Thursday, June 15, 2017

No. 222: The Surplus Limitation Law in Massachusetts and a Quiet Amendment

In No. 218 (posted May 18, 2017), I wrote about the March 2017 settlement of a July 2012 class action lawsuit against Massachusetts Mutual Life Insurance Company alleging underpayment of dividends on participating life insurance policies. The complaint alleged violations of an old Massachusetts surplus limitation law. One hour after No. 218 was posted, an alert reader informed me that the old law was amended effective August 10, 2016, four years after the plaintiff filed her complaint. In this follow-up, I discuss the amendment and other matters.

The Massachusetts Surplus Limitation Law
The surplus limitation law is Section 141 of Chapter 175 of the Massachusetts statutes. When the lawsuit was filed, the law allowed a mutual life insurance company domiciled in Massachusetts to hold a "safety fund" not to exceed 12 percent of reserve liabilities. The law also required the company to distribute to its participating policyholders, in the form of dividends, amounts in excess of the safety fund.

The amendment increased the allowable safety fund from 12 percent to 20 percent of reserve liabilities. The amendment was a small section of Massachusetts House Bill No. 4569. That was a huge bill relating to "job creation, workforce development and infrastructure investment." The bill consisted of 140 sections and 123 pages. The amendment was Section 113, which was buried on page 108 of the bill. Here is the full text of the amended version of the surplus limitation law incorporating the increase in the allowable safety fund:
Any domestic life company may from its surplus funds or profits attributable to its participating business accumulate and hold, or hold if already accumulated, as a safety fund, an amount not in excess of 20 percent of its reserve for such business or one hundred thousand dollars, whichever is greater, and, in addition thereto, any surplus that may have been contributed by the holders of the guaranty stock of the company, or which has been accumulated for the retirement of said guaranty stock and the margin of the market value of its securities over their book value, provided that in cases where the existing surplus or safety fund, exclusive of accumulations held on account of existing deferred dividend policies, exceeds the limit above designated, the company shall be entitled to retain said surplus or safety fund, but shall not be entitled to add thereto so long as it exceeds said limit, and provided that for cause shown, the commissioner may at any time and from time to time permit any company to accumulate and maintain a safety fund in excess of the limit above mentioned, for such period as the commissioner may prescribe in any one permission, by filing in his office his reasons therefor and causing the same to be published in his next annual report. This safety fund shall be in addition to any safety fund accumulated from a mutual domestic life company's surplus funds attributable to its nonparticipating business, which funds may be appointed [apportioned?] equitably, in the discretion of the company, as part of any annual dividend on participating business. This section shall not apply to any company issuing only nonparticipating policies.
I asked Massachusetts Mutual for a statement about the amendment. A company spokesman provided this statement:
The amendment of the statute allows our company and other Massachusetts mutual life insurers the option of maintaining additional capital, so that in times of economic difficulty, policyholders can be confident that claims will be paid and their loved ones will be protected.
The Pennsylvania Surplus Limitation Law
In No. 217 (posted May 11, 2017), I wrote about a similar class action lawsuit against Penn Mutual Life Insurance Company alleging violations of a similar Pennsylvania law. The law is in Section 614 of the Pennsylvania statutes. That section allows a mutual life insurance company domiciled in Pennsylvania to hold a "safety fund" not to exceed 10 percent of reserve liabilities, and requires the company to distribute to its participating policyholders amounts in excess of the safety fund.

The New York Surplus Limitation Law
As I said in No. 217, New York was the first state to enact a surplus limitation law. It was among the reforms enacted in New York in 1906 after the famous Hughes-Armstrong investigation of 1905. Among the parallel reforms, enacted in New York at the same time to prevent mutual life insurance companies from accumulating excessive amounts of surplus, was a law requiring the annual distribution of surplus.

A few other states, such as Massachusetts and Pennsylvania, enacted surplus limitation laws shortly after New York did so. I believe that Wisconsin also enacted such a law, which fell by the wayside during the 1979 recodification of Wisconsin's insurance laws led by Spencer Kimball.

The current surplus limitation law in New York is Section 4219(a)(1). 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 reserve liabilities, (3) 10 percent of reserve liabilities plus (a) 300 percent of authorized control level risk-based capital [which is equivalent to 150 percent of company action level risk-based capital] minus (b) asset valuation reserve, and (4) minimum capital and surplus required by any state where the company is licensed.

Background in New York
Because of the importance of New York's surplus limitation law, some background seems appropriate. The New York legislature created a committee in 1905 "to investigate and examine into the affairs of life insurance companies doing business in the State of New York." The committee was chaired by New York State Senator William W. Armstrong. The other members of the committee were two other state senators and five members of the state assembly.

One of the causes of the investigation was the widespread sale of "deferred-dividend" policies, also called "semi-tontine" policies. The policies allowed the companies to accumulate large amounts of surplus and squander large amounts of money.

Charles Evans Hughes was appointed counsel to the committee. He so dominated the work of the committee that the investigation, normally called the Armstrong investigation, is often called the Hughes-Armstrong investigation. Public hearings began on September 6, 1905, consisted of 57 sessions, and ended on December 30, 1905. I devoted almost the entire 12-page January 2011 issue of The Insurance Forum to a discussion of the investigation.

The investigation led to an illustrious career for Hughes. Shortly after the investigation he was elected Governor of New York. Later he served for six years as an Associate Justice of the U.S. Supreme Court. In 1916 he was the Republican Party's unsuccessful candidate for President of the United States. He served for four years as U.S. Secretary of State, for two years as a judge on the Court of International Justice, and finally for 11 years as Chief Justice of the United States.

Buist M. Anderson, a prominent insurance statesman and author, was for many years general counsel of Connecticut General Life Insurance Company. He wrote an excellent 40-page paper entitled "The Armstrong Investigation in Retrospect," which was published in the 1952 Proceedings of the Association of Life Insurance Counsel. A three-paragraph section of the paper discussed New York's surplus limitation law. Here, without footnotes, is that section:
Mr. Hughes was bothered by the huge surplus funds which had been made possible by the deferred dividend system without annual accounting and he recommended that mutual companies should be limited as to their surplus funds. The limitation recommended was graduated from the larger of 20 per cent of "net values" or $10,000 in the case of small companies down to 2 per cent of "net values" in the case of companies with such values in excess of $500,000,000. The Legislature did not accept the lower limit as recommended but permitted a surplus graded down only to 5 per cent.
Mr. Hughes was obviously not sufficiently conservative in recommending the rather severe limit on surplus funds. He could not, of course, foresee the Panic of 1907, which depressed bond values at the year-end to a point where it was necessary for the Insurance Commissioners to permit the valuation of bonds on an average basis as of the year-end and as of the first of each of the months of 1907, a plan commonly known as the "Louisville Resolution" or the "Rule of Thirteen." Had this concession in valuation not been made, some important companies would have had their surpluses entirely wiped out as of the 1907 year-end. Amortization of bonds which serves to stabilize bond values was first permitted with the passage of enabling legislation in New York in 1909.
Surplus funds for life insurance companies were not regarded as nearly so important in 1906 as later. The surplus limitation in New York for the larger companies was raised from the 5 per cent imposed by the 1906 law to 7½ per cent in 1916 and to 10 per cent in 1920; and the limit was made the larger of 10 per cent of reserves and liabilities or $500,000 as of January 1, 1940, and as the larger of 10 percent or $750,000 as of April 16, 1949.
General Observations
I am not aware of any debate, hearings, or publicity about the recent amendment to the Massachusetts surplus limitation law. Nor do I know who arranged for the amendment. The amendment probably was the result of a quiet lobbying effort by Massachusetts Mutual or by a company trade association of which Massachusetts Mutual is a member.

I believe that the primary objective of the amendment was to reduce the likelihood of future litigation. I say that because of data in the lawsuit filed in July 2012 against Massachusetts Mutual. The plaintiff's estimates of the safety fund ranged from 12.02 percent to 15.87 percent of reserve liabilities from 1999 through 2010. Thus increasing the safety fund limit to 20 percent made future litigation unlikely.

Available Material
I am offering a complimentary PDF of the 12-page January 2011 issue of The Insurance Forum. Email and ask for the January 2011 issue of the Forum.