to each of the four counts:
  1. Plaintiffs claim that Lincoln breached the Policies' terms "[b]y imposing excessive costs of insurance rates." Lincoln argues that the allegation is deficient because Plaintiffs do not cite a "metric by which the new COI rates can be adjudged "excessive." Lincoln also claims the Policies establish a maximum rate that Lincoln may charge and Plaintiffs did not allege that the new COI rate exceeded that maximum rate. Lincoln has the better of this argument but that does not preclude Plaintiffs from having stated, overall, a breach of contract claim. 
  2. Plaintiffs have adequately alleged that Lincoln breached the implied covenant by exercising its limited discretion under the Policies in an unreasonable and unfair manner with the bad faith intent of inducing lapses, frustrating policyholders' expectations and depriving them of the benefit of the agreement. 
  3. Here, Plaintiffs allege that Lincoln is forcing Plaintiffs to "pay exorbitant premiums that Lincoln knows would no longer justify the ultimate death benefits" or "lapse or surrender their Policies and forfeit the premiums they have paid to date, thereby depriving policyholders of the benefits of their Policies." They further contend that Lincoln's "breaches were conscious and deliberate acts, which were designed to...frustrate the agreed common purposes of the Plaintiffs' Policies" and that Lincoln was trying to circumvent the guaranteed minimum interest rate. The court will not dismiss the punitive damages claim at this stage; Lincoln will have the opportunity to renew its argument at summary judgment. 
  4. In response to Lincoln's contention that the declaratory relief sought requires adjudication of precisely the same issues as Plaintiffs' breach of contract claim, Plaintiffs state that "[a] declaratory relief claim that seeks alternative relief is not duplicative of other claims even if it involves allegations that support Plaintiffs' other claims." The Court nevertheless fails to see how the Plaintiffs' claim is not duplicative of the resolution of the breach of contract claim. The Court therefore declines to exercise its discretionary jurisdiction and grants Defendant's Motion with respect to this claim.
General Observations
Judge Pappert's denial of Lincoln's motion to dismiss three of the four counts in the second amended complaint is important. However, even more important will be his rulings on the parties' motions for summary judgment. I plan to report further developments in this case and in the related consolidated class action lawsuit.

Available Material
I am offering a complimentary 48-page PDF consisting of EFG Bank's second amended complaint (26 pages), Judge Pappert's September 22, 2017 memorandum (21 pages), and his accompanying order (1 page). Email and ask for the October 2017 package relating to the case of EFG Bank v. Lincoln.


Tuesday, October 10, 2017

No. 237: Country Life—A Confidential Settlement Avoids a Likely Court Defeat Over a Disability Insurance Claim

In No. 236 (posted September 28, 2017), I discussed a federal jury award of $6.5 million to Benjamin McClure, an Arizona plaintiff in a lawsuit against Country Life Insurance Company (Bloomington, IL). The case involved a disability insurance claim. A reader immediately informed me of an earlier lawsuit against Country Life involving a disability insurance claim. In this follow-up, I discuss the earlier case. After a legal battle that was going badly for the company, the earlier case ended in a confidential settlement shortly before the anticipated jury trial.

In September 2000 Brian Keith Sell, an Arizona resident, purchased a disability insurance policy from Country Life. The policy initially provided benefits of $2,500 per month, and was later increased to $3,100 per month. The benefit period was to age 65. "Disability" was defined as:
Continuous inability to perform all of the substantial and material duties of your regular occupation because of your injury, sickness, or mental disorder. After benefits (including benefits for partial disability) have been paid for two years, disability means continuous inability to engage in any occupation because of your injury or sickness.
The policy defined "regular occupation" as "your occupation at the time disability begins." The policy defined "any occupation" as "any occupation in which you could be expected to engage," and "consideration is given to your education and training or experience." The policy contained a "recurrent disability" clause which stated that "disability or partial disabilities separated by six months or less are considered one disability." The policy also contained a waiver-of-premium benefit. 

Sell is a certified public accountant. He worked for government agencies and engaged in internet technology consulting work for private clients. The medical problems he encountered are described in excruciating detail in the complaint he filed later.

In January 2010, due to severe pain, Sell underwent an anterior cervical disc fusion of C5-C6. After that procedure his pain was largely resolved and he was able to continue his employment duties.

In June 2011, while getting ready for work one day, Sell suddenly experienced extreme pain in his neck and upper back. An MRI revealed he was suffering from a new moderate left paracental disc protrusion at T7-T8, which was indenting his spinal cord, as well as a broad-based disc osteophyte complex at C4-C5 mildly indenting the thecal sac.

In July 2011 Sell underwent a second neck surgery, this time an ACDF at C4-C5. He continued to suffer from debilitating pain.

In January 2012 Sell underwent a Thoracic 6-7 laminectomy and the placement of a dorsal spinal cord stimulator and internal pulse generator. He suffered and continues to suffer from several co-morbid chronic medical conditions including chronic abdominal pain; chronic diarrhea; irritable bowel syndrome; chronic pain of the lower back, mid back, and neck; chronic pain syndrome; depression; anxiety; and other conditions.

The Claim
In October 2011 Sell filed a claim for disability benefits with Country Life. The company gathered Sell's medical records and certifications of disability by his treating physician.

In February 2012 Country Life notified Sell that his claim had been approved and sent his February check. The company said it had requested additional medical records and other information to approve his claim after February, and later paid his March benefit. The company said that "consideration for continued benefits will be pended," and that "further payments have been placed on hold."

In October 2012 Country Life terminated the claim. The company informed Sell by letter that there was no "medical reason to physically restrict you from performing your occupation."

The Lawsuit
In October 2014, in state court in Arizona, Sell filed a lawsuit against Country Life. The two claims for relief were for breach of contract and for insurance bad faith (breach of the covenants of good faith and fair dealing). Sell sought, among other things, damages for failure to pay benefits, emotional damages for pain and suffering, punitive damages, pre- and post-judgment interest, attorney fees, and costs. In February 2015 Country Life removed the case to federal court. (See Sell v. Country Life, U.S. District Court, District of Arizona, Case No. 2:15-cv-353.)

The case was assigned to U.S. District Judge Diane J. Humetewa. President Obama nominated her in September 2013, and the Senate confirmed her in May 2014.

Sell's state court complaint is attached to the notice of removal to federal court. Country Life's letter terminating Sell's claim is also attached to the notice.

On March 4, 2016, Sell filed a motion for sanctions against Country Life. On June 1, 2016 Judge Humetewa issued an order that was devastating to the company. The "Findings and Analysis" section of the order included discussions of "conduct regarding discovery requests," "credibility of deposition and evidentiary hearing testimony," "defendant's systemic deficiencies regarding discovery obligations," and "appropriate sanction." In the order she granted Sell's motion for sanctions against the company. Here are two portions (without citations) of the final section of the order:
Plaintiff has presented substantial and compelling evidence that demonstrates serious misconduct by Defendant and its counsel in this case. Testimony from the evidentiary hearing, deposition testimony, and documentary evidence, as described above, combine to show a concerted effort to wrongfully withhold evidence, misrepresent the facts, and mislead Plaintiff and the Court to comport with Defendant's and counsels' false narrative. Defendant and its counsel withheld relevant and discoverable evidence by essentially ignoring requests for production of documents and then by frivolously asserting the documents were privileged. They misrepresented the facts surrounding their conduct during discovery by asserting they had conducted reasonable searches in response to Plaintiff's  requests when they had not. They misrepresented the facts of the case by redacting highly relevant information and making false assertions of privilege. They then presented false deposition and hearing testimony to align with their fabricated account of what occurred. By doing so, Defendant and counsel sought to prevent Plaintiff and the Court from learning the truth about the circumstances surrounding the termination of Plaintiff's disability claim, thereby misleading Plaintiff and the Court into accepting their narrative. The Court finds that the evidence amply demonstrates that Defendant's and counsels' misconduct was willful and done in bad faith....
Defendant's and counsels' misconduct in this case goes directly to the heart of Plaintiff's claims of whether Defendant breached the terms of the disability insurance contract and breached its duty of good faith and fair dealing in its handling of his claim. Had Defendant not been required to disclose the redacted portions of the emails and letters, the evidence would reflect only that Ms. Payne, Plaintiff's claim adjustor with thirty years of experience, agreed with the termination of Plaintiff's physical disability claim. As the evidence now shows, that is simply not the case. Under these circumstances, it is difficult for this Court to see how Defendant's conduct merits anything less than the imposition of severe sanctions....
The Settlement
On April 24, 2017, Judge Humetewa scheduled the final pretrial conference for June 28 and ordered the parties to file a joint proposed final pretrial order by June 7. On May 18 Sell notified the Court that the parties had reached a settlement. On July 6 Country Life filed a stipulation of dismissal of the case in its entirety with prejudice (permanently), and with each party to bear its own attorney fees and costs. The same day the judge dismissed the case in its entirety with prejudice, and with each party to bear its own attorney fees and costs.

General Observations
As indicated at the outset, the Sell case was going badly for Country Life. One of the most significant setbacks—but not the only significant setback—was Judge Humetewa's June 1, 2016 order. Thus Country Life's decision to settle the case confidentially rather than allow the case to go to trial is understandable. Sell had a strong position and Country Life had a weak position in settlement negotiations. For those reasons, the settlement probably was large.

I do not understand why Country Life allowed the McClure case (discussed in No. 236), which also had been going badly for the company, to go to trial shortly after the confidential settlement was reached in the Sell case. Surely the company could have made an offer large enough to persuade McClure to settle the case on a confidential basis rather than allow the case to go to trial and result in a $6.5 million public verdict against the company.

Available Material
I am offering a 42-page complimentary PDF containing Sell's complaint (10 pages), Country Life's letter terminating Sell's claim (3 pages), and Judge Humetewa's June 1, 2016 order (29 pages). Email and ask for the October 2017 package about the case of Sell v. Country Life.


Thursday, September 28, 2017

No. 236: Country Life Suffers a Court Defeat Over a Disability Insurance Claim

On September 8, 2017, a jury in Arizona awarded $6.5 million to the plaintiff in a lawsuit against Country Life Insurance Company (Bloomington, IL). The case involved a disability insurance claim.

Benjamin McClure, an Arizona resident, purchased a disability insurance policy from Country Life in November 1995. The policy provided disability benefits of $1,500 per month after a 90-day elimination period, and a waiver-of-premium benefit.

In November 2012 McClure suffered a severe head injury. Since then he has suffered, among other problems, memory loss, seizures, headaches, vertigo, confusion, fatigue, and difficulty focusing. He has been hospitalized periodically, cannot drive, and requires assistance with activities of daily living. He cannot engage in his regular occupation or any other occupation for which he is trained, educated, or experienced.

In January 2013 McClure filed a claim for disability benefits. After the elimination period, Country Life began paying the $1,500 monthly benefit. In December 2013 the company notified McClure that its review of the medical correspondence from his attending physicians did not support disability from a physical standpoint. The company requested additional medical information, including a neuropsychological evaluation. In February 2014 McClure underwent the evaluation.

In April 2014 the company informed McClure it was ending his benefits because the medical information did not show physical or cognitive impairments that would prevent him from performing the duties of his regular occupation. Months later, after McClure notified the company that he had been hospitalized and undergone further medical treatment, the company again refused to pay benefits without requesting further medical reports and without a follow-up investigation.

The Lawsuit
In December 2015 McClure filed a lawsuit against Country Life. The two claims for relief were for breach of contract and for insurance bad faith (breach of the covenants of good faith and fair dealing). He sought, among other things, compensatory damages, punitive damages, pre- and post-judgment interest, attorney fees, and costs. The company filed a perfunctory answer to the complaint. (See McClure v. Country Life, U.S. District Court, District of Arizona, Case No. 2:15-cv-2597.)

The case was assigned to U.S. District Judge Douglas L. Rayes. President Obama nominated him in September 2013, and the Senate confirmed him in May 2014.

In July 2016 McClure filed a first amended complaint that included a second defendant: CC Services, Inc. (CCS), a Country Life affiliate that administers Country Life's claims. The defendants filed perfunctory answers to the first amended complaint.

The complaints do not include a copy of the policy. According to the complaints, "disability" is defined as a:
[c]ontinuous inability to perform substantially all important duties of your regular occupation because of your injury or sickness. After benefits have been paid for two years, it means continuous inability to engage in any occupation because of your injury or sickness.
The policy defines "regular occupation" as "your occupation at the time disability begins." The policy defines "any occupation" as "any occupation in which you could be expected to engage," and "[c]onsideration is given to your education and training or experience."

In March 2017, after discovery, the parties filed motions for partial summary judgment. Judge Rayes denied the motions in early August. In his denial of the defendants' motion for partial summary judgment, the judge referred to McClure's expert witness, Mary Fuller. Here are a few of the judge's comments:
Fuller explains that Country Life neglected to obtain records related to McClure's inpatient hospitalization for depression and suicidal thoughts, questioned the reasonableness of the findings of medical providers and examiners without a reasoned basis, and denied McClure's claim based on an [independent medical examination] without first having those results reviewed by an appropriately credentialed medical source or obtaining input from McClure's treatment providers on those findings. Fuller also discusses financial incentives that could have motivated Country Life to deny McClure's claim when it did.
Judge Rayes also commented on Country Life's arguments about why Fuller's opinions should not be allowed. He said: "Whether Fuller's opinion should be credited, however, is a quintessential jury question."

The Trial
On August 24, 2017, the trial began. On September 8, 2017, after ten days of trial, the jury found in favor of McClure. On September 15, Judge Rayes filed a judgment that describes the jury's findings. In terms of dollar amounts, the three most significant findings were:
  • $1,290,000 against Country Life and CCS for emotional distress, humiliation, inconvenience, and anxiety.
  • $2,500,000 against Country Life for punitive damages.
  • $2,500,000 against CCS for punitive damages.
Interest will accrue at the legal rate of 1.23 percent per annum from the date of the judgment until it is paid. I do not know when the judgment will be paid or whether the defendants will appeal.

General Observations
As mentioned, the defendants' answers to the complaints were perfunctory, but they gave their views in their motion for partial summary judgment. Almost four years elapsed between the termination of monthly benefits and the jury's findings, and at this moment it is not known when McClure will receive what the jury awarded. It is unfortunate that it is taking so long for him to obtain redress.

Available Material
I am offering a 40-page complimentary PDF containing the first amended complaint (14 pages), the defendants' motion for partial summary judgment (19 pages), the judge's order denying the motion (5 pages), and the judgment (2 pages). Email and ask for the September 2017 package about the case of McClure v. Country Life.


Monday, September 18, 2017

No. 235: Harvey and Irma—Often Neglected Business Insurance Implications of a Superstorm

Blogger's note: The late Eugene R. Anderson, a longtime close friend of mine, founded what is now Anderson Kill PC, a policyholders' law firm. In No. 146 (posted February 25, 2016), I wrote a memorial tribute to Gene. I also dedicated the October 2010 issue of The Insurance Forum to him shortly after he died in July 2010 at age 82.

Finley Harckham is an attorney in the Insurance Recovery Group at Anderson Kill. On August 30 Harckham issued a memorandum in the wake of Superstorm Harvey about the implications of contingent business interruption insurance. The title is "In Harvey's aftermath, contingent business interruption insurance claims should have broad reach." The subtitle is "Businesses nationwide that rely on plastics or chemicals may have claims for supply chain disruption." The contents of the memorandum are also relevant to Superstorm Irma. Here I show the memorandum, with light editing and with the firm's permission.

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Beyond the toll in human suffering that Superstorm Harvey is exacting this week, severe impact on the U.S. and even the global economy may emerge in the coming weeks and months. The Houston Ship Channel passes not only many of the nation's largest refineries but also major chemical manufacturing plants. As Grist (a nonprofit publication) noted last year, the Channel is "a crucial transportation route for crude oil and other key products, such as plastics and pesticides." A shutdown could disrupt supply chains nationwide and globally, affecting factories in a wide range of industries.

Businesses suffering from Harvey-induced supply chain disruptions throughout the U.S., and with global operations, should look to their property insurance policies for contingent business interruption coverage, triggered when policyholders do not themselves suffer physical damage but still lose revenue after a property loss sidelines a major supplier or customer base. Contingent BI is a standard provision in many property insurance policies, though many businesses are not aware of it.

In the affected areas of Texas, businesses will need to assess not only physical damage to their property but also income losses stemming from flooded and blocked roads and bridges, interrupted shipping and air transport, evacuations, and closures by civil authority. In the aftermath of a storm, physical damage to property stares a business owner in the face. For the future health of the business, though, it is vital to think beyond the cost and challenges of physical repair and begin right away to tally losses of business income and expenses incurred to mitigate that loss. Here are the relevant coverages to consider in a storm's aftermath.

Business interruption or BI insurance covers businesses for losses stemming from unavoidable interruptions in their daily operations. BI coverage may be triggered by circumstances including a forced shutdown, a downturn in business due to damage to premises, or a substantial impairment in access to a business's plant or premises.

Contingent business interruption coverage is triggered when policyholders lose revenue after a property loss sidelines a major supplier or customer base. For example, businesses that rely upon specialty chemicals from the affected area may have to pay more for supplies, and companies which sell into the area, such as consumer products manufacturers, will suffer lost sales. While the business itself need not be physically damaged, it does need to have coverage for the type of damage that affected its suppliers, business partners, or customers. For example, a business must have flood coverage to file a contingent business interruption claim for losses triggered when a supplier is incapacitated by flood.

Evacuation by order of civil authority coverage is triggered when authorities close off access to a damaged area. Relatedly, ingress/egress coverage insures lost profits due to difficulties in accessing the insured premises due to the storm. Here too, damage to the insured's property is not required to trigger coverage—though typically, the losses must result from property damage of a type covered by the insurance policy.

Extra expense coverage applies to additional costs incurred by the policyholder as a result of damage to its property, and to costs incurred to mitigate economic losses.

Too many businesses do not think about insurance unless their premises are damaged or, if they do, they fail to calculate the full range of loss. Some may not even be aware of their civil authority, ingress/egress, and business interruption coverage, let alone contingent business interruption coverage for those far from the damage site.

Many commercial property insurance policies provide different sublimits for losses caused by "flood," "storm surge," and "named storms." How the policy defines these key terms can be critical in determining the amount recoverable for the policyholder's loss. For most businesses in the Houston area, Harvey wrought its worst under the aegis of "tropical storm" rather than "hurricane,"—and that could affect coverage terms in some policies. Check your policy's definition of "flood," "storm surge," and "named storm," and hold your insurance company to the terms of the contract.

In the aftermath of a major storm, damage caused by wind or wind-driven rain and damage caused by storm surge—flood—can be difficult or impossible to distinguish. For policyholders lacking flood coverage, insurance companies often invoke "anticoncurrent causation clauses" to deny any coverage at all if flooding occurred. Many state courts, however, have held that if the "efficient proximate cause" of damage is covered—that is, the dominant cause—then the claim is covered. While most damage in the Houston area was flood-induced, several billions of dollars worth of damage incurred in the storm's early hurricane phase may be attributable to other causes. Denials based on anticoncurrent causation provisions should in many cases be contested. They should in any case be carefully scrutinized and analyzed in light of case law in the state in question.