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.