Thursday, May 11, 2017

No. 217: Penn Mutual's Policy Dividends and the Proposed Settlement of a Class Action Lawsuit

On November 1, 2012, Pennsylvania residents Daniel and Edith Harshbarger filed a class action lawsuit in federal court against Penn Mutual Life Insurance Company, which is domiciled in Pennsylvania. The plaintiffs allege that the company violated a Pennsylvania law by paying insufficient dividends to owners of participating life insurance policies. The case involves not only the court but also the Pennsylvania Insurance Department.

On July 19, 2013, the case was reassigned (initially it was assigned to another judge) to U.S. District Judge Nitza I. QuiƱones Alejandro. President Obama nominated her in November 2012, and the Senate confirmed her in June 2013. (See Harshbarger v. Penn Mutual, U.S. District Court, Eastern District of Pennsylvania, Case No. 2:12-cv-6172.)

The Parties
The plaintiffs own Penn Mutual participating whole life policies. Daniel owns three policies issued in 1973, 1974, and 1977. Edith owns two policies issued in 1993. The defendant is Penn Mutual.

The Allegation
Section 614 of the Pennsylvania statutes allows a Pennsylvania-domiciled mutual life insurance company to hold a "safety fund" not to exceed 10 percent of the company's reserve liabilities, and requires the company to distribute to its participating policyholders amounts in excess of the safety fund. The plaintiffs allege that the company held funds in excess of the allowable amounts in many recent years.

The complaint shows safety fund amounts each year as a percentage of the reserves. It also shows excess amounts each year as a percentage of the reserves. For example, the safety fund at the end of 2011 was 25.7 percent of the reserves, so the excess was 15.7 percent (25.7 percent minus 10 percent) of the reserves. The safety fund law gives the Pennsylvania insurance commissioner the authority to allow a company to hold a safety fund larger than 10 percent "for cause shown," but Penn Mutual never sought or obtained such permission.

Subsequent Developments
On December 28, 2012, Penn Mutual filed a motion to dismiss the complaint. On April 11, 2014, after extensive briefing, Judge Alejandro granted the motion to dismiss. She said the court will abstain from exercising its jurisdiction in deference to the Pennsylvania Insurance Department. She placed the case in "civil suspense" pending resolution of the plaintiffs' claims before the Department.

On February 20, 2015, the plaintiffs filed an administrative complaint with the Pennsylvania Department. Thereafter the parties engaged in extensive briefing and discovery. The officer presiding over the administrative proceeding before the Department scheduled a hearing for October 26, 2016. However, the hearing was not held because the parties were engaged in efforts to settle the court case.

The Proposed Settlement
On April 15, 2017, with the help of a mediator, the parties reached a proposed settlement. The same day, the plaintiffs filed an unopposed motion for preliminary approval of the proposed settlement, and one of the plaintiffs' attorneys filed an unopposed declaration in support of the motion.

The policies affected are all Penn Mutual participating policies that were in effect at any time from the beginning of 2006 to the end of 2015. The policy types are whole life, term, indexed universal life, universal life, variable universal life (fixed), and variable universal life (variable). Almost 300,000 policyholders are affected.

The financial component of the settlement requires Penn Mutual to pay one-time "terminal dividends" to owners of affected policies. Specifically, the company will pay $97,073,303 to the owners of in-force policies, $13 million to the owners or beneficiaries of terminated policies, $10 million of fees to the attorneys for the class, $700,000 of expenses incurred by the attorneys for the class, and a service award of $3,750 to each of the two named representatives of the class. The total of those figures is $120,780,803.

Penn Mutual is allowed to defer payments to the policyholders should the payments cause the company's risk-based capital (RBC) ratio to fall below 250 percent, where the denominator of the ratio is company action level RBC. See No. 122 (posted October 22, 2015) for a detailed discussion of RBC ratios.

Although surplus notes are debt instruments, state surplus note laws and statutory accounting principles allow companies to include surplus notes in surplus rather than in liabilities. However, in the proposed settlement, Penn Mutual is allowed to exclude its surplus notes from the excess funds in the calculation of amounts to be paid to the policyholders. See No. 183 (posted October 19, 2016) for a detailed discussion of surplus notes.

Completion of the settlement requires a hearing on the parties' motion for preliminary approval of the proposed settlement, the mailing of notices of the proposed settlement to the class members, and a hearing on final approval of the proposed settlement. Judge Alejandro has not yet established a timetable for the approval process.

General Observations
I am not able to express an opinion about the fairness of the proposed settlement because I do not know how Penn Mutual calculates its dividends. As I have written over the years, the precise manner in which companies calculate dividends on participating life insurance policies is invariably a closely guarded secret. The companies justify the secrecy by insisting that the details are proprietary information that would place them at a competitive disadvantage if the details were disclosed. I have always argued that the details should be in the public domain, but my argument has never gained traction.

The Harshbarger case involves an old surplus limitation law. New York was the first state to enact such a law. It was among the reforms enacted in New York in 1906 after the Hughes-Armstrong investigation of 1905. A few other states, such as Pennsylvania, enacted similar laws. The current law in New York is Section 4219(a)(1). In general terms, that section allows a domestic mutual life insurance company to maintain a surplus not exceeding the largest of four figures: (1) $850,000, (2) 10 percent of the reserve liabilities, (3) 10 percent of the reserve liabilities plus (a) 150 percent of the company action level risk-based capital minus (b) the asset valuation reserve, and (4) the minimum capital and surplus required by any state where the company is licensed.

Available Material
I am offering a complimentary 64-page PDF consisting of a table of contents (1 page), the complaint (15 pages), the introduction to the stipulation of settlement (5 pages), the proposed notice to be sent to class members describing the proposed settlement (13 pages), the proposed consent order to be issued by the Pennsylvania Insurance Department (17 pages), and the unopposed declaration by one of the plaintiffs' attorneys supporting the motion for preliminary approval of the proposed settlement (13 pages). Email and ask for the May 2017 package relating to the Harshbarger/Penn Mutual dividends case.