Monday, February 6, 2017

No. 202: Nationwide's Cost-of-Insurance Increases and a Lawsuit with an Extra Dimension

On July 8, 2016, two plaintiffs filed a lawsuit against Nationwide Life Insurance Company about cost-of-insurance (COI) increases on two variable universal life insurance policies. The lawsuit has an extra dimension, described below, which transforms the case into a strange one. (See Palumbo v. Nationwide, U.S. District Court, District of Connecticut, Case No. 3:16-cv-1143.)

The case was assigned to Senior U.S. District Judge Warren W. Eginton. President Carter nominated him in June 1979, the Senate confirmed him the following month, and he assumed senior status in August 1992.

Developments in the Lawsuit
On August 31, 2016, Nationwide filed a motion to dismiss the first seven of the ten claims in the complaint. On December 15, for a reason explained later, the plaintiffs filed an amended complaint. On December 29, Judge Eginton filed a stipulation and order regarding Nationwide's responses to the amended complaint. On January 9, 2017, after briefing by both sides, the judge denied Nationwide's motion to dismiss the first seven claims in the complaint. On January 23, Nationwide filed an answer to the amended complaint.

The Parties in the Original Complaint
One plaintiff is Laura L. Palumbo (Laura), a Connecticut resident. She is the trustee of an irrevocable insurance trust created in 1994. The other plaintiff is William J. Palumbo (William). He is the grantor of the trust and the insured in the two policies the trust owns. He was a Connecticut resident when the policies were issued, and is now a Florida resident. Laura is William's daughter. The sole defendant in the original complaint is Nationwide Life. As explained later, there is a nominal additional defendant in the amended complaint.

The Policies
Both policies are variable universal life, and each has a $500,000 death benefit. One was issued in November 1994, and the other in November 1996. Both were issued by Provident Mutual Life Insurance Company, which demutualized in 2002 under the sponsorship of Nationwide Corporation and became part of the Nationwide organization. The policies are now Nationwide Life policies.

The plaintiffs did not attach copies of the policies as exhibits to the complaint. However, Nationwide attached copies of the policies as exhibits to its motion to dismiss the first seven claims in the complaint. Nationwide did not include copies of the applications for the policies.

William was 57 when Provident issued the first policy in November 1994, so he was 79 in November 2016. In the first policy, the initial planned annual premium was $9,800.

A policy's "net amount at risk" is the death benefit minus the account value. In the first policy, the guaranteed (maximum allowable) monthly COI rates per $1,000 of the net amount at risk rose from 79 cents at age 57 to $7.14 at age 79. The mortality charge for a month is the monthly COI rate multiplied by the net amount at risk in thousands. The increasing guaranteed COI rates result from the insured's increasing age. I was not able to deduce the actual COI rates used by the company in calculating the monthly mortality charges imposed on the policyholder.

The plaintiffs said they obtained updated illustrations in September 2014 and were shocked to learn that the account values of the policies had declined sharply. They said they were also shocked to learn that in the first policy, for example, the new planned annual premium—about $29,000 compared to the $9,800 initial planned annual premium—made the policies unaffordable. The plaintiffs said that, when Laura wrote to Nationwide asking how the monthly mortality charges were calculated, the company's compliance office said it was "unable to get that question answered."

The Extra Dimension
Laura has long been a registered representative authorized to sell securities such as variable life, and she was involved in the sale of the policies to the trust. In its motion to dismiss the first seven claims, Nationwide put it this way: "In other words, Ms. Palumbo sold the Policies to herself in her capacity as Trustee of the Palumbo Trust."

On April 3, 2015, Laura wrote to Nationwide alleging that the company had made misrepresentations and omissions relating to the COI charges. She made clear in the letter that it was a complaint against Nationwide, rather than a complaint against herself because of her involvement in the sale of the policies.

On May 18, 2015, Nationwide Securities, LLC filed a U5 with the Financial Industry Regulatory Authority, Inc. (FINRA) stating that a written complaint had been made against Laura by the Palumbo Trust alleging misrepresentations and omissions in the sale of a variable life insurance policy. The U5 is the uniform termination notice that is used in securities industry registration.

On May 22, 2015, Nationwide wrote to Laura informing her of the U5. She contacted FINRA disputing the U5. FINRA said it would provide Nationwide with "some guidance." In January 2017, I looked at the BrokerCheck report about Laura (CRD #1262003) on FINRA's website. I found no mention of the U5 or any other "disclosure event."

The Allegations
The plaintiffs allege that Nationwide made misrepresentations and omissions of material facts to the plaintiffs regarding the COI charges in the two policies. The first seven of the ten claims in the complaint are fraud, violation of the Connecticut Unfair Trade Practices Act, violation of the Connecticut Unfair Insurance Practices Act, breach of contract, breach of the implied covenant of good faith and fair dealing, a request for declaratory relief, and unjust enrichment.

The Amended Complaint
On December 1, 2016, Judge Eginton ordered the plaintiffs to file an amended complaint adding FINRA as a nominal defendant. On December 15, the plaintiffs filed the amended complaint. It is the same as the original complaint except for the addition of FINRA as a nominal defendant.

The final three of the ten claims in both complaints are for defamation, intentional infliction of emotional distress, and injunctive relief. They relate only to Laura. They grew out of the U5 filing, which is discussed in the "extra dimension" section above.

In the amended complaint, the plaintiffs make clear that FINRA is not accused of wrongdoing and is added as a nominal defendant only to facilitate relief with respect to the final three claims, which are asserted by Laura individually. She requests that "a false, defamatory, and malicious" U5 filed against her by Nationwide Securities be expunged. Because there is no mention of the U5 or any other "disclosure event" in the current FINRA report on Laura, it appears that the U5 has been expunged.

In its motion to dismiss the first seven claims, Nationwide says the parties are discussing the possibility of an amicable resolution of the final three claims, that those claims pertain only to Laura, and that Nationwide reserves the right to compel arbitration with respect to those three claims. I do not know what if anything Laura's contract with Nationwide says about arbitration.

General Observations
Usually the focus in a COI case is on the question of whether the actual mortality charges imposed upon the policyholder are implemented in a manner consistent with the precise language of the policy. In this case, I have not yet been able to deduce the answer to that question.

In its motion to dismiss the first seven claims, Nationwide attached not only the policies but also some, but not all, of the quarterly statements sent to Laura in her capacity as trustee of the trust. The statements show beginning account values and ending account values. If the plaintiffs had reviewed the statements, it should have come as no surprise that the account values had declined significantly.

An important question is whether Nationwide should have routinely provided each year, without a request from Laura, updated illustrations showing the future planned annual premiums needed to prevent substantial erosion of the account values. A company may say it has no contractual or other legal obligation to provide updated illustrations. However, I think a company should provide updated illustrations at least once a year in order to reduce the likelihood of policyholder disappointment.

As indicated at the outset, the "extra dimension" made this a strange case and was a factor in my decision to report on it. I had never heard of a case in which a U5 was filed against the very person who submitted a complaint to the company.

I think the parties will resolve amicably the final three claims in the original complaint and the amended complaint relating to the U5. Further, although the complaints survived the motion to dismiss, I think the parties will settle the first seven claims quietly. I say "quietly" because this is not a class action lawsuit (at least not yet) and any settlement agreement probably will be cloaked in confidentiality.

Available Material
I am offering a complimentary 10-page PDF consisting of Judge Eginton's December 29 stipulation and order (4 pages), and his January 9 decision on Nationwide's motion to dismiss the first seven claims (6 pages). Email and ask for the February 2017 package relating to the Palumbo/Nationwide case.